Stock Market Spinoffs; Quotes for Your Soul; and College App Season
On Tuesday, XPO Logistics (an asset-heavy business focused on LTL shipping), spun off one of its subsidiaries RXO (an asset-light freight broker).
Given that the NYSE is only a 20-minute walk from my school, I convinced a friend to sprint to the exchange with me, so we could be there by the closing bell.
As the company’s C suite and SVPs exited the building, dressed in blue shirts and red ties (company colors), I approached them, shook their hand, asked them a few questions, and got their emails.
This got me thinking, however. What are the factors that make a subsidiary ripe for a spinoff?
Drew Wilkerson (the newly appointed CEO of RXO) talks through their thought process in this video.
Essentially he says:
There is low operational overlap (the salesforce for RXO and XPO were already operating independently)
By splitting up large businesses, investors can invest in asset classes that are more niche and specific to the risk profile they want for their portfolio.
In this case, Investors who want to invest in the asset-heavy side of the business (i.e. the part where they own their trucks, trailers, warehouses, and other infrastructure) can invest in XPO without being exposed to the risk of the asset-light part of the business, RXO.
Meanwhile, investors who want to invest in asset-light part of the business can now invest in RXO, without being exposed to the risk associated with the assets in XPO.
These factors made RXO primed for a spinoff and ultimately, increasing shareholder value.
Following what Drew talked about, I decided to do some more digging and learn about the pros and cons of going through a spinoff.
Here’s what I found:
Factors Considered in Splitting Up Companies
Evolving into "pure play" businesses: Splitting up a company into two or more parts allows them to be more specific to their sector. This allows each distinct business the opportunity to be valued more efficiently in the market, and yield a premium valuation. When companies have a blurred focus (from acting across multiple sectors) that is generally valued at a discount (known as the conglomerate discount).
Note: We saw this thought process play out earlier this year when multinationals Kellogg and General Electric announced they are splitting up.
In June 2022, Kellogg announced it will be spinning off its cereal-based division and plant-based division (expected to be completed by the end of 2023)
In July 2022, General Electric became: GE HealthCare, GE Aerospace, and GE Vernova, splitting the company into individual healthcare, aerospace, and sustainable development companies.
Greater focus: Executives with fewer businesses to handle are less likely to spread themselves thin. A greater focus may translate into stronger financial results and greater profitability. As I like to say “Fortune favors the focused”.
More Efficient allocation of capital: Splitting up enables a more efficient allocation of capital when different businesses within a company have varying capital needs.
Strategic imperatives: A company may choose to divest its "crown jewels," a coveted division or asset base, to reduce its appeal to a buyer. Another reason for divestment may be to avoid antitrust issues.
Vulnerability: One drawback is that both the parent company and child subsidiary may be more vulnerable as takeover targets because of their smaller size.
The Effects of Spinoffs on Shareholder Value
Net Market Performance can go Either way
Several studies (dating back to the 80s) show how spinoffs gain a competitive edge in the market. “A Lehman Brothers study by Chip Dickson discovered that between 2000 and 2005, spin-offs beat the market an average 45% during their first two years, while parent companies beat it by an average 40% in the same two years.” (Investopedia). This is especially the case when Sr.management is incentivized by large stock grants as part of their compensation packages.
That said, these impressive figures aren't a certainty. A study by The Boyar Value Group in 2019 found that spin-offs underperformed the S&P 500 by an average of 2.7% a year, during the last decade-long bull market.
Increased Volatility
It’s also important to recognize the volatility that comes with spinoffs.
First, because the parent company is being split in two, both companies now have smaller market caps, making them more volatile.
Second, it’s important to recognize that typically a shareholder in the company pre-spinoff will be given shares in both the parent and the child company. This tends to result in the child company stock selling off in the time after restructuring since the child company may not be desired by previous shareholders.
Index funds will sell it off because it doesn’t meet the fund criteria. Retail investors may sell it off because they’re more interested in the parent company. Institutional investors may sell it off because it no longer meets the risk profile or asset class they are looking for (among other reasons). etc.
Spin-Offs vs Split-Offs vs Carve-Outs
Last, it’s worth making light of the difference between spin-offs, split-offs, and carveouts.
Summarized by Investopedia:
A spin-off distributes shares of the new subsidiary to existing shareholders.
A split-off offers shares in the new subsidiary to shareholders but they have to choose between the subsidiary and the parent company.
A carve-out is when a parent company sells shares in the new subsidiary through an initial public offering (IPO).
Each option has its pros and cons based on what the parent company is trying to accomplish. Check out the Investopedia article to go deeper into the differences.
Whoo I know that was a lot to take in. Take a breather. The next section is a little lighter.
On Life Philosophy
This week, we had to submit yearbook quotes as graduating seniors. I was looking at quotes and found some cool ones that I thought I’d list below:
“I only start counting when it starts hurting because they're the only ones that count. That's what makes you a champion." - Muhammed Ali
“Those who were seen dancing were thought to be insane by those who could not hear the music.” - Friedrich Nietzsche
“Love the life you live. Live the life you love.”—Bob Marley
“Just when the caterpillar thought the world was ending, he turned into a butterfly.” – Proverb
“I am ready to face any challenge that might be foolish enough to face me.” – Dwight Shrute, The Office
Other Updates
Wrapping up Early Applications to University. The next Deadline is Nov 15.
I can’t feel my arms or my fingers from how hard I’ve been rock climbing
I’ve been sending out cold outreach to the CEOs of Trade Finance Fintechs and Tech-Enabled Brokers. As I start to meet people, I’ll share takeaways + interesting insights.
What did you think of this newsletter?
I know I typically send this out on Friday. I’m experimenting with which days and times during the week seem to be optimal for people.
Reply to this email with your thoughts on structure, content, formatting, typos, or anything at all. I read and respond to all of them :)
See you next week 👋,
-Satvik