Stock Spinoffs

GE, Johnson & Johnsonand Toshibajust announced planned spinoffs and IBMjust completed one. These are big and well-known companies so there must be something to this, and perhaps the beginning of a trend. Question: What does this mean to stockholders?

Basically, it means nothing. A spinoff is where a company distributes shares of a company it owns to its shareholders. At the end of the process the shareholders will then own shares in the two companies; the original company and the spun-off company. The share price of the original company would drop an amount similar to the share price of the spun-off company.

Sometimes fractions of shares are spun off, so instead of one new share for each share owned in the original company, you might get five shares of the company or one share for every five of the original company you owned. In either event, you would receive the value in the spun-off shares equivalent to the drop in value of the original company’s shares. This is just simple arithmetic. Sometimes more than one company is spun off, so shareholders would get shares in two or more new companies. One time I received spun-off shares in five companies for each original share I owned. The spinoff is done based on dollar value. Spinoffs are usually tax-free except to the extent cash is received for a fractional share, or if you are given a choice of cash or shares (not usual in a spinoff). If you get the cash in lieu of the fractional share, you can apply basis so the full amount would not be taxable; watch out for this.

However, and there is always a however, the market might value the transaction differently and some of the shares may take off and get much higher while other shares tank or drop in value. As a stockholder receiving these shares, standing still is usually a good strategy until you have a basis for forming your own opinion of the relative values.

When a company is spun off, your cost basis gets divided into the remaining companies. Formulas are usually provided about which fractions of your basis should be allocated to the new and remaining shares owned. Many brokerage firms that have your cost basis will allocate it for you and adjust your account. If you own shares that are not in a brokerage account, you will need to do this yourself. Comment: If you have many shares like this, consider donating them to charity. That way, you do not need the cost basis and will get a deduction for the full fair market value. You will also clean out your portfolio and even reduce the mail you get from those companies, and for those that pay dividends, will reduce handling those checks.

Companies spin off shares for many reasons. Usually, the spun-off company is not part of the core business, or is growing in a way that distracts attention or resources from the primary business, needs new and large amounts of debt, the business diverged from the original reason for its creation or acquisition, the company has become a diversified mini-conglomerate, and the board of directors believes the stock market doesn’t properly value the components properly as part of the whole company, and lots of times the pieces are simply worth much more than the whole. I can recall illustrations of all of these situations, and I am sure there are many more reasons that are not mentioned here.

Many spinoffs take quite a bit of time, up to two or three years. There are a lot of hurdles that need to be jumped over including splitting the company off, unwinding shared costs, services and facilities, clearing regulatory issues, resolving contract and debt issues, obtaining new health insurance and employee benefit plans, establishing proper valuations of assets, and everything necessary in liquidating a business and setting up a new company. Sometimes trading even starts before the spinoff is consummated, and the traders look to make pennies on millions of shares they might trade hourly. None of that early trading has any effect on the company or existing stockholders.

You can also find out a lot more by reading the news announcements of the spinoffs and the reasons provided. I wrote this blog to provide a summary of how this process works.