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Cashing In On Corporate Restructuring



10 October 2007 @ 04:11 pm EST

Companies use mergers, acquisitions and spinoffs to increase their profits. Strategic mergers and acquisitions can help a company become more competitive in its field and improve its bottom line, while spinoffs are a way to get rid of underperforming or non-core business divisions that can drag down profits. While mergers, acquisitions and spinoffs can be great moves for companies, they can be even better for the enterprising investor willing to do a little research! If you do your homework, you can find profitable opportunities in these corporate actions - we'll take you through this process step by step.

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Spinoffs

Why are spinoffs such a great investment opportunity? Typically, underperforming business divisions are loaded with debt. When they are cut off from the parent company, that company can become more valuable as a result.

The Process

Here's how a typical spinoff situation works:

  • The company decides to spin off a business division.

  • The parent company files the necessary paperwork with the Securities and Exchange Commission (SEC).

  • The spinoff becomes a company of its own and must also file paperwork with the SEC.

  • Shares in the new company are distributed to parent company shareholders.

  • The spinoff company goes public .

    • Notice that the spinoff shares are distributed to parent company shareholders. There are two reasons why this creates value:

  • Parent company shareholders rarely want anything to do with the new spinoff. After all, it's an underperforming division that was cut off to improve the bottom line. As a result, many new shareholders sell immediately after the new company goes public.

  • Large institutions are often forbidden to hold shares in spinoffs due to the smaller market capitalization , increased risk, or poor financials of the new company. Therefore, many large institutions automatically sell their shares immediately after the new company goes public.
    • Simple supply and demand logic will tell you that such a large number of shares on the market will naturally decrease the price, even if it is not fundamentally justified. It is this temporary mispricing that gives the enterprising investor an opportunity for profit.

    This article has been reprinted with the authorization of Investopedia.com

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