A spin-off stock is a stock that has been spun out of another company to create a stand alone company. Another way to think of a spin-off stock is that before the transaction, the company is a division of a larger corporation. After the spin-off, the division is now a stand alone company that no longer has a relationship with.
Parent Company – The parent company is the term used to refer to the company who is divesting the division to existing shareholders. Typically, but not always, the parent company is a lot larger than the new company. Usually the parent company will retain the same name of the original company before it is broken up.
Spin-Off Company – The spin-off company is the division or product line of the parent company that is being “spun off” into a new and separate company. Typically it is a smaller division of the parent company. Often times the spin-off company is a division or product line that is not really related to the core business.
Why Companies Use the Spin-Off Process
The conglomerate cycle is kind of like the business cycle, what comes around goes around. A company grows, is successful, and after awhile it kind of hits its peak as far as how much more market share it can gain and how much more it can grow.
As the company no longer has to invest in its growth, the cash starts to pile up on the balance sheet and the company starts to look at what to do with their cash. The typical answer is to go buy another company so they can continue to expand their empire. Sometimes these acquisitions work and sometimes they don’t.
Many times a successful company will feel good about their business skills and decide to purchase a company outside their sphere of knowledge thinking that they will be diversifying their company. After a few years and several acquisitions, the company comes across some hard times.
Suddenly the company is no longer a growing company, rather they are an amalgamation of a bunch of different unrelated companies. This is usually the area where a company is ripe to spin-off some of these old acquisitions and go back to focusing on their core business.
How the Spin-off Works
When the parent company decides to spin-off the division or product line, it does so to its existing shareholders. The existing shareholders who own the company in its current structure will, after the spin-off, own the two companies in the new structure which is two separate companies.
How the spin-off works is the company will set a ratio of current ownership to the amount of shares they will receive in the new company. For example they will say that you will receive 10 shares for every 100 share you currently own. So this will be a 10:1 ratio that you can apply to the exact number of shares that are owned.
On the separation date when the company completes the transaction, you will still have 100 shares in the parent company but will also have 10 shares in the new company.
Typically the share price of the parent company will drop because it doesn’t consist of as big of a company as it was before and the new shares you own will make up for the difference.
Hopefully you better understand how a spin-off transaction works if it happens to a company you own.