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Saturday, June 1, 2024

Navigating Spinoff Investments With Limited Data For High Returns

I spoke about a recent spinoff investment on my X feed. ↗ (WPC) ↗ is a mid-cap company that has a diverse portfolio of high-quality, operationally vital commercial real estate, including 1,416 net lease assets totaling around 171 million square feet and 85 self-storage operating properties. It ranks among the largest net-lease REITs. (WPC) ↗ said in June that it would spin off (NLOP) ↗  as a publicly traded real estate investment trust. The portfolio would include 59 high-quality office buildings with a total of 9.2 million leasable square feet, most of which would be leased to corporations on a single-tenant net lease basis.

(WPC) ↗ said on October 6, 2023, that the spinoff would be done through a dividend of 1 (NLOP) ↗  share for every 15 (WPC) ↗  shares owned on November 1, 2023, which was the record date. 

There was very little information and certainly no brokers were pushing the stock. The market was getting scared and office property was a dirty word. Investors sold the spinoff as soon as it hit their portfolios. Following the spin, (NLOP) ↗  had a difficult start with its when-issued trading opening at $50 and falling by 65% with heavy trading volume, then another 16% decline on its first day of regular trading on November 2, hitting a low of $9.50. NLOP bounced and then ran into additional selling. This was the opportunity I had been waiting for. NLOP was currently trading at ~40% discount compared to its other office REIT peer (ONL) ↗ , and its market value is less than 20% of its book value. Having yet to declare their dividends as a REIT,. There was a little downside versus a substantial upside of north of $20. A few days later, post-spin on November 6th, I bought the company at $12.5 and then sold most of them a little over a month later at $20, realizing a 60% gain. My homework had paid off. The market provided the timing I needed. 

Spinoffs Defined 

A “company spinoff” is when a parent company splits up its shares to make a new, separate company. This is usually talked about in terms of investing. Usually, this distribution is done on a pro-rata basis, which means that owners in the parent company get shares in the spinoff business based on how many shares they already own. There are about 30–40 major spinoffs that go through a year. You may have received some random, odd-name shares in your portfolio this year that you’ve never recognized and probably just sold. They may have been some of your best investments forgone.  

In the eyes of investors, a spinoff is just a bigger company splitting in half, making two new companies with their own leadership, finances, and operations. Different things can lead to spinoffs, but some common ones are having to follow rules set by regulators, focusing management on certain business lines, or finding untapped potential.

Investors can be scared off by the opportunities and risks that come with spinoffs. On the one hand, spinoffs can free up capital by letting the new companies focus on their skills, attract different types of investors, or make their operations run more smoothly. It can be hard to judge spinoffs, though, because there isn’t always a lot of information about the new company’s past and future. When buyers want to figure out the pros and cons of investing in a spinoff, they must do in-depth analyses or subscribe to services such as The Edge.  ↗

The Challenge With Spinoffs 

It’s hard to analyze spinoff purchases because there isn’t a lot of detailed historical data available. By their very nature, spinoffs don’t happen very often, which makes it hard to collect a big, reliable dataset for a full analysis. Spinoffs don’t always have a long history of good financial performance, unlike established companies. This makes it hard to judge their past growth, revenue, and responses to the market. It’s also hard to do full quantitative analyses, like time-series or regression analysis, because there isn’t enough data. These analyses are key to understanding investment risks and returns. Traditional methods of valuation, like discounted cash flow analysis, are also harder to use when there isn’t enough previous data. This is because it’s harder to predict future cash flows when there aren’t any past trends to go on. Spinoffs can also lead to big changes in business models, management, and practical strategies that aren’t always clear or easy to measure right away. This confusion makes it harder to get a good idea of what they will do in the future. It can be hard to generalize or compare with other spinoffs or established firms because each case is different. This is because spinoffs often happen in unique situations. Additionally, factors like investor sentiment or market trends that have nothing to do with the value of the spinoff itself can influence the market’s initial reaction to them. This variation makes it harder to figure out how well spinoff investments will do and predict their success.

How to Approach The Investment

Remember, spinoffs are new companies. To analyze spinoffs with little data, you need a strategic method that focuses on qualitative analysis and insights that are specific to the sector. First, buyers should look at why the spinoff happened, including what the parent company was trying to do and how the spinoff fits in with larger trends in the industry. This can help you understand where the spinoff might fit in the market and how it might grow. Second, it’s important to look at the knowledge and track record of the management team since leadership is a key part of the success of a spinoff. Knowing the past and skills of key employees can help you figure out where the spinoff is going and how good its decision-making is. Third, buyers should check out both the parent company and the spinoff to see how healthy their finances are. To do this, available financial statements must be carefully looked over, with a focus on debt levels, income streams, and the possibility of making money. Even if you only have a small amount of data, comparing companies in the same field can be useful. Lastly, keeping an eye on how the market and investors feel about the spinoff can give you useful information about how important people think it is and what problems it might cause. This method, which combines qualitative evaluation and sector-specific research, can help us understand spinoffs better when we don’t have a lot of historical data.

Managing Risk With Limited Data 

I am a huge proponent of putting risk first. When you only have a small amount of data, you can lower your risks by carefully analyzing them, spreading them out, and using tactics that can change as needed. To begin, put more weight on qualitative analysis than numeric analysis. Look into the company’s business plan, the quality of its management, the way the industry works, and its competitors. Look at the parent company’s reasons for the spinoff and the spinoff’s business plan to get an idea of how successful it might be. Second, do your research very carefully. Even if data is limited, it should be carefully looked over in whatever is provided. If your finances aren’t doing well, look for warning signs like a lot of debt or slow cash flow. Learn about the rules and possible legal issues that come with the business and the specific spinoff. Third, spread your risk by investing in a variety of things. Since it’s hard to guess how one company will do with little information, a diversified portfolio can lessen the effect of a single investment’s poor performance. Finally, be flexible and keep an eye on the market all the time. It’s important to stay up-to-date on new data, rising trends, and market sentiment because they can give you useful information.

Set clear investment standards and ways to get out of the deal. Set benchmarks for success indicators that will cause the investment to be reevaluated or sold. This method makes sure that choices aren’t just made on the spot but are also based on known risk levels. When investors use all these tactics together, they can better deal with the risks and unknowns that come with limited data scenarios.

Why You Should Be Looking At Spinoffs 

Putting money into spinoffs is a unique plan for investors that has a lot of benefits. Spinoffs often start selling at lower prices than what they’re worth, which gives investors a chance to make money off of assets that aren’t worth as much. After being split off from their parent companies, these entities tend to run their businesses with more focus, which can lead to better financial success and more efficient operations. This focus is strengthened when management’s rewards are linked to the success of the spinoff. This usually leads to a stronger effort to increase shareholder value. Spinoffs can also bring to light hidden value in parts of bigger companies that weren’t getting enough attention or value before. As separate entities, they may have growth chances or competitive advantages that haven’t been used yet. The event of the split itself can lead to a revaluation, which can draw attention from the market and possibly cause the stock of the spinoff to go up in value. Spinoffs can also become appealing targets for mergers and acquisitions, which is another possible benefit for owners. Finally, adding spinoffs to an investment portfolio can help diversify it by sharing risk across different investment types and industries. But investing in spinoffs needs a lot of study and a full understanding of how each case’s risks and circumstances are different.

On the date of publication, Jim Osman ↗ had a position in: NLOP ↗ . All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here ↗.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Michael Maren
Michael Maren
Former marine biologist who likes to spend as much time in the tropics as possible, due to a horrible time I once had in Alaska. Brrrr.

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