Introduction
In this article, we will discuss the difference between spin-offs of companies and the sale of subsidiaries or divisions. The answer will be important for your investment portfolio and can help you assess whether you are dealing with management that cares about shareholder interests.
Company Spin-Offs
Assume you own 5,000 shares in Acme Power & Light. For some reason, this utility company also owns a small chain of jewelry stores. The CEO of Power & Light speaks with the board and says, “This has nothing to do with our business. We cannot focus on generating electricity if we have to monitor inventory levels at the jewelry store. We can sell it or set up a spin-off for the shareholders, but I’m tired of dealing with the subsidiary. It has to go.”
If the utility company decides to sell the subsidiary, it could go to someone like Warren Buffett, who typically buys businesses for cash. The problem here is that the IRS will impose a capital gains tax on the sale of the business if it has appreciated in value. If the subsidiary has been part of the parent company for a long time, it has certainly appreciated in value during the holding period. Most companies are in the 21% tax bracket as of 2021, which means that management will only receive about 79% of the subsidiary’s value after taxes are deducted.
If the utility company decides to issue a spin-off for shareholders, it will establish the jewelry store as an independent company, appoint a new CEO and its own board of directors, and corporate offices, etc. It will print stock certificates and, in many cases, distribute them to existing shareholders of Power & Light on a pro-rata basis. If you own 5% of the utility company’s shares, you will receive 5% of the total shares of the new jewelry store.
In some cases, the company may conduct an initial public offering (IPO) of the subsidiary, selling a specific percentage to the public, such as 10% or 20% of the shares, and then separating the remaining shares for shareholders. When Philip Morris spun off Kraft Foods two decades ago, this was the method they chose.
Benefits of Company Spin-Offs
Why should you prefer spin-offs as a shareholder? Here are three reasons:
- There are usually no tax consequences because you did not receive anything new; you always owned 5% of the jewelry store chain, now it is just a separate company. The jewelry store chain will be able to focus on what is best for it. In the past, it may not have been able to convince the utility company’s CEO to allow it to borrow money and expand throughout the United States. Now, it should focus only on making the most of its capital structure. It can sell shares, issue bonds, borrow money from the bank, etc.
- The parent company is free from distractions and does not need to worry about business that does not align with its long-term strategic goals, which could even improve its own performance.
- Most of the time, spin-offs are actually win-win situations for all parties involved. There are numerous historical cases of small subsidiaries that were spun off and were able to grow rapidly to outperform the previous parent company, enriching the original shareholders.
In short, spin-offs provide opportunities for shareholders to benefit from emerging subsidiaries and achieve better financial returns, as well as enhance the performance of the parent company. However, each case should be evaluated individually to determine whether a spin-off is the best option for shareholders under specific circumstances.
In
In conclusion, investors need to understand the difference between spin-offs from companies and the sale of subsidiaries and how this affects their investments. Shareholders should also keep up with the company’s news and developments to get accurate and updated information regarding future management decisions and their impact on stock market value.
Source: https://www.thebalancemoney.com/spin-offs-vs-sale-of-subsidiaries-357857
Leave a Reply