The revenues and earnings of S&P 500 companies are being hammered in a way that is unprecedented since the financial meltdown. This has led many corporate managements to deal with this broad-based financial downturn by engaging in a massive amount of stock buy-backs intended to improve the optics of earnings per share and by spinning off promising divisions and subsidiaries.
Share buybacks by U.S. public companies during 2015 are running at a rate that will exceed $600 billion for the first time. Apple, IBM, Microsoft, Wells Fargo, Pfizer, Walmart, and other titans have decided that it is preferable to juice earnings per share – the consequential effect of buying a company’s own stock – than to invest in their core businesses. So frantic is the pace of buy-backs that more than 50% of earnings are being plowed into share buy-backs.
Corporate spinoffs, too, are at an all-time high with the exception of the frenzy that was the dot com years of 1999 and 2000. In 2014 there were sixty spinoffs amounting to close to $2.0 trillion in value. The motivation behind the trend to carve up legacy companies are varied but the motivation makes common cause with stock buy-backs: corporate performance among large companies has stalled.
Spinoffs have rewarded investors over the long haul. Indeed, since the end of 2002, Bloomberg has maintained a U.S. Spin-Off Index, which tracks the share prices of newly spun-off companies with market capitalizations of more than $1 billion for three years after they have begun trading. Since its onset, Bloomberg’s U.S. Spin-Off Index has risen 557%, compared to a return of 137% for the S&P. For investors who might shy away from holding the stock of a newly spun off unit, the Guggenheim Spin-Off exchange-traded fund [ETF], allows an investor to invest in a basket of spinoff stocks after they have been listed for at least six months.
Activist investors are often the catalyst forcing legacy companies to spin out units with potential. Legacy companies with disparate individual businesses, especially, draw most of the attention of these anxious investors.
BETTER VALUE, BETTER SERVICE
The reality is that smaller, high-growth units are often mired in legacy enterprises which render the true value of the business opaque if not diminished in value. I, and a supporting cast of exceptional entrepreneurial executives, have been involved in the carve out and spin of several technology-based businesses from legacy companies that had many of the hallmarks of conglomerates. After the spin out, these units proved financially rewarding for stockholders generating multiple times the investment required to launch them. This should come as no surprise. The corporate management of a pure-play spinoff is by its very nature smaller and more streamlined. This engenders a laser-like focus and efficiency of motion that is not possible across a multifarious legacy company. No less important is that the management of the spun out unit becomes less distracted with parent company financial and political concerns further enhancing the agility of the executive team.
Customers as well as investors applaud a spin off. In my experience, smaller, entrepreneurial units are more often led by service-savvy leaders than are large legacy enterprises. Individuals with strong service leadership skills are generally attracted to the young and growing firm where attitudes, habits, values, and beliefs on service have not been hardened into sclerosis by the legacy company’s bureaucracy.
Executives who believe they are in business to serve customers ensure that a company’s strategy and plans are framed around customers not markets, products, or technologies.