When Parent Companies Become Bargains: The Value in Spinning Off

I’ve always found it fascinating how corporate restructuring can unlock value in unexpected ways. One of the most interesting aspects of this is how parent companies often become bargains after they spin off a division. Many investors focus on the new entity that gets spun off, but the real opportunity sometimes lies in the parent company itself. Today, I want to share my experience in spotting these opportunities and explain why spinning off a part of a business can create significant value for the parent.

Why Parent Companies Become Undervalued

When a spinoff occurs, there’s often a lot of attention on the newly formed company. Investors and analysts are eager to understand how the spinoff will perform on its own. Meanwhile, the parent company—now a more streamlined and focused business—often gets overlooked. This lack of attention can create a temporary mispricing, which, for those of us paying attention, can be a real opportunity.

A lot of the time, parent companies become undervalued because of indiscriminate selling. Shareholders of the parent company receive shares of the spun-off entity, and if they don’t want to hold the spun-off company, they might sell both the new shares and even some of their original holdings. This can create downward pressure on the price of the parent company’s stock, even when the fundamentals are strong.

Real-World Example: United Technologies and Carrier

One of the best examples I’ve seen of this is the United Technologies (UTC) spinoff of Carrier Global in 2020. When UTC merged with Raytheon, it decided to spin off two major divisions: Carrier, which specializes in HVAC systems, and Otis, the elevator business. Suddenly, United Technologies was transforming into a pure aerospace and defense company under the Raytheon Technologies name. During this time, many investors sold their shares of the parent company and the spun-off entities, causing a dip in the stock prices.

But what was really happening here? By spinning off Carrier and Otis, UTC was essentially unlocking the value hidden within these distinct businesses. The newly formed Raytheon Technologies was now a more focused aerospace and defense company, which allowed it to better allocate resources and pursue growth opportunities in that space. Investors who understood this dynamic and bought Raytheon Technologies after the spinoff saw the stock perform well as the market recognized the efficiency and growth potential of the new streamlined entity.

The Power of Focus

What I love about spinoffs is how they give companies the ability to focus. This focus is not just for the spun-off company but also for the parent. By letting go of a business that might not align with their strategic vision, parent companies can better concentrate on their core operations. This leads to more efficient use of capital, better management attention, and, often, improved financial performance.

Take the example of Siemens AG, which spun off Siemens Energy in 2020. Siemens AG decided to separate its energy business, allowing it to focus more on industrial automation, digitalization, and healthcare technology. Initially, the market didn’t fully appreciate this shift, and Siemens AG shares traded sideways. But as time went on, it became clear that Siemens was benefiting immensely from the streamlined focus. The company’s profitability improved, and its stock price followed suit, rewarding those who recognized the value in the parent’s transformation.

Key Metrics to Watch

Whenever I evaluate a parent company undergoing a spinoff, there are a few key metrics I like to look at. One of the most important is return on invested capital (ROIC). After a spinoff, parent companies often see an increase in ROIC because they are able to allocate resources more efficiently to their core business. This was certainly the case with Raytheon Technologies, where ROIC improved significantly post-spinoff as the company focused exclusively on aerospace and defense.

Another metric to watch is debt reduction. Often, the spinoff takes a portion of the parent company’s debt with it, leaving the parent with a stronger balance sheet. This can make the parent company more attractive to investors, especially those focused on financial health and stability. For instance, when Pfizer spun off its generics and off-patent drug business to create Viatris in 2020, it allowed Pfizer to focus on innovative medicines while reducing the overall debt burden, making Pfizer a leaner, more growth-oriented company.

Practical Takeaways for Investors

1. Look Beyond the Spinoff: While spun-off companies can be exciting and attract a lot of attention, don’t forget to look at the parent company. The parent often becomes a more focused, efficient business that the market underappreciates initially.

2. Watch for Mispricing: The market can be irrational in the short term. Indiscriminate selling of the parent company’s stock can create a buying opportunity if the fundamentals remain strong.

3. Focus on Key Metrics: Look for improvements in return on invested capital (ROIC) and debt levels. These are often strong indicators that the parent company will perform well post-spinoff.

   
   

Conclusion

Spinoffs are fascinating because they create opportunities in places most investors aren’t looking. While spun-off companies often grab headlines, the real bargain can sometimes be the parent company, which is now leaner, more focused, and better positioned for growth. By paying attention to these dynamics and recognizing the value in restructuring, you can uncover opportunities that others might miss. From my experience, it’s in these overlooked corners of the market where some of the best investment returns are found.