The first topic in the book is Spin-offs. When a company decides to ‘spin-off’ a subsidiary or business, it may issue shares of the division being spun off to the existing shareholders. This spin-off may be 100% where in the parent company distributes its entire holding of the spun-off division to the exisiting shareholders based on the valuation of the division.

For ex: when reliance was split into the petrochemical, communication and other businesses, the shareholder were given shares in the spun off divisions based on the valuation of each business.

Spin-offs may partial where the parent wants the market to realize the value of the division and so by doing a partial spin off, the newly spun off company is now valued by the market independently. This enables the company to demonstrate the hidden value of its subsidiary and get a better valuation for the whole company.

In addition there are a few additional reason for spin-offs

a. The company wishes to spin-off a poorly performing division and improve the valuation of the parent company
b. In a regulated industry, by spinning off the regulated division, the parent can operate in a non regulated environment c. The company wishes to improve the valuation of the company by making the subsidiary an independent company with its own management and policies. This improves the valuation of the parent and the spun off company as both can now focus on their core businesses.

The reasons why spin-offs create an opportunity for the investor are listed below

a. The spun off division may be very small with a low market cap. As a result large instutional investors may not be interested in holding it due to various constraints. This creates a selling pressure and drives down the price.
b. The spun off division with its independent management can now focus on the business better and hence perform better in the future
c. The market may give a better valuation to the spunoff business depending on the nature of the industry in which it operates

update : 03/29

An additional approach to profit from spin offs is to look for situations where the company plans to conduct a rights issue instead of an outright spin-off of the subsidiary. In such cases the company is planning to ‘sell’ the division to its shareholders via a rights issue and raise some capital at the same time.

This modified and rare type of spinoff approach is profitable for the same reason as the usual spin off. In such cases large institutional investors may not subscribe to the offer due to illiquidity of the new issue. In addition if the spin off via rights is beneficial to the insiders , then it would make a lot of sense to subscribe to this spin off via rights purchased from the market or via direct purchase of the parent company’s stock.

An additional point repeated by the author several times in this section is that an investor should analyse closely the actions and motivations of the insiders during the spin off. Does the spin-off benefit the insiders ? do they have a stake on the upside ? Answers to these questions would help an investor make a good decision

I am currently re-reading the book by ‘Joel Greenblatt’. I will post my thoughts and key points which catch my eye. It is not a book summary or review. Look at it more as running notes on the book (based on memory).

– 8-9 stocks can help one diversify almost 80-90% of the non-market risk. With 20+ stocks the non-market risk reduces by almost 95 % (quoting from memory)
– don’t depend on broker recommendations. They are baised on buy side as they make commision if you buy stocks. Also as there are always more stocks to buy (for an investor) than to sell (one’s holding is limited in comparison to the total universe of available stocks), brokers are more interested in generating buy recommendations. Have seen the same in india. As a result I tend to look at sell recommendations more closely than buy recommendations.
– small cap and midcap is a fertile ground to find undervalued stocks as these stocks are neglected by brokers and also by large investors due to various size, legal and other types of restrictions.

I will keep posting more notes as I continue reading the book