The stock market is full of various events and phenomena, and one cannot always keep an eye on all of them. There are those that must be tracked anyway; you must know how to behave and what to do in certain circumstances.

One such event is called “spin-off”. This article is devoted to it, its influence on the shares of the company and on investors.

What is a spin-off?

Spin-off means that the company splits up, or a branch of its business separates in a separate structure. In other words, the main (parent) company opens a subsidiary and hands over a part of its assets and liabilities, opening a separate legal entity. The parent company, simultaneously, preserves it legal entity.

This event must not be mixed up with opening a new company at the expense of founders and investors.

An example of a spin-off

Let us take an imaginary business as an example.

Company SSS makes construction materials, gradually extending its product line. A bit later the company offers a whole assortment of such products and takes up its niche in the market.

In such circumstances, the management becomes more and more ambitious, craving for development, and decides to carry out a spin-off. Thus the management aims at taking up another niche, namely, construction and installation works.

SSS is a public company with shares in free turnover. At the general meeting of shareholders, they decide to create a subsidiary SSS-1 that will work in the new niche. They also decide upon allocating money for this and all organizational issues. This is quite a lengthy process that can take from six months to a year.

The conditionally new company acquires some assets and liabilities of the company, issues shares, and sets up its primary cost. As a result, all shareholders of the initial company acquire some new share.

This happens at the exchange rate, which is a ratio of the new shares to the share price of the parent company. This will depend on the decision made at the meeting of shareholders.

An example of exchange rate

The share price of SSS is 100 USD per share. The exchange rate is 0.85 (85%). This means that the initial share price of SSS-1 will be 85 USD. The newly-created company will carry out an IPO at this share price, while investors of the parent company will receive multiple shares of the new one.

Quite often, investors must hold a certain number of shares of the parent company to get shares of the new one. Numbers get rounded: if investors receive 1 share of the subsidiary per 10 shares of the main one, than they will have 3 new shares per 29 shares of the “old” one. Hence, one has to take care and make sure they hold enough shares of the parent company before a certain date.

An example with a construction company was brought up for a better understanding of a spin-off, but most often this procedure is carried out in technology and science, in the branches of software development and research.

Main aims of a spin-off

  1. Making the company more mobile.
  2. Creating a more efficient, competitive company.
  3. Seeking tax incentives and decreasing debts.
  4. Diversifying risks and business. If the new project fails to develop, the initial company will suffer not that much.
  5. Taking up a new business niche and developing a new business, different from the main one.
  6. Making final decisions faster. Fewer managers means faster decisions.

Advantages of a spin-off

  1. A new company based on an existing one is better positioned than those created from scratch.
  2. The new company uses all the results reached by the parent company, including the client base. This eases promotion.
  3. The subsidiary is created for certain market conditions and requirements. There is no need to look for a niche.
  4. The parent company risks less.

How do investors behave at a spin-off

After a spin-off, all who own the shares of the parent company get shares of the new one, and they can be used in several ways:

  1. Investors can keep them in the portfolio, diversifying it. Both companies might go on growing, and even if the shares of one of them go down, the portfolio will remain balanced thanks to the shares of the second one. Of course, both shares might still go down, but this is a place for different decisions.
  2. After the subsidiary carries out an IPO, investors can get rid of their shares and use the money as they please. I this case, the portfolio will remain without a change, while getting some free money. However, keep in mind that in future, the shares might grow.
  3. If upon studying the new company the investor finds that it is promising, they can add more of its shares to the portfolio. As long as people rush at “hot pies” with exceptional greed, chances are that the share price of the new company will be growing.
  4. Trading and investing is always risky, so take your time to study the company and see whether it can yield profit and how big.

Bottom line

A spin-off is most often a good event for the company and investors. They get the shares of the new company apart from the shares of the old ones they already have.

After a spin-off and an IPO of the new company, the share price of the main company might open with a gap and go on growing over next trading session. Rather often after an IPO of the new company the shares of the old one go on growing for several months.

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Material is prepared by

Has been in Forex since 2009, also trades in the stock market. Regularly participates in RoboForex webinars meant for clients with any level of experience.