Lesson 2 of 7
Spin-offs
Read a spin-off's Form 10, see who is forced to sell the new shares, and check whether debt moved onto the company they were spun from.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- A spin-off distributes shares in a subsidiary directly to the parent's own shareholders, who did not choose to buy the new company.
- Its registration document is usually a Form 10, not the prospectus an initial public offering files.
- Check what debt moved onto the new company. The parent can leave itself cleaner and the new company more borrowed for the same combined value.
A spin-off separates one company into two by giving the parent's shareholders stock in a subsidiary, in proportion to what they already hold. Reading the Form 10 tells you what was separated and on what terms. The line worth checking first is how much debt moved with the piece that was spun off.
How a spin-off reaches the market
- Day 0AnnouncementThe parent states it will separate a business.
- Months laterForm 10 filedThe new company's registration statement becomes public.
- Before distributionWhen-issued tradingThe new shares trade on a conditional basis, ahead of the distribution.
- Distribution dayShares distributedParent shareholders receive stock in the new company.
- After distributionIndex rebalancingFunds that cannot hold the new company sell it.
What a Form 10 tells you
An initial public offering files a prospectus and sets a price through a roadshow. No underwriter sets a price in a spin-off: shares simply arrive in an existing brokerage account. Its Form 10 carries the disclosure a prospectus would. The accounts are built as if the unit had always stood alone. It adds the distribution ratio, the reason for the split, and the agreements the two companies sign. Read what the new company's managers are paid in its own shares: it says who the plan is meant to reward.
Who is forced to sell
Many holders of the parent never chose to own the new company, and plenty of them cannot keep it. A large-cap index fund that holds the parent by mandate often finds the new company too small, in the wrong sector, or simply outside the index it tracks, so it sells soon after the shares arrive. A fund restricted to a minimum market capitalisation faces the same problem in miniature. None of this selling reflects a view on the new company's business. It reflects a rule that was never written with a spin-off in mind.
Check the debt that moved
A parent choosing how to split its balance sheet can leave itself with less debt. It can put more debt onto the company it spins off, often through a special payment the new company borrows to make before the distribution. The combined enterprise value does not change. What changes is who is carrying the debt, and a reader who only checks the size of each piece misses it.
When-issued trading
Before the distribution date, the new company's shares often trade on a when-issued basis: conditionally, for settlement once the split is final. That short window is where the earliest forced selling happens, and the earliest buying from investors who specifically want the new company. Prices often move a great deal on very little volume.
Check yourself
What document does a spin-off file to register its shares, in place of an initial public offering's prospectus?
- A proxy statement
- A Form 10
- A quarterly report on Form 10-Q
Show the answer
Answer: B.
A Form 10 is the registration statement a spin-off files. A proxy is for a shareholder vote and a Form 10-Q is a quarterly report, not a registration.A parent spins off a small subsidiary that sits outside any major index. What is a large-cap index fund holding the parent most likely to do with the new shares?
- Hold them indefinitely at the same weight as the parent
- Sell them soon after distribution, largely without regard to price
- Buy more of them to build a full-size position
Show the answer
Answer: B.
A fund that tracks an index has no mandate to hold a company the index does not include, so it typically sells soon after the shares arrive.A parent moves debt onto the company it spins off before distribution. What does this change?
- The combined enterprise value of the two companies
- Which of the two companies carries the debt, and so how much equity value each one's shareholders actually hold
- Nothing, because debt has no effect on either company's shares
Show the answer
Answer: B.
The combined enterprise value is the same either way. Moving debt changes who owes it, which lowers the equity value of whichever company carries it.Sources
- Greenblatt, You Can Be a Stock Market Genius, 1997, on reading a spin-off's filing for forced sellers and for debt moved between the two companies.
- Form 10, the registration statement a spin-off files.
What this leaves out
- The $1,000, $700, $300 and $200 figures are round invented numbers, chosen so the split and the 12.5 percent equity share can be checked by hand.
- Not every spin-off carries moved debt, and not every forced seller is an index fund; each filing states its own terms.
- Nothing here is advice about any security.