Break-ups can be tough, and breaking up on good terms can be even more difficult. However in the world of business split-ups aren’t necessarily a bad thing. Especially when it comes to corporate separations and spin-offs. Steven Wood CFA, the founder of GreenWood Investors, shed some light on this topic in one of the latest posts on the firm’s blog, explaining how they are dealing with corporate break-ups. He did it with a help of Ehren Stanhope, CFA, a Principal at O’Shaughnessy Asset Management, who did some data-crunching.
The article starts off with discussing the era of the spinoff and mentioning Joel Greenblatt and his work (both books and fund), was simply unavoidable given the topic. Everything started with IIT’s (one of the largest and most famous conglomerates) split-ups in ’96 and ’97, followed by Joel’s book “You Can Be a Stock Market Genius” we already mentioned. Apparently, spinoffs outperformed the market by 10-20% per year, according to some studies. The thing is that for many businesses out there, standing apart from each other makes sense. By splitting, “separated” businesses can access a cheaper cost of capital or hire an independent management team focusing on creating value for each unit.
So, Steven read Joel’s book seven years after it’s published, at the time his interest in special situations peaked. It is when he joined Kellogg Capital Group’s Special Situation Group straight out of Tulane University. At that time they generated returns at the rate of 41.8% per year using similar event-driven strategies, while Greenblatt’s hedge fund was compounding returns above 50%. So, 2004 was identified as the year of utmost “interest in Greenblatt, Special Situations, and Spinoffs.” However, as Steven says, Joel’s book “officially killed the category” and during the next decade returns diminished as the word of the performance and the strategy spread. By 2015 the dust has settled down and although spin-offs didn’t vanish and this category still outperformed the index, they weren’t extremely good bargain anymore. And investors chasing >50% returns were to blame for that.
It is when the hunt for attractive special situations began, chasing similar opportunities, focusing on those companies that hadn’t announced a spin or split. And that’s exactly what Greenwood Investors do, being post-catalyst investors – catching the early signs of a break-up, instead of waiting for the actual break-up to take some action. Being contrarians, they are not ignoring assets of a company already ignored by the market but treat them as a window to opportunity.
So, according to Greenwood Investors’ analysis, the above-mentioned retrospective studies pinpointed only the best years in the sample tested, thus throwing a shadow on less great results in subsequent years obtained using the same strategy. The Guggenheim ETF (CSD)’s experience (a company created with the purpose of buying spin-offs after the climax) proves that. Still, this category is not doomed to disaster, but “each opportunity requires serious scrutiny.”
Greenwood Investors’ overall experience with splits was (and still is) positive. Their aim is not to benefit from short-term deals, as investors pushing for corporate separations do. After all, we’re talking about “mostly-long, deep value investment firm focused on special situation opportunities globally.” So, the fact that in the period between 2005 and 2017, 48% of the spinoffs outperformed the market two years after the spin, is going in their favor. The bottom line is they are doing the complete opposite of what the investor crowd is doing.
When it comes to their portfolio and future plans, they are applying “contrarian” approach. With valuable lessons learned from the previous period in their mind, they are investing before a break-up is on the sight while staying contrarian and having constructive starting valuations. The time will show, is their approach the right one, as “special situations” resolve in their top holdings – EXOR’s FCA is planning to spinoff its parts division and its CNH unit is about to spin off its Iveco truck unit. Telecom Italia is about to separate its network infrastructure from the retail arm, and the best part is that this break-up might end “quite well for investors”. And, there’s Rolls-Royce which is pursuing a sale or split of its marine division, and according to Greenwood Investors the best thing, in this case, would be to split the division when results are accelerating, as FCA did.