Nov 2018 Q4 d.
Explain Spin-offs and sell-off and identify THREE (3) reasons for Spin-offs. (7 marks)
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Spin-Off
A spinoff is the creation of an independent company through the sale or distribution of new shares of an existing business or division of a parent company. A spinoff is a type of divestiture. The spun-off companies are expected to be worth more as
independent entities than as parts of a larger business. A spinoff is also known as a spinout or starbust.
When a corporation spins off a business unit that has its own management structure, it sets it up as an independent company under a renamed business entity. The company that initiates the spinoff is referred to as the parent company. A spinoff retains its assets, employees, and intellectual property from the parent company which gives it support in a number of ways, such as investing equity in the newly formed firm and providing legal, technology, or financial services.
Sell-off
A sell-off is the rapid selling of securities such as stocks, bonds, ETFs, commodities or currencies. A sell-off may occur for many reasons, such as the sell-off of a company’s stock after a disappointing earnings report, the departure of a important executive or the failure of an important product. Markets and stock indexes can also sell-off when interest rates rise or oil prices surge, causing increased fear about the energy costs that companies will face. Sell-offs can also be caused by political events, or terrorist acts.
All financial trading instruments have sell-offs. They are a natural occurrence from profit-taking, short-selling or portfolio turnover. Healthy price uptrends require periodic sell-offs to replenish supply and trigger demand. Minor sell-offs are considered pullbacks. Pullbacks tend to hold support at the 50-period moving average. However, when a sell-off continues on an extensive basis, it can be signs of a potentially dangerous market reversal leading to a correction or a crash.
Reasons for Spin-Offs
Here are reasons why some companies are better off as separate units than they are as one bigger business:
- Better management: While executives of a company may be well-suited to overseeing most of its lines of business, perhaps there’s a unit that doesn’t quite match their expertise. In another example, a specific unit may require more attention than it’s getting from top management and its performance suffers as a result. In either case, spinning off the unit and putting it under new management may result in better performance in the unit-turned-independent company, while the parent company’s managers can now redouble their focus on their remaining units.
- Separating growth trajectories and strategies: A business unit that’s slow to make money might prove a drag on a sister unit that’s experiencing robust growth, particularly if the parent company uses profits from the latter to subsidize the former. But when two such units are no longer under the same parent company, they can grow at their own pace and might even see more success in attracting investors who specifically seek out fast-growing or mature companies.
- Better coverage from securities analysts: Research has shown that divestitures —including spinoffs and sales to other companies — by parent companies result in higher quality research by the analysts covering those parent companies. One study of 103 spinoffs, for instance, found that analyst forecast accuracy increased between 30 to 50 percent following spinoff transactions. One of the reasons why is that when a business is less complex, it’s easier to analyze. In addition, after a corporation narrows its array of businesses, it may attract coverage from analysts with specializations matching those businesses who may provide more accurate forecasts about the corporation.
- Unlocking shareholder value: Perhaps the biggest factor driving spinoffs is the idea that the parent company is undervalued— perhaps because of management or strategy issues described above — and that its remaining business valuation would be higher if it spun off one or more business units. (Any 3 points)