There is another, arguably safer, way to benefit from a new listing in the share market – demergers, or “spin-offs.” 

Consider two ground floor opportunities currently facing retail investors.  The first is the upcoming IPO for accounting firm MYOB, set to debut on 4 May.  The second is South32, a spin-off company from BHP Billiton (BHP).  The BHP Billiton split into BHP and South32 is the biggest demerger in mining history, so it is getting above average coverage.  For retail investors, which is the more attractive opportunity?

From a strictly pragmatic viewpoint, ease of entry is the greatest advantage of investing in an upcoming demerger.  All you have to do is buy shares of the parent company and at the time of the split you will own shares in the spun-off entity.  The formula varies from one share of the spin-off for every share you hold of the parent, to one share for every five and so on.  In contrast, few retail investors have the opportunity to invest in an IPO until it begins trading, often at a price higher than that paid by the institutions and high net worth individuals who truly get in on the ground floor at the issue price.

Another issue to consider is company ownership.  In many cases the current owners of a company going public are looking to cash out completely, with no interest in the future of the company.  One of the least successful IPO’s of recent times was Myer Holdings Ltd (MYR) which has seen its share price drop from a first trading day opening price of $3.88 to the current share price around $1.38. The owner at the time was Private Equity Firm TPG.  In a case where the owners are cashing out, their interests are not directly aligned with the interest of investors to grow the company. The MYOB IPO is a “safer” bet, since the current owner, US based Bain Capital, will retain 57% ownership.  In essence, the interests of the current owners of MYOB will match those of investors.

Demergers typically retain current operating personnel and have a track record of financial performance within the parent company.  Many IPO’s come to market without ever having shown a dime in profit.  

While the purpose of an IPO is to raise money, with demergers the purpose is typically greater shareholder value through operating efficiencies.  What’s more, there is evidence that the share price performance of spin-offs is superior to that of IPO’s, at least for the first year.  In 2013 CIMB Group examined the price performance of 17 spin-offs dating back to 2002.  They found an average share price increase of 9.5% for the spun-off companies in the first year of independent operation.

A more recent analysis from Goldman Sachs found similar positive results.  Looking at 23 mergers from the past decade, Goldman found after the demerger both companies outperformed the ASX 100 in the first year.  Perhaps the most interesting finding was the companies were enabled to more easily acquire related businesses and in some cases became takeover targets.

Rather than rely solely on the work of CIMB and Goldman to make a case for considering demergers, let’s look at the track record of four parent companies and their spun-off “children” over the past five years.  In no particular order, here are the parent companies, followed by the children and the year of the demerger.

•    Amcor Limited (AMC)      –  Orora Limited (ORA)  December 2013

•    Brambles Limited (BXB)  –  Recall Holdings Limited  December 2013

•    Orica Limited (ORI)  –  DuluxGroup Limited (DLX) June 2010

•    Tabcorp Holdings Limited (TAH)  –  Echo Entertainment (EGP) June 2011

Demergers make sense when the parent and child have characteristics that suggest operating independently would allow greater growth for both.  The characteristics are often product-related but geography and market segmentation can come into play as well.

Amcor is a global leader in the packaging business.  The decision to spin-off Orora was made to allow parent and child to focus on different types of packaging and markets.  Think of Amcor as retaining the high-tech forms of packaging such as rigid plastics and flexible packaging while Orora retained the more traditional fibre packaging.  Orora now operates across Australasia and in the US.  How have the two companies done since the split?  The following table highlights some interesting comparisons.

Company

(Code)

Share Price

Intraday 17 April

52 Wk % Change

Dividend Yield

(Unfranked)

1 Year Total Shareholder Return

2 Year Earnings Growth Forecast

2 Year Dividend Growth Forecast

Amcor Ltd

(AMC)

$14.491

+45%

3.2%

46.5%

-3.8%

+14.3%

Orora Ltd

(ORA)

$2.26

+68%

3.0%

67.4%

+61.9%

+19.2%

 

Shareholders of Amcor at the time of the demerger received one share of ORA for every share of AMC they held.  The table clearly shows those who held shares in both companies have been well rewarded.  Also, it appears that the child is outperforming the parent.  And what of the stock price?  The following price performance chart tells the story.

Brambles Ltd (BXB) essentially allows customers supply-chain solutions without incurring the cost of buying and maintaining their own.  The company offers pallets, plastic crates, and other containers in reusable “pools” used to move goods from one location to another.  Recall Ltd (REC) offered management information systems support to Brambles customers, a business with little in common with Brambles’ core operations.  So they split.  The following table compares how parent and child have done since the break-up.

Company

(Code)

Share Price

Intraday 17 April

52 Wk % Change

Dividend Yield

 

1 Year Total Shareholder Return

2 Year Earnings Growth Forecast

2 Year Dividend Growth Forecast

Brambles Ltd

(BXB)

$11.77

+26%

2.4%

(30% Franked)

+28.4%

+14.6%

+4.0%

Recall Holdings

(REC)

$7.77

+71%

1.9% (Unfranked)

+76.9%

+2.4%

+74.2%

 

Although the parent company Brambles has the edge here in forward earnings growth estimates, this is another case of the child outperforming the parent in its first year of independent operation.  The stock price movement shows the same result.

Orica Limited (ORI) is reportedly the world’s largest producer of explosives.  The company has long been in a variety of chemical businesses, spinning off its fertilizer operation into Incitec Pivotec Ltd (IPL) back in 2003.   The company spun-off its paint and coating operation into DuluxGroup Limited (DLX) back in 2010.  

Right now the parent ORI is struggling while the children are flourishing.  Orica recently sold much of its chemical business, claiming an outright sale was a better deal than another demerger.  The company’s mining chemicals and mining services operations, which include blasting and explosives, have been hurt by lower commodity prices.  However, the company is cash rich.  The following table compares Orica and its most recent demerger, DuluxGroup.  

Company

(Code)

Share Price

Intraday 17 April

52 Wk % Change

Dividend Yield

(Unfranked)

5 Year Total Shareholder Return

2 Year Earnings Growth Forecast

2 Year Dividend Growth Forecast

Orica Limited

(ORI)

$20.57

-5%

4.6%

-5.6%

+2.6%

-1.4%

DuluxGroup

(DLX)

$6.47

+15%

3.4%

+32.8%

=9%

+7.9%

 

DuluxGroup is a good example of the benefits of demergers as that company has expanded into other building materials related businesses such as garage doors and openers and architectural and cabinet hardware.  DLX has outperformed its parent since it split by a wide margin.  Here is the price performance chart.

Wagering and entertainment company Tabcorp Holdings Limited (TAH) decided to spin-off its casino and hotel complex business back in 2011, leading to the creation of Echo Entertainment Ltd (EGP).  Echo got off to a rocky start and consequently TAH is the only parent we looked at that outperformed the child.  However, as the following table shows, Echo is on the rise.

Company

(Code)

Share Price

Intraday 17 April

52 Wk % Change

Dividend Yield

(100% Franked)

3 Year Total Shareholder Return

2 Year Earnings Growth Forecast

2 Year Dividend Growth Forecast

Tabcorp Holdings

(TAH)

$4.78

+31%

3.7%

+28.2%

+5.1%

+13.8%

Echo Entertainment

(EGP)

$4.62

+70%

1.9%

+5.1%

+28.9%

+18.6%

 

The following price performance chart shows Echo did not come close to meeting the average 9.5% increase for spun-off companies in the first year of operation cited by CIMB.  Yet despite its early growing pains, investors who held on to the shares awarded in the split have realized close to a 20% appreciation since EGP began trading as an independent entity.  Here is the chart.

The upcoming demerger at BHP is somewhat unique.  First, some claim the company opted for a spin-off rather than an outright asset sale for lack of buyers.  Given global commodity prices that is not surprising.  Second, in essence BHP is reversing its 2001 merger with another mining giant, the Billiton Company.  

Investors wary of the troubles in the mining sector should consider some of the positive aspects of this deal.  First, BHP shareholders will receive one share in the new company, South32, for each share they hold of BHP.  Second, shareholders owning less than 10,000 shares can have their South32 shares sold for them by the Sales Agent.

The slimmed down BHP will retain its Australian iron ore operations; coal operations in Queensland; copper operations in Chile; petroleum assets in the US; and potash interests in Canada.

South32 will retain the aluminum, manganese, nickel, silver, lead, and coal assets in South Africa.  

Perhaps the most compelling reason to look at this demerger is the possibility of South32 getting swallowed by another mining giant.  In the last three months speculation has abounded in major Australian financial news outlets that none other than Glencore Xstrata, having been rejected by Rio Tinto Ltd (RIO), may now cast its eyes on South32.  Investors willing to take the risk associated with uncertainties surrounding the commodities complex could be rewarded with shares in the new company and then again with a possible takeover premium.

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