If you’re interested in spin offs, then you may have also come across the term “carve out.” But, how exactly does a carve out differ from a spin off?
In this article, I’ll walk you through the key differences and tell you how to profit from each.
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Carve Out vs. Spin Offs – Key Differences That You Need to Know
What’s the difference between a carve out and spin off?
The core difference between carve outs and spin offs is that in a carve-out, the parent company sells a small portion of a division to raise capital, while in a spin off, a parent company distributes shares in its subsidiary to its own shareholders.
| Characteristic | Carve Out | Spin Off |
|---|---|---|
| Portion Divested | Usually less than 20% | Usually 100% |
| Funds Received | From sale to 3rd party | No proceeds received |
| Control | Majority retained by parent | Passed to parent’s shareholders |
| Organization | New business created, may be public or private | New public company created |
| Purpose | Raise funds for corporate purposes | Increase shareholder returns, unlock potential |
Key Details of a Carve Out
In a carve out, a business does not divest all of its ownership over a subsidiary or division. Rather, it packages up the division into a standalone business and then sells off a small ownership stake in that business.
Companies typically undertake carve outs in order to raise cash for corporate purposes – whether embarking on new marketing programs, retiring debt, or even paying special dividends. In the rare case, a conglomerate may conduct a carve out in order to highlight just how undervalued its shares are.
Key Details of a Spin Off
When a company spins off a division or subsidiary, it packages the business into a new standalone company and then distributes shares in that company to shareholders of the parent. A firm can spin off either all or a large portion of the newly created firm, or conduct the spin off in two steps – distributing the full number of shares in two separate events.
Unlike with a carve out, the parent company receives no money from the distribution of those shares, so the purpose is not to raise funds for corporate purposes. Instead, companies usually spin off shares in order to increase shareholder returns. By spinning off the business, management may be able to remove the parent company’s discount to fair value in the market because the distribution can highlight how undervalued the firm is or remove the conglomerate discount tacked on to many larger businesses.
By spinning off the division, management can also allow the new company to operate free from parental control and bureaucracy, creating a more efficient firm that can set its own strategic direction, managed by a C-Suite with compensation directly tied to company performance.
While a parent company does not receive funds for selling shares in the new business, management can distribute a portion of the parent’s debt onto the soon to be public company, to remove a lot of the debt burden from the parent.
Investment Opportunities in Carve Outs vs Spin Offs
Special situation investors can take advantage from either carve outs or spin offs…
When a firm carves out a division, it could create significant opportunities in three ways:
- Uncovering a deep discount. The carve out can highlight just how undervalued the conglomerate is, causing investors to bid up the price of the stock. If the conglomerate is trading for $15 billion on the stock market, and it sells 20% of a division for $5 billion, the division is likely worth $20 billion to an acquirer. A stock investor making a purchase on that knowledge, then, would know that he is paying a price equal to the per share value of the retained ownership stake in the carved out division and getting the rest of the company’s assets for free.
- Removing debt. If the parent carves out 20% of a division and then uses the funds to retire debt that it would have otherwise struggled to pay off, investors may feel relieved and bid the price of the company back up and out of distressed levels.
- Making a higher return investment. When a company carves out a division, it could use the funds to invest in marketing to expand a much more profitable division. The higher ROI would lead to a higher multiple in the market and may spark ongoing growth.
Really, there are a number of ways that an investor could take advantage of an equity carve out. But it does take some elbow grease to understand how the company could benefit from the sale.
Spin off investors can spot opportunities in a number of different places, as well. Most of it comes down to taking advantage of price-to-value discrepancies that the market will likely close. Let’s review:
- Underpriced spinco. Sometimes a company will spin off a division (known as the Spinco), and this new firm will trade at a price well below fair value. Maybe it is issued to shareholders at a multiple that’s well below peers. An investor could simply buy the spinco and wait for it to reprice.
- Buy the dip. If the spinco is small relative to the parent, funds may dump the newly distributed shares because it’s simply not worth their time to figure out and possibly buy. This also goes for firms interested in investing in a specific sector that the parent operates in, but where the spinco operates in a totally different industry. The selling pressure creates a moment of price dislocation that investors can capitalize on.
- Buy the parent post-distribution. If the spinoff unburdens the parent in some way, the parent may perform better going forward, and investors could profit after the distribution.
The idea here is really to look for some price dislocation or some area of opportunity that is not recognized by investors. A solid tip is to look at what insiders are doing. Are they buying the stock? Do they get a lot of stock options that could provide significant motivation? Sometimes those qualitative pieces of information can provide some great insight.
How to Find Carve Outs and Spin Offs
While these investments can be lucrative, it’s not always easy to find carve outs or spin offs.
If you’re not content with reading the wall street journal every day to find opportunities, one strategy is to visit a site that lists the upcoming spin offs. For example, we list upcoming spin offs on our spinoff calendar. This makes it very easy to find stocks to research.
But, the problem with this method is that you have to keep coming back to the page to see when new spin offs are coming. It’s much better to have us simply send you all the deals that we find over the course of a month.
That’s why you should sign up for our free Morning Brew newsletter. We’ll package up everything that we find each month into a neat email and send it directly to you so you don’t have to keep coming back to our site to see when new opportunities are listed.
So, enter your email in the box below because we’ll take a lot of time and effort out of uncovering these great special situations.
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