Ahead of tax concerns from the fiscal cliff, there is potential that the investing universe will again shift its focus to taxation. One integral method of avoiding corporate and personal taxation is the spin off.
What Happens in a Spin Off?
A spin off is what happens when a piece of a company is disconnected from a parent company and made public as its own little piece. In the past, Kraft (KFT), which makes everything from Mac & Cheese to Capri Sun drinks, has spun off many different pieces of the business.
Most famously, it spun off Post Cereals (POST) to Ralcorp (RAH), which later continued the “hot potato” transaction to spin off Post Cereals once again into its own individual company.
Right now, Abbott Laboratories (ABT), which has previously spun off its hospital supply division Hospira (HSP), is now going to spin off its branded drug company, and will call it AbbVie.
When a Spin Off Happens, Shareholders Usually Receive:
- Shares in the New Individual Company: When a company is spun off, it can be listed and set up for an IPO on the public market as a standalone enterprise. Investors would then own shares in the parent company as well as a proportional amount of shares in the new standalone company. Shareholders then own stock in the original company minus the spin off as well as stock in the spin off.
- Shares in a Merger Deal: In the Kraft-Ralcorp deal, shareholders of Kraft received Ralcorp (RAH) shares, which merged with Post Cereals. Of course, investors also retained ownership of their Kraft (KFT) shares.
In short, shareholders own just as much of a company as they did before, but with changes in how the companies are structured (two individual companies vs. one bigger company).
Why Spin Offs Rock
Spin offs can create substantial shareholder value for investors. Here’s how:
- Spin offs are almost always tax-free to the parent company, which explains their popularity. The best way to sell a company is to do so is to do it in a way that gets you the highest after-tax price. Spin offs are one such way to accomplish this goal.
- Wall Street realizes unappreciated value. Some of the cheapest stocks on Wall Street are those that are too complicated to fit the portfolios of most investors. Value investors might like utility stocks, and growth investors might like Angie’s List, but who would want to own a combined electric company and a dot com in one stock? Dividing the two helps Wall Street realize the full value of each company as a standalone enterprise.
- Spin offs are tax free to the investor, too. Spin offs are one of the few dividends that investors do not have to pay taxes on. Taxes are only paid when an investor sells his or her new position in the spun off firm.
As an investor, there is very rarely anything to lose from a spin off and much to gain. Spin offs are a favorite of activist investors seeking to create a catalyst to push stock prices higher, and companies that want to streamline operations and focus on a single good or service.
Stay tuned in to the business news over the next 12 months. As companies reorganize as REITs, divest non-core businesses, and rethink their operations, spin offs will once again be a major part of the day-to-day discourse on Wall Street.
What are your thoughts on company spin-offs?
Jason @ WSL says
Getting tax-free dividends is a pretty awesome opportunity! Is there a time frame on that? Say I hold onto the spun off stock for 25 years, will I always get tax-free dividends and taxed only when I sell (based on profit/loss)?
It does make a lot of sense to spin a branch off…interesting. I always learn something from you! Thanks!
JT says
Hey Jason, the tax-free dividend is the shares that are spun off. So, the dividends that you get from the spun off company…say, a quarterly dividend, are still taxed. Just clarifying that point.
Spinning off a company still has HUGE advantages, though. In Kraft’s case, spinning off Post Cereals meant they did not have to pay a gain on the sale of the company. So if Kraft acquired Post for $1 (just throwing numbers out as an example) and spun it off for $10 billion, Kraft wouldn’t pay taxes on the gain. Likewise, because the company was spun off, shareholders didn’t pay any taxes on the new shares.
If Kraft were to have sold the company for cash, it would have had to pay corporate taxes on the gain. If that cash were then passed to shareholders as a cash dividend, shareholders would pay dividend taxes on it. A spin off avoided taxes on the corporate and individual level, which obviously makes a huge difference in after-tax shareholder wealth.
John S @ Frugal Rules says
Spinoffs are awesome to be able to take advantage of. I believe, correct me if I am wrong, but Kraft is set to do another spinoff here in the near future, or has just done one really recently.
Robert says
The only thing I dislike about spinoffs is that you may get a jumbled up portfolio over time. I remember when I had Altria and Kraft as one company, which then spun-off. Those are two VERY different companies, and they may not fit within your overall portfolio.