If you’ve recently gotten into the world of spinoffs, the term “split-off” might make you pause.
The term is close enough to “spin-off” that you would be forgiven for thinking that they refer to the same thing. But, in reality, the two events have important differences and important implications for investors.
In this guide, I’m going to walk you through what exactly a split off is, how it works, and then provide you with some strategies for how to capitalize on these lucrative events.
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Split Off Meaning
So, what exactly does "split-off" mean?
A corporate split-off is a type of corporate restructuring or corporate reorganization method where a parent company divests itself of a subsidiary or a business unit by distributing its shares to the parent company's existing shareholders. In this way, it’s like a spin off.
But, unlike a spin-off, where shares of the subsidiary are distributed to all shareholders automatically, in a split-off, shareholders only get the right to exchange their shares in the parent company for shares in the subsidiary.
The process allows shareholders to choose whether they want to retain their investment in the parent company or shift it to the newly independent entity. If they don’t exchange the shares, they simply keep stock in the parent company and forgo any claim to the subsidiary.
How does a split off work?
There are several steps in the split off process. The core essence is to separate from, or to separate something from, a larger group or organization:
- Decision to Divest: The board of directors makes the decision to split a portion of the company off into a standalone publicly traded business. May include a transfer of corporate assets to a subsidiary.
- Planning and Structuring: Management & the board work with advisors to structure the split with the goal of avoiding tax for shareholders.
- Share Exchange Offer: The parent announces the exchange ratio (eg. 1 for 1, of 1 for 0.85, etc) for shareholders to consider. This is where the parent company offers shareholders shares in the new subsidiary.
- Shareholders Tender: Shareholders decide whether to exchange their shares for shares in the subsidiary.
- Execution of the Split: Once the exchange window ends, the parent collects the tendered shares, cancels them, and issues shares of the subsidiary to participating shareholders. The subsidiary becomes a fully independent, publicly traded company (assuming it’s listed), with its own board, management, and stock ticker.
There are some smaller details, of course, in each of these steps, but this is the overall framework that the process involves. In the end, the former division stops being part of the group and becomes separated from it.
Why do companies go for split-offs?
Companies might pursue a split-off to sharpen their strategic focus, unlock value in an undervalued subsidiary, or allow the separated entities to operate more effectively as standalone businesses with distinct management and goals. So, better values or performance is usually the answer.
A split off can also help the parent unload some debt. If they want to get rid of debt, they attribute it to the subsidiary, accepting a less favorable exchange ratio as a result.
Split-off Synonyms - Do All These Terms Mean the Same Thing?
Now, before moving forward, it’s important that we set the terminology straight. There are a number of terms that seem to be related but imply or refer to different things.
Split-Out Meaning
Sometimes, you’ll hear the term “split-out” when discussing special situations. This is not really a corporate restructuring term but can be used in casual conversation to refer to some split-off or spin-off strategy.
Split off vs Carve Out
While split-out is not an official term used in the biz, the term “carve-out” is. But a “carve-out” is not the same as a split-off – so please don’t confuse them.
A carve-out (a.k.a. an “equity carve-out”) is where the parent sells a minority stake (ie. less than 50%) of a subsidiary to the public via an initial public offering (IPO) while keeping overall control of the new firm. Firms sometimes go this route to generate cash from the sale, which is not possible if the parent just distributed shares to existing shareholders.
When part of a firm is sold off, stock doesn’t convert to shares in the new company. Shareholders retain their ownership in the parent, which also represents the portion of the new public company that the parent still owns.
Split off vs Spin off Stocks
This is probably the most important distinction because spin offs are the most common form of restructuring when separating a division from its parent. Here’s the core differences:
- In a spin off, shareholders of the parent get shares in the Spinco automatically. In a split off, parent shareholders have to choose.
- In a spin off, shareholders end up with shares in both the parent and the Spinco after the event. In a split off, shareholders are left with either shares in the parent or the newly public company post event.
So, no, a spin-off is not the same thing as a split off. You need to know whether you’re investing in a split off vs spin off stock because the implications are very large for how you pursue the event.
Split-off vs Split-up
The term “split up” refers to a similar sort of restructuring but is not a synonym of split-off.
In a split up, the parent company splits into a number of different stand alone businesses and ceases to exist post-transaction. So, shareholders can’t be left with shares in the parent because the parent ceases to exist. For example, management may plan a transfer of corporate assets to a subsidiary before separating it from the parent, but then the rest of the company breaks up into different businesses as well, and no parent is left.
United Technologies Corp - A Great Example of a Company Recently Split Up
To get a grasp of the nuts and bolts behind a split up, let’s walk through a recent example.
United Technologies Corporation (UTC) announced that it would split up on November 26, 2018. Activist investor Daniel Loeb at Third Point was pressuring the company to break up into separately traded companies to help unlock shareholder value.
On April 3, 2020, the company split up into three publicly traded companies: Otis Worldwide Corporation (elevators), Carrier Global Corporation (HVAC and refrigeration), and Raytheon Technologies (aerospace and defense, via a merger with Raytheon). The original UTC ceased to exist post-split, with shareholders receiving one share of Otis and Carrier per UTC share, plus stakes in Raytheon Technologies.
The process of dividing up the debt and operational functions took 16 months. Otis emerged as the global elevator leader, Carrier as a climate control giant, and Raytheon Technologies as an aerospace-defense powerhouse.
How to Profit From Split-offs – Investment Strategy
There are a few strategies that you can pursue with regards to a split-off if you want to take advantage of these unique special situation opportunities.
Look for a Value Arb During a Split-off
The first is what I call looking for a value arbitrage. When management teams split off a division into a new company, they’ll usually try to set an exchange ratio that seems fair, so neither shareholders who stick with the parent nor shareholders who opt for shares in the subsidiary receive a better deal.
The reality is, however, that it’s very hard to achieve a perfect split, and the exchange ratio will not result in a perfect match between parent and sub. If you can value each business accurately, you can spot these discrepancies and buy the parent pre-split to exchange for shares in the subsidiary.
Look for Hidden Value Overlooked by Investors During a Split Off
Similarly, if you can accurately value both pieces, you may find that either piece is trading below fair value immediately after the split off. Purchasing the cheap parent or newly public subsidiary could result in some nice gains.
For example, the subsidiary may have much higher growth potential that is more or less unrecognized by the market before being split off. Once split off, that growth potential would come more clearly into focus, and the stock should trade at a higher multiple. Buying the sub immediately after going public may result in a revaluation in the public markets.
Taking Advantage of Higher Multiples After the Split Off
Another source of multiple expansion can happen after a conglomerate splits off a division. Conglomerates made up of multiple divisions or subsidiaries can often suffer from a conglomerate discount, as investors typically look to make investments in specific industries. While a conglomerate may own a business that fits an investor’s interests, it’s buried under other firms that the investor is not interested in, so the investor passes on the investment.
By splitting off the company, the newly public firm can receive a multiple more in line with industry peers. Similarly, if shedding the divisions results in the conglomerate becoming much more focused on a specific industry, its multiple can rise as well.
It may be worthwhile purchasing the conglomerate immediately after the announcement is made if the discount to assessed fair value is large.
Merck - Organon Split-off Example
A great example of a split off occurred in June 2021 when Merck & Co. split off its subsidiary, Organon & CO.
Merck decided that it would be better if the subsidiary was split off from the parent company to achieve a more agile focus for both entities. This would also allow Merck to focus on faster growing areas, such as oncology, and streamline its manufacturing footprint in the process.
Meanwhile, Organon would exist as a separate company, which would allow it to better align its focus and management incentives with shareholders.
Merck Split Off Conversion Rights
Management concocted a deal in 2021, though it turned out to be a hybrid spin-off, split-off structure:
Merck shareholders received one share of Organon for every 10 shares of Merck they owned. However, Merck also offered an exchange option — a hallmark of a split-off — allowing shareholders to tender their Merck shares for Organon shares at a discounted exchange ratio before the distribution.
The split-off was completed on June 2, 2021, with Organon beginning trading on the NYSE under the ticker "OGN" the following day.
So, how could special situation investors have profited from this event?
Pre-Split-Off Arbitrage via the Merck Exchange Offer
Merck management gave shareholders the right to exchange their shares for Organon shares between May 17th, 2021 and June 2nd, 2021, at a 7% discount to the then market price.
Here’s how it worked: Before the exchange period, Merck shares traded around $75-$78. Suppose you bought 100 Merck shares at $76 ($7,600) in early May 2021. Organon’s when-issued price stabilized around $36-$38. Post-split, on June 3, 2021, Organon opened at $38. If you tendered your 100 Merck shares, you’d get 10.71 Organon shares, worth $407 at $38 each. The market value of 10.71 Organon shares at $36 (pre-discount reference) was $385; the 7% discount effectively lowered your cost basis to ~$358. Selling at $38 yielded a $49 profit per 100 shares ($407 - $358), or ~6.5% return, excluding transaction costs, in weeks.
Depressed Bargain Buying - Merck Stock
After the split-off, Organon initially faced selling pressure as institutional investors (e.g., index funds tracking Merck) dumped shares of the smaller, less-followed entity. This drove Organon’s price down to the low $30s shortly after its debut.
Special situation investors valued the company’s strong cash flows and recognized that there was a chance to buy the company at a bargain price.
By mid-2021, as the market better understood Organon’s standalone value, its stock rose to the high $30s and stabilized. Investors who bought at $32 and sold at $38 captured a 18.75% return in a short period, excluding dividends (Organon also initiated a ~3% dividend yield, adding to total returns).
Eliminating Merck’s Conglomerate Discount After Split-off
Merck often traded at a discount to the value of its subsidiary companies – the classic conglomerate discount. The company also refocused on higher growth areas, so it justified a higher multiple.
Post split, the stock saw a small bump up in price, allowing special situation investors to exit at a profit. While it was only a 5 or 6% uptick, those who purchased prior to the spinoff / splitoff also received Oganon shares (1 for each 10.71 shares of Merck), which was worth about $3.50 per share. So, a Merck stock price move from $75 to $80, plus $3.50 amounted to a $8.50 gain on Merck shares in just a couple of months.
Split offs are a unique form of corporate restructuring that can make for some great profit opportunities. But, you have to know the ins and outs of the process before you can form a great strategy for how to approach them.
They’re also tough to find. Actually, identifying one usually requires pouring over the financial papers and monitoring corporate filings for events taking place. This can be a lot of work.
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