Share spinoffs – what are they and how to spot the good from the bad

Pharmaceutical company GlaxoSmithKline is now just weeks away from separating itself from its consumer healthcare business. The two are set to part ways in July this year. Shareholders will receive one share of the new GSK and one share of newly minted Haleon, Glaxo’s consumer healthcare business.

The idea is that the two sides of the existing business, pharmaceutical sales and consumer healthcare, have better growth potential if they’re separate.

The nuts and bolts

When the two part ways, shareholders will be handed shares in Haleon. In theory, shareholders who keep both GSK and Haleon shares won’t have changed their overall position. The two companies will go on to trade independently of each other, rising and falling with the fortunes of the underlying companies.

Shareholders can decide to keep or sell shares in one or both companies just as they would any other investment in their portfolio.

Why spin?

If two businesses have been trading under the same roof all this time, why would they split now?

In most cases, it’s to unlock additional value that’s otherwise buried in a sprawling company portfolio. Housing several different businesses under one roof can be protective. Like with investing, diversity helps to smooth out sharp rises and falls. Trouble in one area of the business can be somewhat offset by strength in another.

However, it also dilutes the highs as well. By splitting the business, management’s giving shareholders two potential, more direct, investment options.

From management’s perspective, it’s a good way to drill down on what’s driving each individual business. Glaxo’s been chopping and changing its consumer healthcare business over the past few years. This focus is expected to allow Haleon to grow its sales somewhere between 4-6% annually.

Meanwhile, what’s left behind in GSK is a pharmaceutical pure-play, with drug development and sales as the underlying engine.

Once separated, the capital structure for each company can be tailored to the underlying business. Haleon will pay out somewhere between 30% and 50% of its earnings in shareholder returns. By contrast GSK will offer investors a 40% to 60% share of its profits.

The autonomy will provide greater control over how the business is run and how the money it generates is shared out. In theory, this should offer better returns to shareholders – be it through increased returns or a higher growth rate, but as always with investing, there are no guarantees.

While the GSK spinoff was the brainchild of the company’s own management team, this isn’t always the case. Sometimes activist investors are the ones demanding a company break up in a bid to juice shareholder returns.

Regulatory issues can also cause companies to shed parts of their business as well. In all these scenarios, it’s important to remember that it might not be in your best interest as an investor.

This article isn’t personal advice, if you’re not sure if an investment’s right for you, seek advice. All investments and any income they produce can fall as well as rise in value, so you could get back less than you invest.

When spinoffs are off

A spinoff isn’t a sure-fire way to improve a business and boost shareholder returns. Sometimes it offers a short-lived bump for shareholders, but longer term it could become a drag.

When a company splits, shareholders are typically left holding shares of the new entities. They can then decide whether they want to hold on to these shares or sell them.

The slicing and dicing often leaves behind a prime cut and one that comes lumbered with quite a lot of fat still to trim. In this scenario, lots of investors will be inclined to hold on to the promising business and discard the other. Remember though, the two are no-longer linked. So the corresponding valuations should line up with the underlying business.

This was the case when IBM shed datacentre business Kyndryl last year. IBM’s aim was to get the slower-growing business off the books so it could focus on righting the ship after years of stagnation.

For Kyndryl, the deal was supposed to offer more mobility as the smaller, more nimble business could go after partnerships with IBM rivals like Amazon and Microsoft.

The case for Kyndryl now rests on a potential recovery, which has been shaky at best. It’s only been two years, hardly enough time to make sweeping judgements, but investors who held on to shares will find themselves down more than 75%. This suggests this spinoff, at least in the short term, was more for IBM’s benefit than Kyndryl’s. 

IBM and Kyndryl share price ($)

Past performance isn’t a guide to the future. Source: Refinitiv, 13/06/22.

Shedding a failing part of the business isn’t the only time spinoffs can be murky. Sometimes a spinoff sees a business rid itself of a key component out of necessity, which can become a detriment to the company’s long-term investment case.

This is a worry for some of the market’s mega-cap tech stocks, who have come under fire from regulators about their sprawling, monopolistic businesses. There’s been a lot of talk about potentially breaking-up the likes of Facebook and Amazon on the premise that their unchecked growth has given them too much power.

This wouldn’t be the first time governments have stepped in to split a monopoly. Telecom giant AT&T saw its local telephone service severed from its long-distance business in 1984. Although AT&T initially opposed a breakup, the split wasn’t necessarily a bad thing. The group’s local telephone service companies were wildly successful on their own given the infrastructure had already been established.  

But this success story wouldn’t necessarily be repeated. Amazon, for example, is essentially an e-commerce business fused with a cloud computing platform. Currently, AWS, the cloud business, brings the money in and retail spends it. If the two were to separate tomorrow, the e-commerce side of things would struggle.

Amazon operating profit breakdown ($m)

Source: Amazon company accounts. 2022 figures are expected according to Refinitiv as at 13/06/22.

How to spot a shoddy spinoff

Spinoffs are rarely cut and dry, so investors need to do their homework to determine whether they want to keep hold of their shares. There are a few key points to consider when it comes to evaluating the two businesses left behind.

The first, and arguably most important, is cash flow. Investors need to be confident that the new business can support itself. While smaller, growth-centred businesses might not be in the black yet, there should be a clear pathway to generating cash. If the spinoff has been reliant on siphoning cash from its larger parent, chances are that company will struggle once it’s been cut off.

The second is debt. Spinoffs often come with an unfair debt distribution. The larger company will sometimes use the spinoff to unload some of its debt with the smaller company. A larger than ideal debt pile isn’t a deal-breaker if cash generation is robust, but it’s important investors are going in with their eyes open.

In the case of GSK, despite its smaller size, Haleon is taking on about half of the debt obligations, starting life with net debt worth four times underlying cash profits (EBITDA). If all goes to plan, this should be reduced over time thanks to the businesses’ stable, more reliable revenue streams. But it’s a significant risk that shouldn’t be overlooked.

All of this information can be found in the prospectus, which will be released ahead of the demerger. But if sorting through piles of financial information isn’t your idea of a good time, we can do a lot of the leg work for you.

Covering over 100 of the most popular stocks, the Share Research team keeps a close eye on market events and updates investors on company developments – including what’s happening at GSK right now. Sign up now to get expert research and insights sent straight to your inbox.

Investing in individual companies isn’t right for everyone – it’s higher risk than investing in funds as your investment is dependent on the fate of that company. If the company fails, you risk losing your whole investment. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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