When a company decides to sell or distribute an existing subsidiary or division as a new independent company, it is called a spinoff. A recent example was the creation of PayPal , which started trading as an independent company after it was spun off from eBay in July. Here's what you need to know about spinoffs' effect on stock prices.
Why companies choose to do a spinoff
There is a variety of reasons a company may want to spin off a portion of its business. For instance, if a portion of its business is heading in a completely different direction and has different strategic priorities, allowing this portion to operate independently can unlock value.
This was the main reason for the eBay/PayPal split. eBay and PayPal were heading in different directions, and creating two independent entities allow the directors of each to focus on their core operations instead of worrying about a broader spectrum of business activities.
Plus, spinoffs allow investors to buy shares in a more specific type of business that fits their investment objectives. For example, if someone wants to add a financial company, they can now buy shares of just PayPal without simultaneously investing in eBay's e-commerce business.
Whatever the reason for a particular spinoff, the common ground is that management feels the company will create more shareholder value with the assets separated.
The stock price: before and after
A company's stock price after completing a spinoff depends on whether any of the spun-off entity was retained.
In a complete spinoff, the stock price of the company right before the spinoff should theoretically be equal to the sum of its post-spinoff stock price plus the initial stock price of the spun-off company. For example, if a company whose stock trades for $50 spins off a subsidiary in its entirety at an initial price of $20 per share, its stock price should theoretically fall to exactly $30. Of course, because stock prices are continuously changing in a liquid stock market, it's unlikely to be exactly equal to the original share price minus the spun-off share price, but it should be close.
If the parent company retains a portion of the spun-off entity, it's a little more complicated.
Let's consider an example of a company whose market capitalization is $10 billion with 100 million outstanding shares, which translates to a share price of $100. And let's also say that this company wants to spin off 50% of one of its business divisions, which is valued at $2 billion, at an initial share price of $20 (100 million shares).
Well, because the parent company is retaining 50% of the spun-off company, its share price should be equal to the value of its business, plus the retained 50% stake in the spun-off division. In this case, the remaining part of the parent company is worth $8 billion, or $80 per share, and the 50% stake in the spun-off entity is worth $1 billion, or another $10 per share, for a total (theoretical) post-spinoff share price of $90.
The $15,978 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. In fact, one MarketWatch reporter argues that if more Americans knew about this, the government would have to shell out an extra $10 billion annually. For example: one easy, 17-minute trick could pay you as much as $15,978 more... each year! Once you learn how to take advantage of all these loopholes, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how you can take advantage of these strategies.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors based in theFoolsaurus. Pop on over there to learn more about our Wiki andhow you can be involvedin helping the world invest, better! If you see any issues with this page, please email us email@example.com. Thanks -- and Fool on!
The article What Effect Does a Spinoff Have on a Stock Price? originally appeared on Fool.com.
The Motley Fool owns shares of and recommends eBay and PayPal Holdings. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .
Copyright © 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy .