Innscor Spinoff – A special situation for making a profit.

Innscor Spinoff – A special situation for making a profit.

Innscor Africa recently advised shareholders that its Board of Directors has approved the unbundling of the Company’s “Quick Service Restaurant” business unit by way of a share dividend. The soon to be unbundled fast food business unit will be listed as a separate entity – a spin off. We consider spin-offs as one of “almost” sure ways for an investor to make a profit.

There is a theory behind the attractiveness of a spin-off. It is summed up in that a spin-off usually goes on sale shortly after being unbundled. Such an unwarranted share price dip provides a buying opportunity. Thereafter the share price is expected to reflect the fundamentals by firming up with time. Padenga, which was coincidentally spun off by Innscor followed this path too. Upon listing in November 2010, Padenga opened at 5cents and within a month it had dropped to 4cents a share. By February 2011, 3 months down the line, there was a course correction which let the share price to peak at 6cents – a 50% price appreciation.

Why Spin-offs often turn into opportunities.

Why do spin-offs fall in price after the unbundling? Often when a conglomerate spins off a smaller and less attractive company through a share dividend, some of the shareholders suddenly find themselves holding shares of a smaller company they do not want to own. For institutional investors, such as pension funds, shares of the spin-off would not fit their investment mandate. Most of such investors have no option but to sell shares in the spin-off which sends the price spiralling down. More often than not, there is nothing fundamentally wrong with the company, but that it doesn’t fit in their investment plans.

The initial fall in share price has also been confirmed by market analysts across the world. They have however explained it as stemming from a lack of familiarity with the spin-off among investors. It follows then that the rebound in price is the result of a recognition of the value of the company. Whatever the reasoning, the price movement phenomenon is a proven reality among spin-offs.

A common arguement why the fundamental business of a spin-off tends to perform well with time has to do with alignment of incentives and focus. In a lot of cases a spin-off is instigated by the business unit’s management executives who think their unit could perform better if it stands alone. By standing alone, all the bureaucracy and politics associated with conglomerates which often slows decision making is done away with in a spin-off structure. Management of the new spin-off often recieves share options which reinforces alignment of their interest to that of the business.

Cautionary notes

Spin-offs do not always end on a happy note. A few precautions are necessary.

Prospects of the business

No matter how cheap a company sells on the stock exchange you want to pay attention to growth and returns prospects of the business. A declining industry; obsolete products and a competitive industry are features associated with spin-offs you want to avoid. It is therefore important to understand why Innscor is seeking to unbundle the ‘quick service restaurant business’.

Pay attention to what the new company looks like

It is important for the investor to pay attention to the fine print of the transaction – what is Innscor actually spinning off? As an example, it is not unusual for a parent company to offload all debt onto the spin-off, thereby retaining a cleaner balance sheet for the conglomerate. Excessive debt can harm the operations of the business and weaken the share price of the spin-off in the long term. On the other hand more debt could help enhance returns for shareholders.

Way forward

Meanwhile, we can keep our ears to the ground with some capital in hand. Innscor’s latest spin-off of the fast food business could play out better than Padenga Holdings.

Ray Chipendo is Head of Research at Emergent Research. He can be reached on:

ray@emergent-research.com

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s