For reasons good and bad, companies are dividing in two. Keep your eye on the smaller stock.
If you’re a Hewlett-Packard shareholder, your head may be spinning. In October, CEO Meg Whitman announced HP would split off its PC and printer division from its technology services business so each side would gain “independence, focus, financial resources, and flexibility.”
Sounds plausible. Except three years ago she argued against this move—which was recommended by her predecessor Léo Apotheker—claiming that it would lead to billions of dollars in wasted costs.
Ignore the Hype, Not the Stock
This kind of CEO flip-flop may turn you off. So might Wall Street’s perpetual cycle of mergers and acquisitions, split-ups, and then new mergers. This year, M&As and spinoffs are both surging.
That said, spinoffs like Hewlett-Packard’s are the one kind of deal with a good record. “While the data is overwhelming that the average acquisition destroys shareholder value, the average spinout tends to work well,” says Christopher Davis, chairman of Davis Advisors.
Focus on What’s Being Spun
Pat Dorsey, founder of Dorsey Asset Management, says, “There comes a point when mature companies take a hard look at themselves and say, ‘We need hair dye.’ ” Often, this means concentrating on the faster-growing division. In HP’s case, that’s the tech services business, which will be dubbed Hewlett-Packard Enterprise. Whitman will be its CEO.
The spun-off hardware division will be called HP Inc. It offers less earnings growth—but might be the better buy. A 2004 Purdue study of breakups from 1965 to 2000 found that while parent companies don’t meaningfully outperform their peers on average, spinoffs do, especially in the first couple of years. A Bloomberg index of spun-off stocks has outpaced the S&P 500 by five percentage points annually over the past 10 years.
Why? Spun-off companies are usually smaller, and history says there’s a small-stock advantage. Also, if the spinoff is unloved by the parent, it’s likely to be overlooked by fund managers and analysts, especially in the early going, Dorsey says. This creates an opportunity for bargain hunters.
Of course, “not every spin works,” says Joe Cornell, founder of the advisory firm Spin-Off Advisors. (And full disclosure: MONEY is owned by Time Inc., which was split off this year by Time Warner.)
What about Hewlett-Packard Enterprise? Dorsey, for one, can’t imagine it will grow as fast as Whitman hopes. “Servers and consulting—that’s what IBM does,” he says. “Have they looked at how IBM has been doing lately?” That stock is down 14% this year.