What Effect Does a Spinoff Have on a Stock Price?

In a spinoff, a parent company allocates certain assets into a separate entity and spins off or distributes shares in that entity to the current shareholders, typically in a tax-free transaction. In some cases, spinoffs may allow both entities to end up in a better place and maybe even outperform. However, different spinoffs affect parent companies' stock prices in different ways.

The most typical reason for a spinoff is that the stock price of a large diversified company does not fully reflect the value of all its diverse components. A spinoff can increase shareholder value by allocating certain assets from the core business into a separate company.

Another reason may be that a company has built a valuable fast-growing subsidiary whose business differs from the parent company's main business. A spinoff is a way for a subsidiary to function as an independent entity.

According to McKinsey and Company, a spinoff may free a parent company and its subsidiaries to pursue new strategies that were difficult when the entities were tied. An example is when PayPal separated from its parent company, eBay. The separation allowed both entities to grow and compete in their markets.

Whatever the reason for a spinoff, the underlying math is essentially the same: the parts should be worth more than the whole.

Notable examples of spinoffs include Smith & Wesson spinning off into American Outdoor Brands in 2020. The spinoff was structured as a tax-free distribution to existing stockholders, and shareholders received one share of spinoff shares for every four shares of common stock in the parent company.

In November 2022, Johnson & Johnson (JNJ) announced plans to separate its consumer health business from its core business. In a press release, JNJ said the spinoff allowed the brand to "pursue more targeted business strategies and accelerate growth."

In June 2022, Kellogg announced its plans to spin off into three separate companies to transform its portfolio and enhance shareholder value.

Most recently, General Electric completed its spinoff of GE HealthCare Technologies, Inc. For every three shares of GE common stock, stockholders received one share of GE HealthCare. GE also plans to launch GE Aerospace and GE Vernova as independent companies in early 2024.

On the day of the spinoff, the parent company's stock price typically drops, reflective of the removal of certain assets from the parent company and the allocation to the new spinoff company. Once a spinoff starts trading on the stock market, the prices of the parent company's and spinoff's stocks should add up to the price of the old parent company stock before the spinoff, at least initially.

Eventually, the prices of the two new companies will be set by the market based on their individual values and prospects.

In a complete spinoff, the parent company's stock starts trading on its own merit – that is, on the growth prospects of the remaining business. In a partial spinoff, the parent company's stock price should reflect the value of that subsidiary's stock holding.

A parent company may spin off the entire subsidiary or distribute only a small percentage of shares as a dividend and retain a stake for possible sale later.

According to the Financial Industry Regulatory Authority (FINRA), new shares are typically distributed on a pro-rata basis, with investors receiving a number of shares in the spun-off company relative to what they hold in the parent company.

A corporate split-off differs in that shareholders in the parent company can relinquish their existing common stock shares for shares in the new subsidiary.

ABC is a large, established company with diverse businesses. Its current stock price is $48. With 1 billion shares outstanding, ABC's current market cap (current stock price multiplied by the number of shares outstanding) is $48 billion. Its book value (balance of assets and liabilities) is $60 billion, so the management feels ABC stock is undervalued.

The ABC Board of Directors decides to spin off its fast-growing subsidiary, XYZ, into a separate independent company.

XYZ is created with 100 million shares outstanding. ABC decides to carve out 20 percent of the shares – 20 million – to the parent company's shareholders by segregating $6 billion in assets into the new entity and retaining an 80 percent stake. XYZ's $6 billion book value suggests a stock price of $60 per share ($6 billion divided by 100 million shares).

After the spinoff, ABC stock drops to $42 per share to reflect the $6 billion drop in its book value. In the meantime, excited about its growth prospects, XYZ investors quickly bid up its share price to $200. XYZ's market cap is now $20 billion.

ABC's 80 percent stake in XYZ is worth $16 billion (it lost $6 billion million in assets but gained $10 billion in the market value of the spinoff). Therefore, its stock begins to trade at around $58 per share to reflect the new valuations.