> what does that mean for the new company that represents that worse part? I can obviously see the upside for the business that jettisons the dead weight.
As someone who used to do a bit of recreational "special situations" investing, I can say with some confidence that counterintuitively the worse part is often the better part, and the "dead weight" often soars after it is jettisoned vs the "good part" flatlining. Not always but it can definitely happen.
The reason for this is logically apparent when you think about the second-order effect of people's opinions on a stock valuation. Say IBM has two halves: "Cloud IBM" which is funky and "Boring IBM" which is everything else. As one company the valuation is the weighted average of everything everyone thinks about the funky part and the boring part put together and is therefore fairly boring overall.
So when you do a spinoff the funky cloud part should soar, right? Wrong. Or not always, anyway.
What often happens when you split a business into a good part and a "bad" part is that all the overinflated expectations of investors are concentrated in the funky part so at the time of the split it has a very high valuation and the boring part is massively oversold and undervalued. So after the split the boring part performs well even if it just phones it in because expectations are so low whereas the funky part needs to do amazingly just to meet the expectations of people who are already in the stock at a valuation that is too high.
> As someone who used to do a bit of recreational "special situations" investing, I can say with some confidence that counterintuitively the worse part is often the better part, and the "dead weight" often soars after it is jettisoned vs the "good part" flatlining.
Often, the “good” part is actually the high-risk, high-growth potential part and the “bad” part is the low-risk, solid returns part.
Exactly. And if investors have already priced in the high growth potential, sometimes even if the "good part" grows a lot it can be that it doesn't grow enough to justify the valuation.
Fair to add that this doesn't refute the structural logic of seperating the parts - if your business has two halves that are that different, a split can make total sense.
As someone who used to do a bit of recreational "special situations" investing, I can say with some confidence that counterintuitively the worse part is often the better part, and the "dead weight" often soars after it is jettisoned vs the "good part" flatlining. Not always but it can definitely happen.
The reason for this is logically apparent when you think about the second-order effect of people's opinions on a stock valuation. Say IBM has two halves: "Cloud IBM" which is funky and "Boring IBM" which is everything else. As one company the valuation is the weighted average of everything everyone thinks about the funky part and the boring part put together and is therefore fairly boring overall.
So when you do a spinoff the funky cloud part should soar, right? Wrong. Or not always, anyway.
What often happens when you split a business into a good part and a "bad" part is that all the overinflated expectations of investors are concentrated in the funky part so at the time of the split it has a very high valuation and the boring part is massively oversold and undervalued. So after the split the boring part performs well even if it just phones it in because expectations are so low whereas the funky part needs to do amazingly just to meet the expectations of people who are already in the stock at a valuation that is too high.