It seems that in 2012 there has been a large increase in the number of stock spin offs. I'm not sure if it is a total increase across the world of equities, or if I just notice it more since it is occurring at companies that I closely follow. A few of the notable dividend growth companies that are impacted in 2012 are:
- ConocoPhillips (COP) to Phillips 66 (PSX)
- Kraft Foods (KFT) to Mondelez International (MDLZ)
- Abbott Laboratories (ABT) to AbbVie
- The McGraw-Hill Companies (MHP) to McGraw-Hill Education
As a dividend growth investor, I am not quite sure what to think about spin-offs and how they will impact my income stream. Will the income stream continue? Will it continue to grow? Will it grow faster or slower compared to before? All these question culminate into the final question; what actions should I take before and after the spin off?
There are 3 clear actions that any investor can take when a spin off occurs:
- Keep the parent and child company
- Keep the parent company and sell the child company
- Sell the parent company and keep the child company
I'm not sure if there are any clear patterns that we can discern from historical spin-offs, but I felt it would be interesting to analyze the outcomes of some of the larger spin-offs of dividend growth companies.
Spin Off Analysis Setup
The first spin off analysis will be focused on PepsiCo Inc (PEP)
PepsiCo Inc. spun off a restaurant chain called Tricon Global Restaurants Inc. in 1997. Tricon has since been renamed Yum! Brands (YUM). Shareholders of PepsiCo Inc. received 0.1 share of Yum Brands for every share of PepsiCo that they owned.
This type of analysis has an infinite number of ways to analyze if the spin off was successful in creating additional shareholder value or not. My focus will be placed on the income stream and the total return. For my analysis, I decided that I would compare the 5 years prior to the Yum Brands spin-off occurring, and then the 5 years after the spin-off. I will continue this series analyzing additional spin-offs over the past couple of decades to determine which option above would bring the most value for a dividend growth investor.
Analysis Results
5 Years Prior To Spin-Off
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The 5 years prior to the spin-off were during a time period that the overall stock market was performing quite well. Pepsi had an annualized return of 18.17% during this time period and was actually trailing the performance of the S&P 500 by 3.69%.
The dividend per share CAGR for Pepsi during this time period was at a respectable 13.97%. This means that, even without the additional compounding from dividend reinvestment, your income stream would double about every 5 years.
Source: Yahoo! Finance Historical Prices and Backtesting Software
Spin-Off Accounting
Accounting for a spin-off can be tricky. It becomes even more difficult when you have to take taxes into consideration. For the purpose of this study, we will ignore tax implications on the entire analysis. To calculate the various transactions that took place on October 7, 1997, when Pepsi spun off Yum, I used a letter that was sent to shareholders during that time period. The letter can be found at http://www.pepsico.com/Download/TriconYUMCostBasisLetter.pdf
The Yahoo! Finance statistics were slightly different for this spin-off. I defaulted to the shareholder letter, as it was a direct communication from PepsiCo. For future analysis on spin-offs, it is possible that the shareholder letter will not be so readily available, and the data on websites such as Yahoo will have to be used instead. The amounts on Yahoo were close enough that I would have been comfortable using them instead if the letter was not available.
As you can see, the Pepsi per share amount is adjusted downward due to the spin off of the YUM Brand (Tricon Global Restaurants at the time). No value is lost or created during a spin-off. The market of course will have buying and selling that changes the valuation, but the actual action of spinning off a company does not create nor destroy value. It is a neutral transaction from an accounting perspective.
For simplicity, I reset the net investment to $100,000 to analyze the 5 years after the spin off. For the total return analysis of the 5 years after the spin-off, I will invest $91,783 (shown in table above) in PEP and $8,217 in YUM to determine what the annualized return was and what it is relative to the S&P 500. I will also look at the dividend amounts from PEP and YUM during the 5 years after the spin-off to see if the income stream continued to increase at the pace that was set prior to the spin-off.
5 Years After Spin Off
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The results of the 5 years after the spin off are mixed. On one hand, the annualized return is 4.29%, better when compared against the S&P 500. If my primary goal was total return, then I would be thrilled with the results. YUM provided all of the total return in this time period. YUM had an 86% return over the time period, and PEP had a -1% return. On the other hand, the yearly dividend growth slowed down substantially. This is due in part to YUM not paying a dividend at all until July of 2004. The dividend growth for YUM and PEP in recent years has picked up significantly when compared to the 3.71% CAGR for the 5 years after the spin-off.
Conclusion
If your time horizon was limited to the 5 years after the spin-off, the Yum spin-off from Pepsi could be considered a failure for a dividend growth investor. If that time horizon is extended, then it would be considered a large success. Recent years have shown significant improvement in the dividend growth of both of these companies. If I weigh the current dividend per share amounts by the original share count at the spin-off, the dividend CAGR would be 11.07%. This is a respectable dividend growth rate especially for such a long term horizon (since 10/7/1997). Patience would have prevailed for investors. It would be interesting to see how many investors stuck with this investment especially during the euphoria that was taking place with dot com investments.
Total return investors would no doubt be satisfied for the first 5 years after the spin-off, if they benchmark against the S&P 500. I was curious to see if the growth continued, and thus I extended the time horizon to present day. The annualized return, if the time horizon was extended to present day, would be 7.80%. This is still substantially better than our benchmark, the S&P 500. The S&P 500 (VFINX) returned 3.74% during this extended time horizon. This means the spin off performed 4.06% better on an annualized basis over this extended time horizon (10/7/1997 to 5/31/2012).
I will continue to look into additional spin-offs to see if any patterns emerge in respect to the dividend growth CAGRs and annualized returns. Since hindsight is 20/20, the ideal state in this example would have been to sell the parent company and use those proceeds to invest more into the child company. Over the past 14-15 years, Yum has outperformed PepsiCo when looking at total return. I believe that my behavior would have been to keep both the parent and the child company as Pepsi was a much larger holding when the spin-off occurred. It also was the only holding that provided a income stream with dividend growth which is my primary goal.
