All Is Not Equal in the World of Spinoffs

By Jerry Knight
Monday, August 1, 2005

When Marriott International Inc. spun off a new real estate investment company to buy hotels, so many investors wanted in on the deal that the year-old company, DiamondRock Hospitality Co., sold $292 million worth of stock in May instead of the $172 million it had first offered.

When David Gladstone decided to add a third member to his family of firms that invest in small businesses, investors inundated him with $230 million -- even though Gladstone Investment Corp. had yet to make a single deal when it went public in June.

But when Liberty Media Corp. spun off its stake in Discovery Communications Inc., the Silver Spring creator of more than a dozen cable TV channels, investors yawned and watched the stock drift down after it began trading three weeks ago.

All spinoffs are not created equal.

Usually buying stock in the newly minted offspring of an existing business is a better bet than investing in the initial public offering of a start-up. Academic research shows stocks of spinoffs generally outperform other new issues.

The reason: Spinoffs have a track record, a proven business strategy and often even profits. None of those are necessary to sell an initial public offering -- though investors these days are more demanding than they were a few years ago when the IPO market was red hot.

Spinoffs often have another advantage -- the new venture is freed from the corporate confines of its parent. The offspring operation can be more entrepreneurial, more nimble, than it was as a division of a bigger company.

There's no better example of that than Trex Co. in Winchester, which makes plastic composite deck boards under a process developed by what is now Exxon Mobil Corp. The decking business was never going to be more than a blip on the balance sheet of the world's largest oil company, so the venture was spun off to its managers. Trex has grown to become the dominate player in its business, which probably wouldn't have happened under the Exxon Mobil umbrella. Even if it had, Trex profits wouldn't have made a bit of difference to anybody investing in Exxon Mobil.

Entrepreneurial freedom -- or lack of it -- is an important reason the market is showing so little interest in the stock of Discovery Holding Co., parent of Discovery Communications.

Before last month's spinoff, Discovery was owned by three mega media companies -- Liberty Media Corp., Cox Communications Inc. and Advance/Newhouse Communications Inc. It became publicly traded when Liberty Media spun off its 50 percent stake in the venture to its shareholders.

In a somewhat unusual transaction, there was no initial public offer. Liberty Media simply passed out Discovery Holding stock to its shareholders -- who got one share of Discovery for every 20 Liberty shares they owned.

Instead of investment bankers setting the price of Discovery shares, that decision was left to the market.

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