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.
The first few trades were at $18.50 a share. At that price there were more shareholders willing to sell than buyers wanting the stock. In what amounted to a reverse auction, the price slipped until the buyers and sellers balanced out. The market's verdict so far is that Discovery Holding stock is worth about $14 a share. The shares (DISCA on the Nasdaq Stock Market) traded around that price all last week, closing Friday at $14.27.
So far, the stock has mostly gotten neutral ratings from media industry analysts and pans from firms that specialize in stocks of spinoffs.
"The typical features that you see in a spinoff to lay the foundation for future growth are not there," said Al Cardilli, an analyst with Spin-Off Advisors LLC of Chicago.
What's missing, he said, is the entrepreneurial freedom. Because Cox and Advance/Newhouse own 50 percent of the stock and Liberty Media Chairman John C. Malone owns a big stake, they call the shots. Malone remains chairman of both companies; the same four people occupy the top jobs at both Liberty and Discovery Holding, and Discovery's corporate offices are in suburban Denver. Operations of Discovery Communications in Silver Spring are run by chief executive Judith A. McHale. The company was founded by John S. Hendricks, who is chairman.
"There's nothing new," Cardilli said. "We think it's a nonevent."
"If you owned Liberty before, we wouldn't be a seller [of Discovery Holding shares]. If you didn't, we wouldn't be buyers."
Discovery would be a more interesting investment if Cox and Advance/Newhouse sold their stakes to the public, Cardilli and other analysts say. But as long as majority control remains in the hands of the three big investors, the benefits of being a spinoff will be muted.
In contrast, the governance of DiamondRock Hospitality has clearly been separated from Marriott International, from which it springs. DiamondRock Chairman William W. McCarten and President John L. Williams are long-time Marriott executives. But neither the Marriott company nor the Marriott family have representatives on the board, even though Marriott International is DiamondRock's biggest shareholder.
DiamondRock was formed 13 months ago by Marriott and private investors who put up $196 million and began buying hotels, primarily Marriott hotels that needed upgrading. In May, the company want public, drawing so much interest from investors that DiamondRock was able to raise 70 percent more money than originally projected.
By the standards of today's initial public offering market, DiamondRock stock is off to a good start. Trading on the New York Stock Exchange as DRH, the stock has risen from the May 25 IPO price of $10.50 a share to close Friday at $12.01.
It's too soon to gauge Wall Street's reaction to the IPO of Gladstone Investment (GAIN on Nasdaq), the latest public company launched by David Gladstone, the well-known Washington specialist in financing small, private companies.
Gladstone Investment went public five weeks ago at $15 a share and the stock closed Friday at $15.20. The lack of movement is no surprise, given that the company, which plans to buy small businesses, has yet to announce its first deal.
Ferris, Baker Watts Inc. of Washington managed the offering and had no trouble attracting Washington investors, largely because of Gladstone's track record.
Once a top executive at Allied Capital Corp., and later American Capital Strategies Ltd. -- two other local firms that finance small businesses -- Gladstone and his team in McLean also run Gladstone Capital Corp. (GLAD on Nasdaq) and Gladstone Commercial Corp., a real estate investment trust (GOOD on Nasdaq).
Gladstone's strategy is straightforward. "We try not to do crazy things and go for home runs, just doubles and singles," he said. "Slow, natural growth." That approach produced a 34 percent total return (dividends plus stock price growth) over the last 12 months for Gladstone Capital.
While Gladstone Capital makes loans to and investments in small companies, Gladstone Investment is a buyout fund that will acquire small firms, the founder said. The original firm mostly generates income from its lending, while the latest one, as its trading symbol hints, mostly seeks long-term capital gains.
All three companies take advantage of federal tax law provisions that allow them to pass through profits to stockholders untaxed. That means that once GAIN gets going, it will be generating capital gains that will be taxed at a lower rate than the ordinary income paid out to GLAD shareholders.
To make its stocks even more attractive to small investors, the Gladstone companies pay dividends monthly -- a plus for retirees looking for regular income.