In addition to the common list of reasons why spin-off stocks are likely to be good investments, the fact that they start without obvious sources of overhang.

The term overhang describes blocks of shares that are likely to be sold into a rising trend in the stock’s price, slowing or perhaps even stopping that rise.  In the markets right now you can see overhang in many issues by opening up first a daily 1 year chart and finding one of the many stocks that are up significantly over the past year.  Looks awfully good, doesn’t it?

Switch the chart view either to a 2 or 3 year chart.  Does the one you picked have a huge “mountain” on the left  side from the previous highs?  If it does, that is overhang.  And, what is that “mountain”?  Obviously it is a graphical representation of the path that the price of that stock has traveled over time, but more importantly it is a picture of everyone who bought shares at those prices that were higher than today’s price and are under water.  They are sitting on losses or they are out of the stock nursing their wounds from the losses they have taken.  The painful situation of the owners of those shares is literally hanging over the attempted rally.

At every level of the upward price path there is a new set of investors who are back to break even or are getting near enough to be thinking about getting out of this thing and just making it stop.  And, they are like an ongoing series of speed bumps or mudholes between you and where you want to go.

Spin-off stocks don’t have this.  Even when they head down for a while right out of the gate (and not all do), it is a different situation.  They are free of the reminders of past trades gone bad and once they start their uptrend they are moving into open spaces.

(Unless of course the spin-off was an IPO in which the parent had retained a significant number of shares as was recently the case with Bristol-Myers Squibb’s stock spin-off of Mead Johnson Nutritional which is another whole kettle of fish as discussed here earlier.)

Tags: Bristol-Myers Squibb, Mead Johnson Nutritional, overhang

When Bristol-Myers Squibb did the stock spin-off of its Mead Johnson (MJN) nutritional unit I wasn’t too excited about it, because I figured that it didn’t fit the successful spin-off stock model that tends to create a value situation, but I overlooked one place where it did, and that turned out to be an important one.

Generally, the simple stock spin-off in which shares of the new company are distributed to current shareholders of the parent company is the easiest kind for me to understand.  People get shares whether they want them or not.  For various reasons many of them don’t want or can’t keep the shares they receive, so they sell them soon after the spin-off which drives the price down below where it “ought” be by common measures of value.

The IPO route taken by Bristol-Myers Squibb did not hand shares to people who were very likely not to want to keep them.  It sold them to willing buyers.  So, I asked myself where the value creation force is in that.  No one had shares they wanted to unload right away and if you look at MJN’s chart you will see that they didn’t.  But something else was at work.

BMY kept 83% of the total shares of the company.  What this did was limit the public float.

Public float describes the number of shares that you or I or anyone else can go buy on a stock exchange.  The public float does not include shares owned by officers, directors, or others with a very large stake in the company.  In other words people who can’t or are very unlikely to sell them.

Thus, for large scale investors, no matter how good MJN might look to them,  setting up large positions was very difficult or impossible.  They couldn’t get in without distorting the market .

Going back to the reasons I like spin-off stocks notice the one about how the “big guys” often aren’t interested or can’t go there.   When I wrote that I was thinking of a case in which the spin-off company was simply too small for most big investors.

What I hadn’t considered was how this same thing might be accomplished by holding back stock and creating a small public float.  Nor had it occurred to me that when they completed the spin-off by selling the rest of the shares, this would be the selling that pushed the price down as the chart seems to show the October, November, December time span.

So, there it is:  lesson learned, (I think).  Will I be smart enough to see signs that an IPO spin-off has this potential?  To work both the potential for big price movements due to the small float and not get caught flat footed when the rest of the shares are dumped onto the market?  Frankly, I don’t know.  I hope I’ll be smarter about it, but of course these things never look exactly alike.  I do know that I will not reject an IPO spin-off out of hand.  Beyond that, we’ll see.

Tags: BMY, Bristol-Myers Squibb, Mead, MJN