The Hindu Business Line : When to spin off the profits

HOW can investors in the stock of a company benefit from a de-merger situation? For long-term investors, there is no rule of thumb that can be applied across all de-merger situations.

There are wide divergences in the way stock prices behave in the years after a de-merger.

However, there appear to be certain common trends in short-term stock price behaviour in de-merger situations:

The bulk of the short-term gains to be had from a de-merger situation seems to come in the immediate aftermath of the de-merger announcement.

It is not necessary that investors buy a stock on the first vague rumour of a de-merger.

Even if they wait for the de-merger proposal to be formalised at the company's board meeting, there is further scope for gains in the immediate aftermath of the de-merger announcement.

For instance, in eight of ten de-merger announcements examined above, the stock of the parent company registered a healthy appreciation in the three-month period immediately after the board meeting to clear the de-merger.

On an average, stock prices of the parent appreciated by 25 per cent in the three months after the board meet. But the gains made in the immediate aftermath of the de-merger announcement can evaporate after the initial euphoria.

For instance, few of the above stocks managed to sustain the gains registered in the first three months after the announcement, over the succeeding six months.

Most stocks tended to correct in value, even fall, after the initial three to six-month period. Investors may thus look to invest in the parent stock just on the eve of the board meet and use any sharp run-up in stock price over the next six months to exit.

Buying a stock soon after a de-merger announcement in the hope of a windfall on the listing of the de-merged company may not be an advisable strategy. Given that every de-merger proposal has to go through the long-drawn-out process of shareholder and court approvals, the listing of the new entity may take months and, in some cases, even over a year.

In the best case, the de-merged company has been listed six months after the board meet to clear the proposal. In the worst case, investors may have had to wait as much as a year and four months.

Since brief market rallies may come and go in as short a period as six months, there may be a significant opportunity loss involved in such a strategy.

The stock prices of the parent company (the original company) usually tend to weaken in the first few months after the de-merged entity is listed, as the newly listed company draws all the attention.

Due to their small size and sharp focus on core business, the products of de-mergers often appear to end up as targets for acquisition. The Syngenta India and Cyanamid Agro cases appear to buttress this point. But those looking to invest in newly listed spin-offs should probably wait for the company's valuation levels to stabilise before investing.

In many cases (such as those of Syngenta, Sterlite Opticals, Wockhardt Life Sciences), the de-merged company has tended to list at very high valuation levels. Valuations have subsequently slumped as a clearer picture of financials became available from the company's maiden results announcements.

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