Young spin-off companies generate big rewards

Established tech companies are increasingly spinning off portions of their businesses through initial public offerings, a trend that investors are finding nearly irresistible.

Dawn Kawamoto Former Staff writer, CNET News
Dawn Kawamoto covered enterprise security and financial news relating to technology for CNET News.
Dawn Kawamoto
4 min read
Sometimes small is big.

Established tech companies are increasingly spinning off portions of their businesses through initial public offerings, a trend that investors are finding nearly irresistible for a couple reasons: Tech IPOs are hot and the young companies have a strong pedigree through their association with the successful company that spawned them.

The past few months have seen several such deals, and more are in the works.

Oracle spun off set-top box software maker Liberate last July, and Microsoft marked its first spin off with online travel site Expedia earlier this month.

So far, the spin-offs have been can't miss propositions for investors, and in the case of HP the progeny is helping boost shares in the parent company.

Expedia shares went public early this month at $14 and are currently trading at about 42. Liberate went public in July at $16 and is now at about 160.

Meanwhile, HP owns 85.4 percent of Agilent, which jumped to as high as 50 today from its IPO price of $30. Because HP plans to distribute its Agilent stake to current shareholders, HP's stock also climbed about 17 percent today.

"At some point, the stocks will trade in tandem," explained Phil Rueppel, an analyst with Deutsche Banc Alex. Brown. "If you buy an HP share, you get more than 80 percent of Agilent. That's a quick and simple way to look at it."

Kurt King, an analyst with Banc of America Securities, said every $1 movement in Agilent's share price should translate into a 36-cent price movement for HP's stock.

He added that Agilent's spin-off represented 15 percent of HP, and, as a result, had a greater affect on the computer giant's shares.

"With Microsoft, I don't think they have anything in their operations that would be as big as the company if they were to spin it off that could move Microsoft's stock," King said.

If the parent company does not distribute shares in the spin-off to shareholders, "then there is the potential for the valuations to diverge much more greatly," Rueppel said.

HP plans such a distribution to shareholders, although no details have been determined. Microsoft, which holds a 86.4 percent stake in Expedia, and Oracle, which owns 48 percent of Liberate, do not plan to distribute shares.

That difference apparently was reflected in the stock performance of the two giants on the day their spin-offs debuted, with Microsoft dipping slightly and Oracle rising slightly.

Phil Leigh, an analyst at Raymond James, said large companies are spinning off their operations more to unlock hidden valuation, rather than achieve a direct run up in their stock.

"Certainly they have P/E envy," said Leigh, referring to the high price-to-earnings ratios that many Internet companies now enjoy. "Spinning off a unit is a great way to unlock the valuations that might be locked up in their stocks that might be trading at more conventional price/earnings multiples."

But some analysts say such spin-offs may taper off.

"I think this is going to be a temporary trend," said David Menlow, president of IPO Financial Network. "Although these IPOs are getting a great reception now, the tune will turn flat with investors as a whole unless companies start spinning off operations that are in the heart of what the IPO market is most after right now."

Menlow said that investors are going to look for companies that are building the plumbing, or infrastructure, of the Internet.

For example, the stock of little-known companies such as Foundry Networks and Cobalt Networks have soared on the public market.

"Investors are coming after these 'plumbing' companies in a manner that is beyond description," said Menlow. "It is past a feeding-frenzy environment." As a result, if Cisco Systems or Lucent Technologies were to spin off a division, those IPOs would likely be wildly successful.

David Simons, managing director of Digital Video Investments, warned that a lot of the spin-offs come with baggage and may be less attractive despite the brand name tied to their background.

"A lot of these companies, with the exception of Liberate, come with baggage, with history, whereas many of the new companies come with limited or no history," said Simons. "So it is easier for investors to buy them on the sizzle of a story."

Other analysts, however, cited the name recognition as a contributing factor for helping these companies shoot out of the gate.

"I think that Expedia will benefit from its affiliation with Microsoft not only in perception of the investor, but also in the perception of the consumer," said Leigh.

Leigh said that consumers might feel greater confidence in the products and services offered by a company backed by a well-known parent.