2023's Spinoffs: Johnson & Johnson, Kellogg, and Two Others

At least on Wall Street, people are not only willing to break up companies due to the fact that it's not a hard thing to do, but it's something that companies are considering as a way to maximize shareholder value.

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Among U.S. companies last year, Goldman Sachs reports that 44 spinoff announcements were made, which is a near-record number, according to the firm. It is expected that there will continue to be a lot of splits in the near future due to higher interest rates, the slowing economy, and the continued adjustments to business in the post-pandemic world.

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There is a tendency for management pitches for spinoffs to follow a similar script. It has been argued that a leaner, meaner company with more focused executives and investors, along with a more appropriate capital structure, will remove the "conglomerate discount" and boost the company's valuations.

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Recently, however, a growing number of spinoffs have changed from being a means of shedding underperforming businesses, obsolescent divisions, or unwanted debt, to being a way for companies to shed underperforming businesses or divisions.

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Among the 20 spinoffs that were completed in 2022, only six of them have outperformed their former parent companies' stocks in the stock market over the same period. Goldman Sachs data suggests that 55% of the 377 completed U.S. spinoffs since 1999 have beat their parents' stock-market performance by a median of four percentage points a year after the split, which goes against the history, which shows 55% of the 377 completed U.S. spinoffs since 1999 have done so.

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While there are some differences in performance, there is a wide range as well. 10% of the companies outperformed by at least 70 percentage points, whereas 7% of the companies trailed by at least 70 percentage points. There have been recent winners, including a spin-off of Sylvamo (SLVM) by International Paper IP -1.13% (ticker: IP) that has outperformed by 77 percentage points since the separation. However, IBM's (IBM) spinoff of Kyndryl Holdings (KD) has trailed by 59 points, which makes it the most significant loser in the list by a wide margin.

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The performance of an organization can be attributed to a number of factors. There are a few things that are relatively obvious: Spun-offs that have a lower valuation and have less debt tend to outperform their parents' shares. Some are easier to understand than others. Chris Senyek, the chief investment strategist at Wolfe Research, believes that during the period of 2011-2021, spinoffs that had lower profit margins than their sector outperformed their sector. This may be due to mature companies spinning off faster-growing businesses that become more profitable later in life. Historically, spinoffs from different sectors have also done better than their parents, he observes, because they have benchmarked against more relevant groups of peer companies than their parents or because they have used a new management team.

Here are four spinoffs planned for 2023 that deserve a look:

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• Kellogg K +0.33% (K) is envious of your munching habits. Mondelez International (MDLZ), a pure play on junk food, trades at 20.4 times 12-month projected profits, while Kellogg gets only 15.9 times. What is the issue? Its cereal business in North America. Despite owning names like Froot Loops and Frosted Flakes, it's developing slowly and going through a rocky patch that includes a strike and a fire at a Memphis facility. Kellogg intends to sell it off this year, keeping only its snacks, like Pringles and Pop-Tarts, plant-based meals, and cereal outside of North America. According to J.P. Morgan, the firm will have a smaller profit margin than the cereal industry but three times the sales growth, making it the more appealing portion of the acquisition.

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• Johnson & Johnson JNJ +1.36% (JNJ) will depart the consumer health sector later this year. Its spinoff, dubbed Kenvue, sells Tylenol, Listerine, and Band-Aids and accounts for around 17% of the present company's sales. Spun off, it may resemble Procter & Gamble (PG) and Colgate-Palmolive (CL), which trade at roughly 23 times projected earnings, much above J&J's 14.7 times. Separating should help the company gain more attention and a better valuation multiple, however outstanding liabilities from lawsuits alleging cancer-causing talc in baby powder will loom over the stock. J&J's fortunes will be related to its biotech and medical-device businesses, where its value makes more sense in comparison to rivals like Merck (MRK) and Pfizer (PFE) (PFE).

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• Crane Holdings (CR), an industrial company, intends to divide into two nearly equal-sized firms. The RemainCo will create components for power management, aerospace parts, and fluids for pumps and valves. The more intriguing Crane NXT is. It will provide materials and security features for national mints in addition to products for processing payments and cash at ATMs and self-checkouts in retail. It is a wager on the expansion of self-service checkout lanes worldwide and banking in emerging nations. The market value of Crane is $6.9 billion. Both firms may make lucrative acquisition targets after the breakup.

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• BorgWarner BWA -0.94% (BWA), a manufacturer of automotive components, intends to spin off its internal combustion engine operations, which are today's money generator, allowing the parent firm to concentrate on electric vehicle components, which are tomorrow's potential. According to Emmanuel Rosne of Deutsche Bank, a split makes tactical sense. While the remaining BorgWarner invests in EV development, it will enable the spinoff, Phinia, to optimize current revenues. Only one appears to be worth investing in. The EV company will have rapid growth, "best in class" EV exposure, and a value more than the current 10 times 12-month forward profits BorgWarner demands, according to Rosner. Yet, Phinia can be seen as a market dud that is melting at the edges. Investors ought to hold off investing until after the split.