What are the reasons behind Orgachim's Spin-off?

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What are the reasons behind Orgachim's Spin-off?

Orgachim () will spin off its production of phthalic and maleic anhydride through the restructuring of the company and the establishment of a new enterprise, it emerged recently.

The news was not received well by investors and accidentally or not the stock price of the company declined considerably.

This may be put down mainly to the poor arguments presented by the management for this decision for the split of the company.

Let's take a look at the reasons why a corporate parent decides to spin-off a subsidiary. The investor-friendly reasons usually are:

- Streamlining or consolidating business operations.
-Tying management performance more closely to the subsidiary’s performance.
- Freeing a subsidiary that is being held back by the parent corporation’s regulatory environment or other factors.

There have been numerous studies done on how spin-offs tend to outperform the market as well, if not better, than their former corporate parents.

So it’s important to know the parent companies’ motivation. Are they divesting underperforming assets to revive the parent stock, or breaking out quickly growing operations being held back?

In the case with Orgchim, it is the first one – the company is trying to get rid of its less profitable division.

However, the fact that it is less profitable doesn't mean that it is not worth anything.

When being a part of a big company, the non-profitable business is a burden and we all know that a company is valued on the basis of its financial results and not that much on its assets.

The separation of the “bad unit” will improve the results of the parent company and at the same time the new company may be looking for a buyer or good managers that would be able to turn it into a profitable business.

According to a study titled “Restructuring Through Spinoffs,” published in 1993 by Penn State University, spin-off companies outperformed peers and the S&P 500 Index by approximately 10% per year in the first three years after the initial spin-off.

The study, which looked at 25 years of market history, also found that parent companies outperformed peers by more than 6% the year after the spin-off.

A 1999 McKinsey study of 168 corporate restructuring showed that spin-offs substantially outperformed the market. The McKinsey study of companies spun off between 1988 and 1998 showed that the new firms had a two-year annualized total return to shareholders of 27%, versus 14% for the Russell 2000 and 17% for the S&P 500.

Spin-offs tend to outperform because investors often sell when they receive stock in a new company they never intended to own, keeping share prices low initially. Also, index fund managers sell off spin-off shares if the new company is not added to the original parent company’s index. Institutional fund managers will also sell spin-off shares due to lack of liquidity or dividend.

At the same time, management’s performance will have a greater impact on the shares of the spin-off than it had on the parent company, often spurring greater efforts to innovate and succeed.

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