Spinoffs: the piece nobody chose

Imagine your uncle owns a big shop that sells two very different things: sweets in the front, and cycles in the back. One day he decides the two do not belong together, so he splits them. The sweet shop stays as it is. The cycle part becomes its own separate little shop, standing on its own, with its own owner and its own signboard.

Now here is the funny part. Everyone who owned a piece of the old big shop is suddenly handed a piece of the new little cycle shop too - even people who never cared about cycles at all. They wanted sweets. They did not choose the cycle shop; it was just dropped into their hands. So what do many of them do? They sell the cycle-shop piece straight away, quickly, without really thinking about whether it is any good. They just want it off their plate.

When a big company cuts off a small part of itself to become a separate, independent company, that new small piece is called a spinoff. Joel Greenblatt loved spinoffs. He noticed that because so many owners dump the new little piece at once - not because it is bad, but because they never wanted it - its share price (the price of one small piece of it) can be pushed down far too low for a while. And a price pushed too low, for a silly reason, is exactly where a careful reader goes looking. This study is about why that happens, and why it can create a bargain.

Think about why people sell a spinoff without thinking. A big fund might own the giant parent company because it is big and important. When the tiny spinoff lands in its hands, that little piece is too small to matter to a huge fund - it is a nuisance. So the fund sells it, not because it studied the little company and disliked it, but because it is too small to bother with. Many small owners do the same: they never wanted the cycle shop, so out it goes.

Now remember what a crowd of sellers does to a price. When many people want to sell the same thing at the same time, and few people want to buy it, the price drops. This is not a judgement about whether the little company is good or bad. It is just supply and demand - too many sellers rushing for the door at once. For a while, the spinoff can trade well below what its own business is actually worth, purely because of this wave of unthinking selling.

So the read is this. When you hear that a spinoff has just happened, do not assume the new little company is weak just because its price fell. Ask instead: is this price low because the business is bad, or low because a wave of owners who never wanted it are dumping it at once? If it is the second reason, the low price is a gift left by other people's carelessness - and after the selling wave passes, the price may slowly find its way back up to what the business is really worth.

illustrative Suppose a big company called Sunrise Group spins off its small snacks business as a new company, Kavi Foods. On its own, Kavi Foods steadily earns a profit (money left after all costs) of about ₹30 per share, and a calm, sensible price for such a steady little business might be around ₹300 a share.

But look what happens in the first weeks. Big funds that owned Sunrise Group are handed Kavi Foods shares they never asked for, and Kavi is too small for them to care about, so they sell. Small owners who wanted the big company, not the snacks, sell too. This flood of sellers pushes Kavi's price down to just ₹180 - not because ₹180 is what the business is worth, but because everyone rushed for the exit at once. A reader who understands why the selling is happening can see that ₹180 does not match a steady ₹30-a-share profit. Months later, once the wave of careless selling is over and a few people finally study the little company on its own, the price drifts up toward ₹300. The business never changed. Only the crowd's rush to dump it did.

Some spinoffs are cut off because they are the weak part. Sometimes a parent company keeps the good business and pushes out the troubled one - loaded with debt, or with a shrinking market. Then the low price is not careless selling; it is a fair price for a weak business. You must check which piece got spun off, and why. A spinoff is a place to look, not proof of a bargain.

Not every spinoff falls to a bargain price. The idea that owners always dump the piece is a tendency, not a law. Sometimes the little company is exciting and people rush to buy it, pushing its price up, not down. The unthinking-selling bargain only appears when the piece is dull, small, and unwanted. If it is popular, there may be no bargain at all.

The selling wave takes time, and so does the recovery. Even when you have found a genuinely good spinoff that was dumped too cheaply, the price may take a long time to recover - or may not recover the way you expect. Reading the situation correctly does not promise a quick reward. It only tips the odds in your favour if you have done the work and can wait.

Spinoffs and demergers happen in our markets too, when a group decides to separate two different businesses into two listed companies. The same human behaviour appears: owners who wanted the big, familiar name may sell the new smaller piece without studying it. So the habit transfers well - when a demerger happens, look at the smaller, unloved piece and ask whether it is being sold cheaply for a silly reason. But the warnings matter even more here. In India you must also ask whether the group treated the small piece fairly when splitting - did it push the debt onto the spinoff and keep the good assets? Did it give small shareholders a fair deal? The low price could be careless selling, or it could be a genuinely poor business handed a bad start. The reading tells you where to look; only careful study of that particular company can tell you whether it is a bargain or a trap.

• Watch for the split itself. When a big company cuts off a small piece, that new piece is the place to look - few others are studying it.
• Ask who is selling, and why. If owners are dumping it only because they never wanted it, the low price may be a careless gift, not a true verdict.
• Check which piece got spun off. Is it a healthy business set free, or the weak, indebted part being pushed out? That decides bargain versus trap.
• Study the little company on its own. Ignore that it used to be part of something famous. Read its profits, its debts, its owners.
• Be ready to wait. The selling wave and the recovery both take time. Only use patient money, and only after you have done the reading.