Stock spinoffs are one of my favorite corporate events. If you are a shareholder of a company that is undergoing some kind of divestment, it is usually wise to pay attention. It is almost certain that the spun-off company has a different growth profile, earnings quality, and overall debt picture than the parent. Sometimes, a spinoff is done to pass off liability–like when Arch Coal and Peabody Energy shed assets to create Patriot Coal which was destined for immediate bankruptcy (a matter that is still being litigated to this day.)
Other times, the company spinning off the stock is the one in trouble–look at what Sears has done since 1993. In the end, Sears will go bankrupt, but in the past two decades you would have collected Allstate, Discover Financial, Morgan Stanley, Sears Canada, Lands’ End, and perhaps even a Seirs REIT before it is all said and done. That portfolio of spinoffs has collectively beaten the S&P 500 by such a wide margin that someone buying Sears stock in 1993 would have beaten the S&P 500 by almost two percentage points annually since then.
The nice thing about owning Sears for the past two decades is that it didn’t require any sophisticated decision-making: you did absolutely nothing, and these brand new companies would show up in your account. You got the shares, and then you had to affirmatively take the action of selling it if you wanted to get rid of it.
The General Electric divestment of Synchrony Financial belongs to a subset of spin-offs known as “split offs.” This is where you have to choose how much of the new split-off stock you want, and you have to give up your existing stock in order to acquire it. This is how McDonald’s discarded Chipotle. Unlike a spinoff, a split-off gives the former parent company a big chunk of cash. If the GE divestment were structured as a spinoff, the industrial company would simply hand the new company Synchrony to shareholders and then have nothing to do with it ever again.
In a split off, you have to give up your stock to make the acquisition–you give The General Electric Company your shares of General Electric stock, and then they will hand over part of Synchrony Financial to you in exchange. GE will then take that $30 that they receive for each share and either convert it into cash or use it to retire shares of its own stock.
Of course, General Electric deciding to conduct a split off requires them to talk out of both sides of their mouth a little bit. Ever since April, General Electric has been talking about cleaning up its balance sheet, removing the financial assets that were around during the financial crisis, and improving the company’s earnings quality by becoming a firm that focuses almost exclusively on industrial products. Now, it has to turn around and convince investors that it is worth picking up shares of a financial asset that had been publicly ridiculed in the months previously.
This is the situation: General Electric owns 84.6% of Synchrony Financial. Synchrony has 835 million shares outstanding, and as of October 18th, 2015, General Electric owned 705 million of them. Between October 19th and November 16th, General Electric is trying to dump the entirety of its 705 million stake.
GE knows that this is a lot of stock to dump in a short period of time, and it also knows that many of its shareholders still consider GE as the quintessential blue-chip stock and are happy to see the company divest its financial assets. In short, the shareholder base is somewhat reluctant to embrace Synchrony Financial with open arms.
To sweeten the pot a little bit, GE isn’t making the exchange a perfect pro rata distribution. Instead, for each $100 of General Electric that you choose to tender, you will receive $107.53 worth of Synchrony Financial stock. The Synchrony stock trades at $30.76. You get to collect 1.01 shares of Synchrony for every General Electric share that you tender.
I’ll give a demonstration of how this transaction might look on a round lot of 100 shares.
Say you currently own 100 shares of General Electric. The stock trades at $28.92, giving you a $2,892.00 value for your holding. You decide you want to trade in half of your position (50 shares) of GE for shares of Synchrony.
You call or e-mail your broker and issue the instruction. Tell them you own GE, and state how many of the shares you want to tender for Synchrony. Their order will go through later that business day. At 4:30 Eastern Time each day, the exchange of GE to Synchrony stock has its rate reset because the $107.53 must be divided against the closing price of Synchrony that day.
After informing your broker of your tender order, your new situation should look like this:
50 shares of General Electric that earn $65 per share in annual profits and pay out $46 in dividends.
50.5 shares of Synchrony Financial that earn $131 in annual profits but pay out no dividends.
The market value of the 50 GE shares would be $1,446, and the market value of the Synchrony shares would be $1,553.38. That $107+ surplus you see created on those 100 shares is your incentive to give up your General Electric stock. If you tendered all 100 shares, you would have an extra $214.
For every 100 shares of General Electric that you tender in exchange for Synchrony Financial, you get $214. That’s your incentive to engage in the transaction. It’s a shrewd way for GE to attempt to unload 705 million shares in a little over three weeks. If you don’t tender your shares, you get to own the pre-eminent industrial firm in the world that has enormously vast operations. If you do tender your shares, you receive a decent bit of free money, but you must accept an ownership position in a private credit card label that has inferior operations to Visa, Mastercard, American Express, and maybe even Discover Card. It truly is a decision that involves trade-offs: you either leave free money on the table, or lower the earnings quality and maybe even growth profile of your investment a bit.