Stocks to Watch 2014: Major Spin-Offs Ahead

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Breaking up may be hard to do, but on Wall Street it's the thing to do in 2014.

Indeed, a trio of big U.S. companies announced spin-off plans yesterday (Monday):

  • Chesapeake Energy Corp. (NYSE: CHK), the country's second-largest natural gas producer, filed paperwork to separate from its oilfield services business Chesapeake Oilfield Operating LLC. The unit is expected to be renamed Seventy Seven Energy Inc. and will trade on the New York Stock Exchange under the ticker "SSE."
  • Sears Holdings Corp. (Nasdaq: SHLD), the biggest U.S. department store company, announced its board has approved the spin-off of the company's Lands' End clothing business. Lands' End will trade on the Nasdaq with the ticker "LE" in early April.
  • Hertz Global Holdings Inc. (NYSE: HTZ), the largest publicly traded U.S. rental car company, reported it will detach itself from its equipment rental unit. Details of the split are expected this week.

The busy spin-off activity is creating a list of "stocks to watch," as some of the biggest profits for investors can come from spin-offs.

Why Companies Engage in Spin-Offs

While spin-offs can take many forms, the end result is the same: A company takes a subsidiary, a subdivision, or part of its business and separates it to create an independent free-standing business.

There are many reasons to do a spin-off.

Sometimes, successful but unrelated businesses are separated to unlock untapped potential for the unit, parent company, and shareholders. Sometimes, a thriving business' aim is to shed itself from an underperforming or heavily regulated business that has become a drag.

Spinning off subsidiary businesses has become an increasingly popular way to create shareholder value while also reaping a tax advantage. A spin-off distribution can be made tax-free to both the parent company and the receiving shareholders.

Several studies show spin-offs tend to outperform their parent companies.

A 25-year Penn State study showed that stocks of spin-off companies outperformed industry peers and the S&P 500 by about 10% per year. And a J.P. Morgan study revealed that spin-offs beat the stock market by more than 20% on average during the first 18 months after the transaction.

Spin-off shares tend to be inexpensive right out of the gate because investors frequently sell when they receive stock in the new company – one they never intended to own. Additionally, spin-offs are dumped by index funds when the new company isn't part of the underlying index. Moreover, institutional fund managers are quick to sell spun-off shares due to their lack of liquidity or dividend.

Yet providing a cushion and catalyst are insiders who often receive generous incentives to make the spin-offs work. Plus, management of the newly separated company is keen on finding ways to boost shareholder value.

Following are 22 more notable spin-offs expected this year.

Stocks to Watch: Spin-Offs to Look for in 2014

Agilent Technologies Inc. (NYSE: A) will spin off Keysight Technologies, its electronic measurement unit, sometime this year.

Darden Restaurants Inc. (NYSE: DRI) will spin off its seafood chain, Red Lobster, in Q2 2014.

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