Many market experts predict a very positive year for stocks in 2014. However, according to a report in today's Australian newspaper, equity strategists at Credit Suisse beg to differ and predict that companies will have to begin "helping themselves". This is because of a sluggish backdrop for the economy and profits, due to subdued Chinese growth and weak domestic earnings.
Demergers are the tool that enable a company to help itself. Sometimes referred to as a spin-off, a company is split into two or more fully independent parts. In 2013 several companies demerged or revealed plans to do so, including Brambles (ASX: BXB), Amcor (ASX: AMC), UGL (ASX: UGL) and Westfield (ASX: WDC).
According to Credit Suisse, there are up to 14 companies that could undertake restructures this year, including National Australia Bank (ASX: NAB) and QBE (ASX: QBE). The former may spin off its troubled British arm, while the latter may sell its non-core businesses in the US and Europe.
To provide evidence on how to profit from demergers, I scanned a study conducted over 10 years by the Centre for Economic Performance (CEP), one of the leading economic research groups in Europe.
The results showed that, unlike mergers, demergers are, on average, beneficial for shareholders. Findings revealed that the spun-off entity, or smaller part, far outperformed the market (by 18%) over the three years following the demerger, with most of the value creation occurring in the second year. The larger parent tended to slightly underperform the market.
Some small parts of a larger organization are starved of cash. These "hidden jewels" are able to raise new capital in the market within weeks of the demerger. It is very clear that after the demerger announcement and for the long-term these companies performed extremely well, though CEP found there was insufficient data to draw a statistically significant result.
Large firm demergers underperformed the market by 20%, resulting in the parent underperforming by 29% in the following three years. However, for small firms the parent and spin-off together significantly outperformed the market by 26%.
Foolish takeaway
The comprehensive study shows there is money to be made for the medium-to-long-term investor from demergers. An opportunity may arise with the rash of upcoming demergers by focusing on "hidden jewels", smaller spin-offs and smaller parent firms.
