Spin-offs are kind of similar to the above-mentioned split-off transactions, only that here the company is divesting part of its business into a second public company. Consequently, the parent company also distributes its shares in the spin-off on a pro-rata basis to its current shareholders. Often a spin-off is done to separate potentially undervalued business, which should help to increase the market’s awareness. Thus, if the market starts recognizing the previously undervalued business, it could increase the combined value of both companies and result in a profitable trade. Spin-offs include a considerable amount of valuation work as you have to estimate the potential value of the remaining parent and separated entity.
Aside from these basic mechanics, one other interesting potential opportunity may arise when the spin-off is done into an OTC stock. Most institutional investors are not allowed to hold OTC stocks, thus, creating significant selling pressure right before/after the transaction. This might offer a chance to play on the eventual rebound.
Additional research may include the shareholder structure – particularly if besides the institutional investors, there are any other large shareholders, which are likely holding the parent for its core business and won’t be interested in owning the spun company shares post-transaction. It is also necessary to look into management’s background – track record, share ownership, and spin-off-related role transfers.