Low-growth macro environment will lead to more spinoffs

The second quarter of 2016 marks the fifth consecutive quarter of declining S&P earnings. One result of the continued earnings recession plaguing companies? More splits and spinoffs, according to Goldman Sachs analyst David Kostin.

“We expect that the prospect of modest top-line growth and a difficult margin environment will spur managements to pursue corporate spinoffs as a means of boosting shareholder returns,” he wrote in a recent note to clients.

In 2015, the value of spinoffs at completion jumped by 81% to $176 billion, the highest level in the last 15 years. And given modest top-line growth and flat margins in 2016, he said he believes management teams will continue to pursue corporate spinoffs as a means to boost shareholder returns.

SpinCo equity cap during 2015 was driven by the $46 billion spinoff of PayPal (PYPL) from eBay (EBAY) in July, and the $30 billion spinoff of Hewlett Packard Enterprise (HPE) from Hewlett Packard Co. (HPQ) in October.

Goldman Sachs economists forecast US GDP will grow at an average annual rate of 2% in 2016, suggesting modest 4% top-line growth for US companies.

Meanwhile, Kostin added, S&P 500 profit margins have stagnated at around 9% since 2010, a trend he expects will persist.

Analysts say that the benefits of breaking up reflect spinoffs with a greater focus than conglomerates and flexibility to operate business. Additionally, leaner businesses that often have become attractive acquisition targets, adding a takeover premium. WhiteWave Foods (WWAV)—which was spun off from Dean Foods (DF) in 2013—recently was acquired by Danone.

Recent spin activity

A study led by Citigroup’s Chris Montagu showed that the average market-excess return upon announcement to the parent company is 1.4%, rising to 9.3% over the subsequent year. Spun-off companies also experience similar positive excess returns. This has fueled even more activity, according to the analysis.

Alcoa (AA), which just kicked off earnings season this week, recently detailed its plans to split into two companies.

The aluminum maker is changing its name to Arcnoic, with a focus on engineering parts for aerospace and automotive business. The spin-off of a new company, Alcoa Corp, will house the company’s traditional mining, smelting and refining divisions.

And, according to Kostin, many more will come.