Lukewarm Reaction to Corporate Splits Dings Hedge Funds

Wall Street Journal

Liz Hoffman and Rob Copeland

Oct 21, 2014

Corporate slim-downs aren’t the moneymakers they once were for investors.
U.S. companies looking to focus on their core businesses are spinning off or selling divisions at a record pace, moves that, in the past, have given shares a healthy boost.
But lately, those efforts have been met with investor indifference at best and selloffs at worst. Even when shares jump on spinoff news, gains quickly shrivel. That has meant losses for some hedge funds that seek to profit from—and sometimes actively push for—such corporate splits.
Big bets on Hertz Global Holdings Inc. and eBay Inc. have soured after the companies announced plans to slim down. Similarly, Hewlett-Packard Co. and Symantec Corp. popped earlier this month on news of potential split-ups but quickly coughed up the gains.
“It’s been brutal,” said one portfolio manager at a New York-based hedge fund. “You spend months in a stock, hoping for something to move the needle, and then it comes along and it’s a mess.”
Some attribute the muted reaction to broader market swings, which have pushed investors to cut exposure to some stocks to cover losses elsewhere. Others cite company-specific factors like falling commodity prices or poor quarterly earnings.
The spinoff slumps exacerbate a tough run for hedge funds, especially those that wager on corporate spinoffs, mergers and other shake-ups. These funds have been hit hard by recent market turmoil and by the collapse of the year’s largest corporate deal, AbbVie Inc. ’s $54 billion takeover of Irish drug maker Shire PLC.
Over the past year, 46 companies that announced a spinoff have seen their median stock prices drop 0.3%, versus a 2.4% rise in the S&P 500 index, according to FactSet. Thirty days after announcement, the median had returned 1.2%, versus a 1.7% rise in the broader index, according to FactSet.
Hertz is down 21% since laying out plans in March to spin off its equipment-rental business, versus a 2% gain in the S&P 500. EBay dropped 7% since announcing it would spin off its online and mobile payments unit, PayPal, versus a 3.5% drop in the broader index.
“There are some winners but the performance tends to range from in-line to poor,” Gordon Haskett Research Advisors wrote in a note earlier this month. “The pops are modest and way too short-lived to make any real money.”
Many corporate breakups work out in the long run. From Time Warner Inc. to ConocoPhillips, many former conglomerates now see their parts trade higher apart than together, on the theory that narrowly focused companies are easier to manage and nimbler amid market shifts.
But those returns can come too late for investors that wager on corporate shake-ups, so-called event-driven hedge funds that tend to have shorter investment horizons.
As a group, these funds fell about 1% in the third quarter, their first quarterly drop in more than two years, according to research firm HFR Inc.
Among hedge-fund firms squeezed by spinoff stocks are $13 billion Fir Tree Inc., which has bet heavily on Hertz and eBay, and $25 billion York Capital Management LLC, which backed Hertz and B/E Aerospace Inc. All three companies have underperformed the market since announcing division spinoffs.
Fir Tree Value Fund LP dropped about 2% in the third quarter, a person familiar with the fund said. York Investment Ltd. fund is down nearly 7% this month through Friday, though it is up about 1% year-to-date, another person said.
B/E Aerospace Inc. had been a drag on performance at several firms. Shares are down 22% since the company said in June it would split in two. Four of its top nine holders as of June 30 were hedge funds, including York, Och-Ziff Capital Management Group LLC and Relational Investors LLC, the activist firm formerly run by Ralph Whitworth. Citadel LLC, Kenneth Griffin ’s hedge fund, also held shares, filings show.
Funds’ updated holdings won’t be disclosed until mid-November. Some may have pared positions in underperforming stocks over the summer. What’s more, speculation of a spinoff had driven some stocks higher ahead of formal announcements, giving firms a chance to pocket gains before shares fell.
Some companies have other issues weighing on their stock price. Hertz fell sharply after its CEO resigned last month amid disappointing results and accounting problems, while eBay fell on disappointing third-quarter earnings.
Investors cheered some spinoffs, bucking the trend. Energizer Holdings Inc. is up 20% since late April, when it announced plans to separate its household products from its personal-care businesses, versus a 1% rise in the S&P 500.
The stock slumps could make life tougher for activist investors, who have publicly pressed companies to slim down. Tepid market reaction to these ideas could force activists to up their game, Don Bilson, an analyst at Gordon Haskett, said in an interview.
“Activists may have to bring more to the table than just ‘break up the company,’ ” Mr. Bilson said. “Today, that alone may not be enough.”