Spinoff mania

Last week, two household names announced that they would be spinning off major sectors of their companies into separate entities. First, eBay, the giant consumer-to-consumer e-retailer, voted to spin off PayPal, its online payment service. Then, Hewlett-Packard (HP) announced that it would be spinning off its software and data operations into its own company.

Wall Street reacted positively to both announcements, sending shares of eBay up seven-and-a-half percent and those of HP up five percent.

Companies commonly spin off sections of their businesses when they feel that the two segments have different goals, or that one has outgrown the other.

eBay is a perfect example of the former. When eBay bought PayPal in 2002 for just $1.5 billion, PayPal was just a small startup that had pioneered a way to transfer money online. Though eBay had invested in its own online billing system, it realized that PayPal’s market share -- roughly 85 percent of all online payments -- would be crucial to the business of eBay and online transactions everywhere.

PayPal now accounts for more than half of eBay’s revenue, with an estimated valuation of more than $30 billion. Such a split would cut eBay nearly in half, with PayPal accounting for more than 45 percent of eBay’s market value.

In the case of HP, the software side of the business has clearly outgrown the hardware side. Founded in 1939 as a generator company, HP has gradually shifted away from PC manufacturing towards enterprise business solutions and data storage over the past decade. According to 2013 figures, HP’s hardware business now accounts for less than half of the company’s total value. Both sides have struggled in recent years, as the traditional desktop PC market has withered away.

In both cases, spinning off a large segment of the company allows the two entities to operate more freely.

PayPal faces more serious competitors now than ever before, as Apple Pay, Venmo, crypto-currencies and traditional credit card issuers have ramped up their operations to challenge PayPal’s reign. PayPal will be able to adjust its strategy and technology much more quickly without having to worry about what eBay is doing, and eBay will likely see similar benefits.

HP, however, is fighting just to stay afloat at this point. After its board debated selling various businesses within HP for months, the hardware-software split will allow both sides to move forward as smaller, nimbler companies.

Spinning off a business also gives investors more freedom in where they put their money.

Say you really like this company “Balloons ‘n’ Stuff.” You own 100 shares, and you think it has a big upside. Those shares represent a stake in the company’s assets and any profits it might generate.

But, the company also owns a porcupine zoo -- that’s the “Stuff.” As an investor, you believe that “Balloons ‘n’ Stuff” would probably be better as two separate companies: “Balloons” and “Stuff.” Maybe the porcupine zoo is expertly run and makes plenty of money, but you still think it should be separate.

Thankfully, the board listens and decides to split the company into two parts. Assuming it’s a simple 50-50 split, you now own 100 shares of “Balloons” and 100 shares of “Stuff.” You still have the same stake in both companies, and you’re still entitled to the future profits of both companies. But now you have the option to sell your stake in one aspect of the business and hold on to the other.

Though the terms of the split won't be set until 2015, the same is true if you hold shares of eBay before it spins off PayPal. Before the split, those shares will represent ownership in an eBay that includes PayPal -- after the split, you’ll have shares that represent ownership in just eBay and shares that represent ownership in just PayPal.

Stock splits might sound confusing, but it’s a basic concept. In the end, you own the same thing, but in a different way.