If you haven’t noticed, recently some of the biggest household companies are getting smaller and some are just about to become smaller. DuPont, United Technologies
UTX
, IBM
IBM
, and General Electric
GE
are just a few of the multi-billion-dollar corporations that have decided that the sum of their parts is greater than the whole in recent years. Kellogg
K
, 3M Co. and Danaher
DHR
are scheduled to break up later in the year too. But why this phenomenon?

Spinoffs As Investments

For several reasons, break-ups, or more formally Spinoffs, are seen as solid corporate actions for value creation. Firstly, management of businesses naturally prefer to add to or grow their assets rather than get rid of them, so when a business decides to Spinoff a segment, it’s typically because it has the potential to perform better on its own. Secondly, because of their smaller size and a management team that is driven to succeed, Spinoffs can have a significant potential for growth.

Thirdly, unlike segment sales, Spinoffs typically generate more value for shareholders since the distribution and listing frequently attracts a higher public market valuation. Finally, Spinoffs frequently succeed because the new firm may raise its earnings multiple, which raises its value. Knowing these four pointers will put you ahead of the masses and help to avoid value destructive situations (like the average IPO in recent years). It’s something you should put on your investment radar in these sideways moving markets.

Spinoff Performance

Spinoffs can be very sector and market cap specific, but our 22-year study (2000-end 2022) shows that on average, Spinoffs generate a return of 17% one year after the effective date, while Spinoffs generate 25% return two years after the effective date, more than doubling the returns of the S&P 500’s 12%, the MSCI World Index’s return of 9%, and Euro Stoxx 600 Index’s return of 2%.

Spinoffs, Not IPO’s

Before we head down into the rabbit hole, something should be clarified. Spinoffs are the most valuable corporate action when it comes to a break-up. They are not manufactured investments like IPO’s, which are sold to the public at the highest possible price. With a Spinoff, you gain shares of the Spinoff company whether you like it or not, which throws up a range of dynamics. In fact, Spinoffs are the most inefficient way of distributing stock to the wrong people, but that creates opportunity.

Alibaba announced a breakup recently, followed by JD.com. Unlike press and media coverage purporting them as ‘Spinoffs,” they are in fact IPO’s. Take a listen to my recent appearance on CNBC below for a view on that particular break-up.

However, Alibaba breaking up into six segments is still significant. The company has been troubled for a long time, facing heat from investors on growth, US-China dual listing, regulatory clamp-downs, ambiguity on Jack Ma’s presence, his successor’s ability (Daniel Zhang), Covid lockdowns, and the economic slowdown in China. However, recent announcements will boost investor confidence and also provide a signal to other tech companies on how they can create value and maintain their legacies.

The Case for Big Tech Break-Ups

Of all sectors, big tech hasn’t succumbed to breaking itself up as it chose to get larger and larger. With size come problems.

Tech companies are facing multiple challenges as they grow in different phases: Meta is rolling out its roadmap for handsets and wearables through 2027; TikTok is facing regulatory scrutiny from the US, EU, and Canada; and Twitter’s declining performance post-takeover (earnings fell -40% in Dec 2022). Additionally, META’s enormous investments in the Metaverse might not suit investors’ current interests as investment returns in the Metaverse are expected in the long-term. We at The Edge believe these external factors are forcing big tech to think differently, such as Alibaba’s plan to reshape its empire through the exploration of a six-way split of its business units. JD.com has also recently followed Alibaba’s strategy through its own separation of its Property and Industrials units. Alibaba’s successful restructuring will stand as a great example for other big tech conglomerates on value creation through break-ups.

Regulatory Scrutiny

What I’ve found over the years is the bigger and more powerful the company is, the reluctance to break-up is stronger. However, they could be forced to.

Although the size and impact of major tech corporations like Google
GOOG
, Meta, Apple
AAPL
, and Amazon
AMZN
have come under growing scrutiny and criticism, breaking them up would require significant legal and regulatory action, which has not yet appeared, but watch this space. The momentum is building.

Having said that, a few recent events have the potential to result in more regulation of major digital firms. To address concerns about data privacy, competition, and other issues, new legislation has been proposed as well as antitrust actions that have been brought against some of these businesses.

Ultimately, several variables, such as public sentiment, political pressure, and legal changes, will determine whether large digital businesses are broken up. It may not take much to get there in the current political and social environment and if the economy takes a downturn, these businesses will be under more pressure to act.

Spinoffs can unlock the value of the FAANG stocks. The probability of Spinoffs increase as we see regulatory interference in big tech companies. Governments across the globe are considering new regulations that limit how big tech companies can treat their smaller competitors. Most recently, on January 24, 2023, the US Justice Department sued Google for monopolizing digital advertising technologies. Furthermore, the Federal Trade Commission (FTC) pursued changes in August 2022 to how big tech (Amazon, Apple, Facebook, and Google) handles consumer data. They aim to focus on any actual harm caused by data collection, whether through data breaches, ad targeting, or algorithmic discrimination, and how big tech companies’ automated decision-making systems might impact consumers without their knowledge. To answer these factors, we believe Spins are a way FAANGs can boost investors’ confidence, create shareholder value, and protect their interests.

Amazon.com Inc. (AMZN)

Amazon’s strengths are its wide economic moat of network effect and cost advantage, especially considering the company’s size and scale are unmatchable. AMZN continues to grow by acquiring adjacent businesses, including One Medical (for $3.9 billion in July 2022) and iRobot (for $1.7 billion in August 2022), and the company dominates the US retail e-commerce in terms of Gross Merchandise Volume (GMV).

An AWS Spinoff will result in reduced market competition and higher customer prices, which in turn reduces the risk of antitrust regulatory pressure to some extent and unlock further growth as a standalone company. There has been continuous speculation about the Spin of Amazon Web Services (AWS). For FY22, AWS segment sales increased by +29% Y-o-Y to $80.1 billion, which is ~16% of AMZN’s total revenue. AWS is a leading choice for data and analytics applications for businesses across industries, evidenced by Yahoo Ad Tech and Brookfield Asset Management recently selecting AWS as their preferred cloud provider. With the rapid adoption of electric vehicles, Duke Energy
DUK
is also working with AWS on smart grid solutions to improve reliability.

A Spin of AWS can unlock a Base case upside of +54.1% (target price of $155.78) and +98.0% Bull case upside (target price of $200.17) on a combined basis over the next three to five years.

Meta Platforms, Inc. (META)

Over the past few years, Meta and Alphabet have lost their dominance in the digital advertising market, as no one previously anticipated Amazon, TikTok, and others entering the advertising space and challenging the giants on their home turf. Regulators in the US and Europe have ramped up their antitrust scrutiny. On January 24, 2023, the US Justice Department sued Google for monopolizing digital advertising technologies. This indicates a critical and complex structure shift ahead for big tech companies that have historically enjoyed unbridled growth by neutralizing or eliminating their rivals in the online ad marketplace through acquisitions and forcing advertisers to use its products, making it difficult for competitors to sustain.

A Spinoff of Instagram will result in relief from future uncertainties of data privacy. Meta’s Facebook was in legal trouble with the FTC over allegations of the social network dominating its position as a monopoly in the market. In the meantime, the company has rolled out its roadmap for handsets and wearables through 2027, focusing on AI and the Metaverse over the long-term. Both Facebook and Instagram show relevant content to users through their AI systems, which makes their services unique and a strong case for Instagram’s independence from the Parent after years of operating alongside Facebook.

Our valuation of META (Combined) over the next three to five years follows the Spin of Instagram and provides a Base case upside of +31.9% (target price of $279.02) and +48.5% Bull case upside (target price of $314.10).

Alphabet, Inc. (GOOGL)

With an increase in the demand for internet-based television, many people are cutting the cord; this provides Alphabet with an opportunity to list YouTube as a separate entity. Since cable players still hold most of the TV market, Google may not consider this a suitable time to Spinoff YouTube, but it does make sense to capitalize on the growing market in the long-term. It will also allow YouTube to focus on taking on other players with short video reels options like TikTok, Instagram, Snap, and Facebook. According to Nielsen, YouTube is the leader in US streaming watch time. The company’s subscription business continues to grow, with YouTube Music and Premium surpassing 80m subscribers, including trailers.

There are two major concerns at play for GOOGL: (i) softening advertising budget and adverse economic conditions have resulted in underperformance of the advertising revenue for many big tech companies, including Alphabet (GOOGL), and (ii) regulators in the US and Europe have increased their antitrust scrutiny. On January 24, 2023, the US Justice Department sued Google for monopolizing digital advertising technologies. Out of the Google Service segment, YouTube ad revenue has increased tremendously by 27% CAGR from 2018-22 ($11.2 billion in 2018 to $29.2 billion in 2022). We believe by 2025 YouTube ad revenue will reach ~$38 billion, and YouTube will be able to survive as an independent entity. Therefore, in the next five to seven years, YouTube’s listing will help GOOGL significantly reduce regulatory flak surrounding its dominant position in the advertising market and unlock value for shareholders.

In the event of a YouTube Spinoff in the next three to five years, we believe GOOGL (Combined) has a potential Base case upside of +40.7% (target price of $147.02) and +60.4% Bull case upside (target price of $167.62).

Should you wish to discuss further these valuations or the deeper thesis, contact me at www.edgecgroup.com

The author owns shares in Amazon, Meta & Google.