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PayPal, Baxalta Are The Best Bets In July's Rich Crop of Spinoff Stocks

This article is more than 8 years old.

A flurry of spinoffs from companies such as DuPont , Baxter International , Energizer Holdings , Gannett , and Babcock & Wilcox formally began trading on Wednesday, as firms distribute businesses to shareholders and plot a more straightforward corporate strategy heading into the second half of the year. Spinoffs are often an opportunity for value-hunting investors to buy into a business at a discount, and they can lead to improved performance at the parent company, but quality matters.

Among today's current crop of spins, Baxalta, a biosciences unit being spun from Baxter International, stands out as the cream of the crop. The business, which is replacing QEP Resources on the S&P 500 Index, is a leader in hematology and immunology with $6 billion in annual revenue, and it is in the process of bringing a pipeline of orphan drugs to market. Those attributes may appeal to competitors, who are bolstering their operations through acquisitions, and to investors in the red hot biotech sector, given the potential upside to Baxalta's drug pipeline.

Jonathan Morgan of The Edge Consulting Group, a research firm focused on spinoffs and specials situations, told Forbes Baxalta is his top pick among the spinoffs hitting stock markets in July. He compares Baxalta's margins, pipeline, and leading position in niche markets like hematology and immunology to the position of Humira-maker  AbbVie when it was spun from Abbott Laboratories in late 2012, and animal health specialist Zoetis when it was spun from Pfizer in 2013.

Both AbbVie and Zoetis have performed strongly since their spins, gaining 107% and 55%, respectively exclusive of dividends. In the deal-heavy pharmaceutical and healthcare sector, both firms are seen as prized assets. Like AbbVie and Zoetis, Baxalta, with its $21 billion market cap, is incorporated in the United States, meaning it could become a target for foreign domiciled drug rollups such as  Valeant Pharmaceuticals , Allergan and Shire , who may be on the prowl for new acquisitions that yield tax synergies.

Morgan of The Edge Group also notes that  despite a mixed performance of spinoffs during their first year on public markets -- some 40% of spins do not generate a return in the first year post separation - healthcare spinoffs have been top performers. Spins in the sector have risen 45% in their first year of trading, while parent companies have risen nearly 20%, according to The Edge Group's data.

Credit Suisse analysts initiated Baxalta with a 'buy' rating and a $37 price target, stating that the firm's market leading hemophilia division can sustain revenue growth as it launches HyQvia in coming quarters. They also believe the company's drug pipeline in oncology and biosimilars is strong enough of offset and revenue headwinds if Roche, Alnylam Pharmaceuticals or a gene therapy specialist successfully enter the hemophilia market. Goldman Sachs analyst Jami Rubin initiated Baxalta with a 'neutral' price target, citing Baxalta's over $20 billion valuation at its spin-off.

Baxter International shares rose 5% in the month leading up to the Baxalta spin, underscoring investor interest in Baxalta. PayPal, the soon-to-be spun payments division of eBay, could create similar upward stock pressure ahead of its July 17 spinoff, says The Edge Group's Morgan.

PayPal is a leader in online payments, with high margins and strong revenue growth. It could prove valuable to tech giants like Google, Apple, Microsoft and Facebook, who are all toying with payments, and its standalone prospects will likely generate significant investor demand. Buying eBay shares ahead of the July 8 record date to receive PayPal shares, may be the cheapest entry point to build a position in the payments firm.

Many of the spins hitting the market come from high quality parent companies, and have strong prospects,  but investors may want to wait for a better entry point.

Cable One, the internet service business spun from Graham Holdings  should have been listed at a price of between $300 and $315 a share, according to The Edge's Morgan; however, it hit 'when issued' markets at over $400 a share. Investors are enthusiastic about the company's position in the consolidation internet and cable market, with French cable operator Altice, showing an interest in buying U.S. firms of Cable One's size at high multiples. However, M&A expectations may be priced into Cable One shares.

Chemours, the former Performance Chemical division of DuPont, has struggled since it began trading on 'when issued' markets. Investors speculate that S&P 500 index funds sold the Chemours shares they received, putting downward pressure on the stock. Technical factors aside, Chemours carries a heavy debt load and is exposed to volatile commodity prices. Strong anti-takeover provisions put in place by former parent DuPont dampen speculation about its prospects as a takeover target.

For now, DuPont may be the better value, as CEO Ellen Kullman prepares to show Wall Street the fruits of her multi-year transformation effort. Activist fund Trian Partners, which lost a proxy campaign in 2015, is lurking in the wings, potentially creating support for DuPont shares if the company stumbles in the second half of 2015.

The Edge's Morgan points out that there is a dearth of spinoffs set to hit the market in coming quarters.

Forbes, however, has combed through corporate coffers to identify five crown jewel assets that could stand on their own on public markets. Here's Forbes' list of the five businesses that could be the next great spinoff.