How Russia’s Military Move Roils Markets

The stock market is gyrating this morning. Oil prices are up. Prospects for even higher inflation are, too. Russia’s military move into two of Ukraine’s eastern provinces is leading other countries to place sanctions upon it, with more likely to come, especially if Moscow invades the rest of the country.

The S&P 500, which already had lost 8.8% this year, slumped almost 0.7% at the market open, along with downward movements at other major exchanges. But that dip moderated and edged into a small 0.2% advance as traders digested the news. They expect more big moves throughout the day, with the Chicago Board Options Exchange’s Volatility Index, or VIX, hovering around 30, a notable jump from earlier in the month, when it was at 19.

Oil, already seeing a big price escalation in 2022, leapt 3.3% to $94 per barrel today. Pricier oil already is a driver for higher overall consumer prices, and the Consumer Price Index (up 7.5% year over year) could thus rise still more.

The likelihood of still higher oil prices is strong, should Europe’s access to Russian oil be shut off. Thus far, the European Union has sided with the US and Britain in opposition to Russian President Vladimir Putin’s aggressive stance toward Ukraine.

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Russia’s deployment of troops into two breakaway Ukrainian provinces could be the opening gambit of a broader invasion of the rest of the country, once under the Kremlin’s sway is the days of the Soviet Union. That’s the White House’s fear, and further diplomatic engagement between the West and Putin remains up in the air.

And that’s exactly where stocks are today.

Activist investors regularly demand that companies spin off a subsidiary, arguing that shareholders will be better served without the one dragging down the other. That, for instance, is what Alta Fox Capital Management wants toymaker Hasbro to do with its Wizards of the Coast and Digital Gaming unit (one title: Dungeons & Dragons).

But to Goldman Sachs, more companies should themselves decide to part ways with noncore subsidiaries, rather than have the likes of Alta Fox mount a proxy fight to force them into a spinoff.

That’s particularly true for businesses with lower-end profit margins on the order of 5% to 10%, plus expected revenue growth of just 10%, Goldman argued in a research note. Almost half the companies in the S&P 500 fit that description, the investment house observed.

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By saying goodbye to divisions that aren’t core, such a parent company could double its valuation, the report contended. The Wall Street firm dryly dubbed the notion “self-activism.”

Goldman highlighted 46 companies, with margins trailing their sector peers, which it said would benefit from jettisoning a subsidiary—via a spinoff or perhaps by selling it to one of the special purposes acquisition companies, aka SPACs, hungry for a merger target. Prominent on Goldman’s list were oil giant ExxonMobil, retailer Best Buy, and medical supplier McKesson.

Another Goldman study, of spinoffs between 1999 and 2020, discovered that the departed unit usually was undervalued by investors and yet ended up outperforming the former parent over the next 12 months.

Boosting margins is not easy to do, which broadens the appeal of a spinoff, in Goldman’s estimation. The research report said “it is arguably a more achievable objective than trying to lift sales growth at the same time as US economic growth decelerates.”

Spinoff deal counts were the highest last year, through Nov. 15, since 2011, according to Bloomberg Law, with a 205 tally. This report concluded that “pressure from shareholder activists has played a role in some of these decisions to carve up conglomerates.”

Big names are involved. General Electric plans to divest its health care unit next year and its energy operation in 2024. This maneuver would let GE devote itself to aviation. By the same token, Johnson & Johnson intends to shed its consumer products business, allowing it to focus on pharma.

Overall, spinoffs have been successful as standalone public companies, by the count of the S&P US Spin-Off Index. Over the past 10 years, this index has returned 11.7% annually, just a little less than the broad-market S&P 500’s 14.4%. But such happy news is far from guaranteed.

This rocky year, the spinoff index is down 5.9%, which at least is better than the S&P 500’s 8.8% loss. Last year was better, with a 12.1% showing, although that was slightly less than half what the S&P benchmark logged.