The company decides to spin-off a business division.
The parent company files the necessary paperwork with the Securities and Exchange Commission (SEC).
The spinoff becomes a company of its own and must also file paperwork with the SEC.
Shares in the new company are distributed to parent company shareholders.
The spinoff company goes public.
Notice that the spinoff shares are distributed to parent company shareholders. There are two reasons why this creates value:
Parent company shareholders rarely want anything to do with the new spinoff. After all, it’s an underperforming division that was cut off to improve the bottom line. As a result, many new shareholders sell immediately after the new company goes public.
Large institutions are often forbidden to hold shares in spinoffs due to the smaller market capitalization, increased risk, or poor financial s of the new company. Therefore, many large institutions automatically sell their shares immediately after the new company goes public.
Simple supply and demand logic will tell you that such a large number of shares on the market will naturally decrease the price, even if it is not fundamentally justified. It is this temporary mispricing that gives the enterprising investor an opportunity for profit.