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Stub

Stub

What Is a Stub?

In finance, a stub is a security that is created as a result of a corporate restructuring, for example, a spin-off, bankruptcy, or recapitalization in which a portion of a company's equity is separated from the parent company's stock. Stub stocks may likewise be created by converting a distressed company's bonds into equity.

The term stub may alternatively be used to refer to the balance part of a check, for example, a paystub or from a receipt that is retained for record-keeping and audit trail purposes or as proof of payment.

Understanding Stubs

Stubs are generally created through a spin-off. In a spin-off, the parent company distributes shares of the subsidiary that is being spun-off to its existing shareholders on a pro-rata basis, often as a special dividend. The company that is spun-off is a distinct entity from the parent company and has its own management and board of directors. The parent company might spin off 100% of the shares in its subsidiary, or it might spin off 80% to its shareholders and hold a minority interest of less than 20% in the subsidiary. In a stub, the parent spins off the greater part of the subsidiary. Because the parent company's stock might retain the vast majority of the attractive characteristics of the original investment, stub stocks are not typically viewed as desirable by investors.

Stubs may likewise arise from a corporate restructuring, for example, when emerging from bankruptcy. Stub stock values typically represent just a small fraction of the price of the parent securities from which they have been created. Their lower prices can reflect the uncertainty that market participants perceive regarding the recapitalized company's prospects. That uncertainty makes stub stocks often speculative investments with huge positive return potential should the company's managers succeed in turning the firm around, yet additionally greater risk. For example, investment firm Salomon Brothers had created an index of stub stocks during the 1980s. The index's value had steep swings in relation to the market's performance. In 1987, it crashed by 47.4% during that year's bear market. The S&P 500 fell by a more modest 33% in the same period.

To value stubs, analysts center around the amount of their debt and capital available at the company to service the debt. The cash flow ratio becomes an important measure in this analysis because it provides an investigate the amount of cash that the company has at its disposal to service debt. The price-to-earnings (P/E) ratio, an important metric for valuation in traditional analysis, isn't as important because profits for stub companies are generally not high.

Example of a Stub: 3Com and Palm

Networking company 3Com, which manufactured the successful Palm Pilot device series during the 1990s, spun out 7% of its Palm subsidiary in 2000. 3Com still owned 95% of the new company after the separation and received a $200 million special dividend and tax rebates from the spin-off.

Palm likewise offered a limited number of shares to the public in 2000. Investors unable to get in on the action of the offering loaded up on 3Com's shares, driving up its valuation from $5 billion to $22 billion surprisingly fast. Palm surged even higher, because of the dotcom mania around computing products. It had a closing price of $95 toward the end of its most memorable day of trading and a market capitalization of $54 billion, higher than that of its parent. It was even higher than that of established names like General Motors, Chevron, and Mcdonald's.

With the presentation of new portable computers and smartphones, the market for Palm's products dwindled. Eventually, the company was bought by Hewlett Packard in 2010, and its flagship product, the Palm Pilot, was discontinued in 2011.

Highlights

  • A stub is a security created after spinning off a subsidiary from a parent company or as the result of a bankruptcy or restructuring.
  • Stub stocks can be highly speculative with volatile price swings, representing greater uncertainty around the stub's valuation and growth potential.
  • Stub stocks generally trade at a lower price and valuation as compared to their parent company.