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Spin Cycle

Companies attempting incubator strategies have found BARGEMAN the buoyant stock market to their liking. Since the premise of an incubator …

Companies attempting incubator strategies have found BARGEMAN the buoyant stock market to their liking. Since the premise of an incubator company is to develop independent subsidiaries that are then spun off to the public, a healthy and receptive stock market keeps the process oiled.

Granted, not too many U.S. companies attempt incubator strategies along the lines of the Thermo Electron model, which spins out promising technologies by offering a minority share in newly created subsidiaries. But a number of east and west coast high-tech companies are making the attempt – some successful, some not.

Over the last 18 months, the volume of corporate spin-offs totaled $13.1 billion, reports Securities Data Corp. This includes public offerings from buy-out funds, divestitures from foreign governments which now trade on U.S. stock markets, and larger corporations separating out non-core subsidiaries. Just a tiny percentage were incubator spin-offs.

One of the most successful of these is ATL Products, which Odetics Inc. spun off just over a year ago. Anaheim, CA-based Odetics, a leading supplier of digital data management products for the security, broadcast, and computer storage markets, boasts annual revenue of about $100 million. ATL Products supplies automated tape libraries for mass data storage in midrange and client/server computing environments. It, too, does about $100 million in revenue.

ATL went public in an $18.2 million offering at about $11 a share. Today it’s trading around $15 a share. “We purposely structured ATL as a subsidiary in anticipation of it becoming an IPO,” says Joel Slutzky, chairman and CEO. “We want to develop entities, spin them out, and let them be their own companies.” Odetics calls this a triple-win philosophy: a win for stockholders who become invested in a pure play company alongside Odetics; a win for Odetics, which is reimbursed for intercompany debt and expenses for growing the spin-off; and a win for employees who have a chance to invest in an IPO at a relatively inexpensive price.

ATL issued new equity of 1.650 million shares in its public offering. With that, Odetics’ ownership position was diluted from 100 percent to 82.9 percent. By keeping its ownership position at over 80 percent, dividend distribution from the deal is tax-free.

There are a lot of ways to spin off companies, says Greg Miner, VP and CFO for Odetics. “Our strategy is to get maximum return to our shareholders on a tax-free dividend basis.”

One month after ATL went public, Palomar Medical Technologies sent its subsidiary, Nexar Technologies, into the public market as well. While the IPO was successful, its public offering was actually the culmination of a failed incubator-type strategy.

The Lexington, MA-based supplier of laser systems to the cosmetic and healthcare industries boasts about $60 million in revenue. It began life a decade ago as a company developing technology to treat psoriasis. To maintain its NASDAQ listing, the struggling start-up opted to increase its market presence by acquiring other companies which it would then fix and spin-off. This misbegotten strategy was a failure from the start, and Palomar ended up as a 10-year bleed. Its one subsidiary with promise was Nexar, which made an upgradeable PC. It was spun off in a $22.5 million offering.

Louis (Dan) Valente took over Palomar as president and CEO in May last year and has proceeded to cut the company back down to its core product. “Palomar acquired all these companies but it wasn’t able to fix them and take them public. The company was losing money at a substantial clip and the board decided to make a change in management,” says Valente, who has since also become chairman of the company. “Turning companies around and spinning them off sounded like a good idea for management but it really didn’t work.”

Palomar’s failure in strategy was partly due to the divergent businesses it acquired. “There was no competitive advantage in technology because the acquired companies were all so different,” Valente says. As for Palo-mar’s other businesses, they weren’t  strong enough to go public, so they were sold to other businesses or to managers.

At the time of its offering, Palomar retained about 70 percent of the company, but has since reduced its ownership position to 30 percent, patiently selling blocks of stock so as not to drive down price, which has happened anyway. Nexar went public around 9 and is now trading around 4 1/2. But the spin-off turned out to be a good deal for Palomar as it used cash from the sale of stock to invest in its core business.

“If you are going to follow an incubator strategy,” says Slutzky, “you have to believe that every one of the businesses that make up the consolidated group has the potential to become an independent company. That is fundamental to strategy.”

Steve Bergsman is a Mesa, AZ-based freelance business writer who has written about corporate finance for Reuters, Barron’s, Global Finance, and Corporate Finance.

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