Spot spin-off candidates to profit from activist activities Activists are back, leaving a trail of capital gains in their wake. According to Activist Insight, which tracks the sector, some $209bn in equities is now held globally by investors with activist intentions, while the year has featured a series of high-profile fights between investors and incumbent managements. The strategy is working. The Activist Index, covering 29 specialist activist funds, gained 30.5 per cent last year, and led the MSCI World index in the first half of this year (it slightly lagged the US S&P 500). One region is relatively untouched. Some 80 per cent of the action is taking place in the US, according to Deutsche Bank, while most activism in Europe is restricted to the UK. As mainland Europe has much cheaper stocks, it could be fertile ground for activists. Mainland Europe is also home to more conglomerates (14 per cent of European corporates operate in five business segments or more according to Factset, against 11 per cent in the US), while its companies are sitting on a lot of cash. According to Credit Suisse, European cash levels are now at a 17-year high. So there is a clear case for activism in Europe, even given the region's liking for concentrated ownership structures that make activism difficult. The problem is how to tap into this potential. Being an activist yourself takes effort and scale. The likes of Carl Icahn and Bill Ackman are taken as seriously as they are because they can take huge stakes. It is not a strategy that most of us can mimic. And in any case, second-guessing both the activists and the response of the managements can carry great risks. So this is a dangerous game. But the potential is obvious, particularly for spin-offs from sluggish conglomerates. An interesting way to do this comes from the Credit Suisse "Holt" methodology. This column has featured Holt in the past - it is a system for crunching companies" numbers and evening out the vagaries of accrual accounting to take a sophisticated look at their underlying profitability. The Holt team examined spin-offs in the US, and found that candidates could be identified in advance using three main criteria. Their profitability is in line with their peers, but they are struggling to grow, and their share price is cheap compared to peers. Spin-off candidates identified on this basis tended subsequently to produce above-market returns for both the parent and the target (although the dispersion in performance for the spun-off entities was very wide). For transactions over the past 12 months, with the overall market driving forward impressively and small-caps underperforming the S&P 500, Holt has found that parent companies have underperformed the Russell 3000 by 1 per cent since announcement - while the spun-out entities have underperformed by 14 per cent since achieving independence. But in the longer run, the screen for a spin-off candidate produces a portfolio that in effect combines value and quality styles. This is appealing, and provides some defence against the risk that no activist chooses to become involved. Further, in Europe, the Holt screen - conducted without any information on whether activist investors are already involved, and without any details of shareholder structure - finds more candidates than in the US, confirming the intuition that Europe should now be fertile ground for activists. Holt's results very much pass the smell test. Its screens, although produced blindly, turn up a number of companies widely thought to be candidates for splits or spin-offs. For example, Holt knows nothing about Bill Gross and Pimco, and yet Allianz shows up on its screen as one of the most promising candidates for a spin-off. Allianz has an earnings multiple significantly lower than its peers, unexciting profitability, and an obvious opportunity to spin off a business. Other candidates that rank high on these measures include Standard Chartered. Candidates with low growth compared to peers include Metso Oyj, Imi, KBC Group and Reckitt Benckiser. The most appealing point about these screens, for those who cannot afford to set up our own activist funds? These companies look like interesting investments even if the activists do not get involved.