Spinoffs: 40% of them don't pay off

As activist investors help push spinoffs to record levels, it pays to remember some history: It can be very risky to hold onto spinoff companies after they are let go.

"Investors will be surprised to learn that 4 in 10 spinoffs don't generate any value over year one," said Ryan Mendy, COO of consulting group The Edge. Specifically, 38 percent of spinoff company stocks deliver a negative return one year after listing – in up and down markets alike.

That's one result of new study conducted by consulting firm The Edge and accounting firm Deloitte. The study looked at 385 global spinoffs between January 2000 and June 2014 involving parent companies with a market capitalization of $250 million or more. To qualify, transactions needed to be pure spinoffs with shareholders of parent companies receiving shares of newly-listed companies.

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A pedestrian walks past a sign displayed at eBay headquarters in San Jose, Calif., Sept. 30, 2014.
David Paul Morris | Bloomberg | Getty Images
A pedestrian walks past a sign displayed at eBay headquarters in San Jose, Calif., Sept. 30, 2014.

The findings come as activists have pushed companies aggressively to split into pieces. Carl Icahn, for instance, was a vocal advocate of the recently-announced split up of eBay and PayPal. Similarly, well-established companies like Hewlett-Packard and Barnes & Noble announced spinoffs in the last several months after some shareholder prodding. It's unclear how long activists hang on to spinoff companies, but the findings suggest other investors should think twice about it.

Of all spinoff companies in the study, 56 percent had negative returns one-month after demerger, 47 percent after three months, and 38 percent one year, Mendy said.

What puts spinoffs at risk? One thing to bear in mind is that companies whose shares soared after a spinoff was announced – but before it was completed – tended to see weaker performances by spinoff companies.

And plenty of companies see big share-price moves after breakup announcements. On average, a company's stock rose about 4 percent between the day a spinoff was announced until just before it took place. But in the upper quartile, the average was a 38 percent gain, the study showed.

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One potential issue is a lack of information about spinoff companies. While spinoff companies issue filings with details about their finances before listing, investors don't always comb through those details carefully. Only after spinoff companies are public do hidden concerns become more obvious through reports. "Investors can easily get excited about an activist getting what he wants and not pay attention to the details," Menday said.

The risk of a weak performance is similar with parent companies after a spinoff. Some 37 percent of parent companies see share-price declines in the year after a spinoff, the study showed.

On the positive side, a full 44 percent of spinoff companies had share-price returns of greater than 20 percent after one year. And there have been so many stellar performers that the aggregate numbers turn out quite strong. The average spinoff company generates a return of 22 percent after listing. The average performance over the first year for parents: 14 percent.

As for the best-performing regions for spinoffs, the U.S. ranks first. Spinoff companies tend to gain 27 percent over the first year after listing while parent companies gain 21 percent. In Europe, spinoff companies gained 20 percent while parents rose 10 percent. And in the rest of the world, parent companies gained 3 percent in the first year while spinoff companies gained 18 percent, the study showed.

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Spinoffs have ballooned over the last five years and the growth looks unlikely to slow down. In 2010, the total value of companies that completed break-ups was $131 billion. That should reach $664 billion in 2014 and is likely to be $775 billion or more in 2015, based on deals already announced, the study showed.

The study found that value creation wasn't dependent on economic growth or company coverage by analysts. The best-performance came from sectors including consumer, healthcare, energy and utilities.