Last year was a record year for spin-offs, with deals worth an estimated $116 billion completed. There are even more expected in 2012.

Spin-offs occur when companies want to shed units that are performing poorly, undervalued or unrelated to the main business. Instead of selling to a rival, companies can make a tax-free distribution of the business to investors that often increase shareholder value. In return, the newly spun-off company is often able to innovate and grow, leading to better returns for shareholders.

Unlike IPOs, which get lots of media attention, spin-offs often fly under the radar. This means investors can buy shares before the spin-off is well-known and often lock in above-average yields.

A case in point is Exelis (NYSE: XLS). This $6 billion defense business was spun off from ITT Corp.(NYSE: ITT) last year. Exelis hit the ground running in 2011 by delivering 12% growth to $5.4 billion in funded orders and free cash flow of $489 million. Exelis shares currently yield 3.6% and have a 23% payout that provides very comfortable dividend coverage.

Several big deals were announced last year that will close this year. Here are three spin-offs that should appeal to dividend investors…
 
#-ad_banner-#1. Abbott Laboratories (NYSE: ABT)
Yield: 3.4%
Abbott plans to spin off its $18 billion research-based pharmaceutical operations from its more stable $22 billion medical products business. The parent company, which will sell nutritional products, branded generic drugs, medical devices and diagnostic products, will keep the 124-year-old Abbott name. The spin-off, which has been named Abbvie, gets to keep a top-selling arthritis drug, Humira, which has almost $9 billion in projected sales, as well as drugs like Lupron, for prostate cancer and Synagis for respiratory disease.

Investors were worried about Abbvie’s growth prospects because the patent on Humira expires in 2016, but these fears have eased since the company launched a promising new arthritis drug in February and advanced a new Hepatitis C treatment in clinical trials. Abbott is on track to complete the spin-off by year-end.

Abbott has a 22-year history of dividend growth. The last increase was 9% last May to a $1.92 annual rate. The company is guiding for 2012 earnings that will exceed $5.00 a share and provide better than two-fold coverage of the dividend. Both Abbott and Abbvie will pay a dividend, with payout being split between the two spin-offs.

2. ConocoPhillips (NYSE: COP)
Yield: 3.6%
ConocoPhillips is spinning off its refining & marketing business as Phillips 66, an already well-known brand. Shares of Phillips 66 (NYSE: PSX) will be distributed on April 30th, with current shareholders receiving one share of Phillips 66 for every two shares of ConocoPhillips currently owned.

ConocoPhillips has long been a favorite of dividend investors for its 13% yearly dividend growth and yields that have consistently exceeded 3% in the last five years.

Going forward, the company intends to pay out 20%-25% of cash flow as dividends every year. That means dividends may rise to $4 billion this year from $3.6 billion last year. ConocoPhillips also plans to make $10 billion in share repurchases, which will reduce the share count and further enhance dividend growth per share.  

Phillips 66 has a similar commitment to dividend growth. This company will pay a $0.80 annual dividend and plans to grow payments by 5% a year. The initial dividend is roughly 20% of Phillip’s annual cash flow and very affordable. Phillips shares began trading in mid-April in a $35-$36 price range and have a 2.3% yield.

3. Sara Lee Corp. (NYSE: SLE)
Yield: 2.1% plus special $3.00 dividend
Sara Lee is splitting into two companies and will pay a special $3.00 dividend to shareholders in June. Shares currently trade near $21, so the special dividend will deliver a 14% yield. Sara Lee also plans to continue paying a $0.46 annualized dividend that currently yields 2.1%.

One company will retain the Sara Lee name and consist of the North American packaged food and meats business. The second company, named D.E. Master Blenders, will operate the international coffee, tea and beverages business.

Sara Lee is a classic example of the individual pieces being worth more than the package and a spin-off being done to unlock hidden value. Analysts peg the break-up value of the packaged food business at $7 a share and the coffee business at $16 a share. Include the $3 dividend and that’s a $26 value for the spin-off. Shares currently trade for less than $22.

D.E. Master Blenders will trade on the New York Stock Exchange and be headquartered in Amsterdam. The business generated operating income (before corporate overhead) of $452 million last year, and analysts think the stand-alone business will easily produce more than $380 million of income this year. 

D.E. Master Blenders and Sara Lee will pay dividends and have investment-grade credit ratings. Sara Lee has a 65-year track record of paying dividends, but recent dividend growth has been weak at just 1% a year.

Risks to consider: ConocoPhillips bases its income projections on “flat” gas prices and in the short-term will be partially funding the dividend from cash on hand and asset sales. This limits future flexibility and means a dip in oil prices could hurt the dividend. In addition, while both Sara Lee businesses will pay a dividend, the company hasn’t disclosed initial rates, payout targets or dividend growth policy.

Action to take–> My top pick is ConocoPhillips because of the company’s excellent dividend track record and transparent plan for future dividend growth. Abbott is also a strong choice for dividend investors who want a safe payout and steady growth. Sara Lee is appealing as a value play with modest income growth.