3 Potential Spinoffs That Could Lead To Big Gains
What do Wonder Bread, Avis Rent-A-Car, Sheraton Hotels and Hartford Insurance Group have in common? They were all held under the corporate umbrella of telecom firm ITT in the 1970’s.
ITT was one of many companies that became convinced that operating a wide range of companies in a vast number of industries is the quickest way to wealth-building. Yet ITT and others eventually buckled under the weight of their unwieldy operations and many large companies subsequently began to “de-conglomerate.”
#-ad_banner-#Now, Carl Icahn is taking the de-conglomeration theme one step further: He’s imploring companies to spin off key divisions as a way to boost shares. He rattled eBay, Inc.’s (Nasdaq: EBAY) cage for nearly nine months, pushing the e-commerce company to spin-off its PayPal division. When eBay relented on September 30, announcing such a plan, its shares rose nearly 8%.
Other activist investors are getting their case heard. Ralph Whitworth, who has publicly pushed Hewlett-Packard (NYSE: HPQ) to spin off its printer business, applauded the company when such a plan was announced earlier this month. “Shareholders will now be able to invest in the respective asset groups without the fear of cross-subsidies and inefficiencies that invariably plague large business conglomerates,” he recently told the New York Times.
HP and eBay are in the midst of a clear trend: According to Dialogic, $1.6 trillion of spin-offs or asset sales — the highest figure since 2007 — have been announced thus far in 2014.
To be sure, there are dozens of major companies that are involved in disparate businesses, many of which must be at least thinking about unlocking value through a break-up. Here are three on my radar.
EMC Corp. (NYSE: EMC)
If you scanned the weekly insider buying headlines in 2010 through 2012, you would have seen repeated purchases by data storage firm EMC of VMware, Inc. (NYSE: VMW), a fast-growing provider of data virtualization. (EMC had already owned a considerable chunk of VMware and needed to report it to the SEC every time EMC bought more shares). Many wondered what EMC, which now owns 80% of VMware, aimed to do with its big investment. Thus far, it remains unclear.
Elliot Asset Management, which owns more than $1 billion in EMC stock, is pushing for bold action. The hedge fund is pushing EMC to unload VMware and also look for an asset monetization strategy for EMC’s pivotal software development business and its RSA security management business.
You can see why Elliott and other investors are growing anxious. Shares of EMC rose less than 10% over the past two years, even as the Nasdaq rose roughly 40%.
It’s hard to know what VMware would fetch in an asset sale or spin out, but many think that its current value is negatively impacted by EMC’s controlling interest. Merrill Lynch, which spots several catalysts capable of helping VMware boost sales another 15% in 2015, to around $7.8 billion, think the company is worth around $120 a share, or roughly $50 billion. That would value EMC’s stake at around $40 billion, not far from the company’s $55 billion total market value.
Yum! Brands, Inc. (NYSE: YUM)
Analysts at Oppenheimer took a stab at the value of this fast-food company’s three key areas of focus: The core KFC/Pizza Hut operations, which they think is worth $17 billion; the Taco Bell franchise, valued at $6 billion; and the company’s fast-growing operations in Asia, valued between $15 and $22 billion. For context, the entire company has a market value of $29 billion and an enterprise value of around $31 billion.
Oppenheimer figures a break-up would push shares from a current $67 to a range of $81-to-$97 a share. “The theoretical separation would also free investors to access three attractive stories with value-creation drivers best maximized as stand-alones,” they add.
The drumbeat for action may be growing louder. Shares moved to more than $80 earlier this summer, but negative media coverage regarding food safety issues in China pushed shares back into the $60’s. The problems were isolated to a meat supplier of just a few toppings, but the bad press still had a strongly negative impact on sales at the company’s Chinese restaurants. It has typically taken Chinese consumers roughly six months to forget about such media scares. In any event, it’s not a savory issue for U.S. investors, who feel that China’s growth potential and risk would be better controlled in a spun-out division.
Masco Corp. (NYSE: MAS)
This producer of plumbing, paint and other home supplies recently announced plans to spin off its insulation division in the coming months, though investors have largely yawned at the move, as shares trade near 52-week lows. But the plan is expected to lead to a massive streamlining of its operations and free up enough cash to buy back 50 million shares. The move should also enable Masco to focus on higher-margin offerings, which could prove timely as new home construction starts to slowly build in 2015 and 2016.
Risks To Consider: Such asset moves can lead to a shift in the shareholder base, with some investors pulling stakes while others step in. An upheaval in a shareholder base can lead to a choppy stock price.
Action To Take –> Over the past five years, many companies have re-built their lean cost structures and now find that they are carrying a lot more overhead than they once did. Spinning out assets reduces the managerial oversight necessary to run a sprawling set of divisions and can lead to an improvement in operating margins. That’s why many companies are now taking a fresh look at their corporate structure as a way to unlock shareholder value. You can get a sense of whether a company is too unwieldy by looking at its overhead expenses, in relation to sales, if that metric is higher than the peer group, then a spin-out of a non-core division may be the next logical move.
My colleague Nathan Slaughter, chief investment strategist for Total Yield talked about the power of spin-offs before. His unique Total Yield strategy looks at companies that are paying back shareholders in multiple ways — dividends, share buy backs and debt reduction. In fact, last year 24 of Nathan’s top 25 Total Yield stocks doubled the S&P’s returns and some gained more than 100% in less than eight months. Learn more about Total Yield investing — and get names and ticker symbols of some of Nathan’s top picks — by clicking here.