http://www.businessweek.com/stories/2007-02-16/breaking-up-is-not-so-hard-to-dobusinessweek-business-news-stock-market-and-financial-advice

Markets & Finance

Breaking Up Is Not So Hard to Do


Several big companies have announced spin-offs. If history is any guide, some of these offspring may beat the market

From Standard & Poor's Equity ResearchThe investment world is spinning with spin-offs. Conglomerates such as Tyco International (TYC; ranked 3 STARS, hold), American Standard (ASD; ranked 3 STARS, hold), and Altria Group (MO; ranked 5 STARS, strong buy) are breaking themselves into smaller companies—all in a quest to unlock shareholder value.

But what's the true spin on spin-offs? Investing in spin-offs can be can be very profitable, according to Spin-Off Advisors, a Chicago research firm. In November, 2006, the firm reported that nearly two-thirds of the companies spun off over the past three years had beaten the Standard & Poor's 500-stock index in the first 10 months of 2006.

Late in 2006 an exchange-traded fund, the Claymore Clear Spin-Off ETF (XCSDX), was launched in a bid to capitalize on spin-offs. The Claymore philosophy is that many index funds and ETFs must sell a spun-off asset because it is not in the index that the fund tracks. So spin-offs can come under pressure as big institutional investors unload shares. The Claymore ETF buys them at that point and attempts to sell them later at a profit.

Too Difficult

There's certainly plenty of action in spin-offs these days—for Claymore and other interested investors. On Feb. 12, Home Depot (HD; ranked 5 STARS, strong buy) announced it was evaluating strategic alternatives for its professional supply business, including a possible sale, spin-off, or initial public offering (see BusinessWeek.com, 02/12/07, "A Wholesale Change at Home Depot").

S&P equity analyst Michael Souers thinks management found it too difficult to juggle strategic decisions for both the professional supply business and the retail stores. Given what he sees as the big improvements that can be made in the retail stores, Souers thinks it would be a prudent call for Home Depot management to disengage from the professional supply business entirely. Souers also believes the most likely scenario is a sale to private equity investors.

Meanwhile, on Feb. 8, EMC (EMC; ranked 4 STARS, buy) said it would spin off about 10% of its computing virtualization unit, VMware, sometime this summer (see BusinessWeek.com, 2/9/07, "EMC's Billion-Dollar IPO"). EMC said it would retain the remaining 90% stake in VMware. The company has not yet disclosed any financial details about the spin-off.

Sharpening Strategic Focus

S&P equity analyst Richard Stice believes EMC's decision to spin off a portion of VMware makes strategic sense. He says VMware has been the best-performing of EMC's recent acquisitions (which include Documentum, Legato, and RSA).

Also, by spinning off just 10%, EMC will continue to be able to incorporate VMware's business into its financial results. Another positive is the additional proceeds that may be generated as a result of the IPO.

Stice says EMC mentioned a desire to return a portion of the proceeds to shareholders, pending the results of the IPO. "The timing of the entire process is also quite interesting," says Stice, who believes Microsoft (MSFT; ranked 3 STARS, hold) will unveil its own virtualization product in the near future.

On the last day of January, Altria, parent of the world's largest cigarette maker, said that it would spin off its remaining stake in Kraft Foods (KFT; ranked 2 STARS, sell) on Mar. 30. Although Kraft had its IPO in June, 2001, Altria still owns 49.5% of the Class A common stock and all of the Class B common stock, giving it an 88.6% economic interest and 98% of the combined voting power of all shares outstanding.

In the January announcement, Altria said Kraft would grow more quickly as an independent company. Investors will get 0.7 shares of Kraft for each share of Altria. Altria believes that once Kraft becomes an independent concern, it will be able to increase debt and use its own shares to pay for acquisitions.

S&P equity analyst Raymond Mathis believes the planned spin-off will allow Altria and Kraft to sharpen strategic focus, become more nimble, and adjust respective capital structures to make acquisitions and compete more effectively. Kraft is the world's second-largest food maker after Nestlé.

Bath and Kitchen

On Feb. 1 the board of industrial conglomerate American Standard Products completed a strategic review of the company and unanimously approved a plan to separate its three businesses this year. American Standard said the spin-offs will allow it to focus on its biggest business—air-conditioning systems and services. It will rename itself Trane, after its signature brand.

American Standard plans to spin off its vehicle control systems business into a publicly traded company named Wabco. It also said it will sell its bath and kitchen business. These proposed transactions are expected to be completed by early fall.

On Jan. 25, Tyco filed with the Securities & Exchange Commission to spin off its electronics and health care divisions by early in the second quarter. After the spin-offs, Tyco will be three distinct companies: Tyco Healthcare, Tyco Electronics, and Tyco International, which will encompass Tyco Fire & Security and Engineered Products & Services.

S&P equity analyst Michael Jaffe believes that companies such as Tyco and American Standard are acknowledging that their hodgepodge of businesses have very limited synergies. They seem to think it makes sense to operate these businesses as separate companies, as greater management focus on each should allow them to operate more efficiently.

In the long run, he believes the spin-offs might also make these holdings more valuable to the current shareholders of American Standard and Tyco, as they both currently have what he views as valuation discounts typically accorded to conglomerates.


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