Thursday, November 24, 2005

Valuable Spin-offs

I have been following public offerings of corporate spin-offs for three years now. You may ask what does this have anything to do with value investing? Well, the rationale behind most, if not all, of these spin-offs is that the entities are not being fully valued by the market as long as they are wholly owned by the parent company. The idea is therefore to unlock value by floating the companies as independent entities. I have only tracked a handful of these spin-offs since 2002. They have all performed spectacularly. Undoubtedly there are cases when the plan goes awry.

It is important to understand the true motif behind a spin-off. Is the parent off-loading debt onto the balance sheet of the new entity? Will the spin-off be allowed to truly compete and behave independently from the parent? Has the spin-off been given a competitive edge by its former parent through a transfer of intellectual property portfolio, for example?

I got interested in spin-offs after I read a BusinessWeek article in early 2002 about FMC Technologies (NYSE: FTI). At the time the stock was trading below $20. Over the past three years I have added Genworth (NYSE: GNW), Hospira (NYSE: HSP) and the recent American Express spin-off Ameriprise (NYSE: AMP) to my watch list. I held FTI for a while but sold it way too early. I have never owned the others. Too bad.

It will be interesting to see what Mr. Buffett will do with his newly found shares of Ameriprise (He owns 12% of American Express (NYSE: AXP). If he keeps them, then perhaps that is a signal that indeed the shares offer the value investor a decent Margin of Safety. It is interesting to note that in an article about Ameriprise published by the Wall Street Journal on September 28th, Mr. Nadel of Fox-Pitt Kelton said: ""If the stock falls below $34, then investors should want to own it because the downside in the stock is limited and the upside could be very attractive if management could execute on improving the company's return on equity." at the time of the article the shares were trading on the "when-issued" market at $37.25. When trading officially began in early October, the shares where at $35 and traded to a low of $32. Today they trade at $44. Yes, spin-offs can be lucrative.

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