Spin-Offs Back in Vogue: Six Must-Watch Special Situations

24/7 Wall St.

When the markets go through periods of great gains, it is not uncommon to see companies start to take more radical efforts to increase their total return for shareholders. Some may go borrow money to pay a big dividend or to buy back large amounts of stock. Others may make transformative acquisitions. We have seen activist investors being very influential of late, but now we are seeing waves of de-mergers in the form of break-ups and spin-offs.

The idea behind a spin-off is very simple. Either a unit or operation of a company does not fit in with the broad effort, or the aim is to unlock value for shareholders. The end of 2013 is riddled with spin-offs, and we have some that are formal and some that are merely expected.

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24/7 Wall St. wanted to evaluate some of the spin-offs currently taking place. The logic or reasoning is different on each, but the aim is obviously to drive greater total return to shareholders. We have given the value of the combined company today as a "total market value" in the analysis and named what each effort is. Some are named specifically and some are still pending as units. We have given a timing analysis as well.

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The hardest part of any analysis is determining what net impact this will bring to shareholders. We call this the "value add" and have given a quick snippet of how or why we assess these, but we would be the first to admit that these numbers are highly subjective and different analysts will have a different expectation of what is truly added. The reason you do not see 50% upside is simple: if you break two companies apart, is the sum-of-the-parts suddenly worth twice as much as today? Very rarely.

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Rather than listing these spin-offs alphabetically or by perceived upside, we have ranked them simply by total market value or market capitalization today. Hopefully this will show which spin-offs are larger and which will stand out systemically over smaller pending deals.

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Lastly we have added in some recent spin-offs of size and even shown an ETF strategy around this effort. Here are six coming spin-offs that investors should pay attention to.

GE and parts of GE Capital
> Total Market Value: $245 billion
> Value Add: 4% to 10%

General Electric Co. (GE) is in the midst of evaluating exactly what to do with certain consumer parts of its GE Capital unit. Spin-offs are nothing new for GE. Jeff Immelt moved the prior CFO Keith Sherin over to run GE Capital as CEO, a clear move that "putting the money guy in charge of the money outfit" was needed. We met with a GE spokesperson in the past year, and the conglomerate wants to pare down GE Capital's influence on revenue and profits so that GE can command a market-multiple for industrials rather than being evaluated as part-bank and part-industrial.

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As far as what to expect from GE and GE Capital, you will have to wait a few more weeks or so. Bank of America Merrill Lynch said in a fresh early October research report that it expects some $50 billion of consumer assets to move out, with a market equity value of $8 billion to $10 billion, with a staged IPO as a likely exit mechanism. They expect that the deal will be dilutive to earnings but should benefit GE's multiple and stock price.

How you get to a breakup value of only 4% higher is complex, and there is not just one answer. Some analysts see GE rising to $28 in the next year, and the consensus price target of $26.31 is already close to 10% higher than the current share price. A range of $8 billion to $10 billion is also close to a 4% value based on the market cap. The reality is that investors will have to wait and see here.

National Oilwell Varco distribution and transmission business
> Total Market Value: $33 billion
>Value Add: 5% to 20%

National Oilwell Varco Inc. (NOV) will spin off its distribution business. We recently showed that NOV's distribution and transmission business accounted for about 20% of the company’s total revenues, but it was also shown that the operating margins are in the 6% range. What is interesting is that Wilson Supply and C.E. Franklin were recently acquired.

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The analyst team at Raymond James & Associates recently said that this proposed spin-off would allow both companies to independently focus on their specialties without so much overlap of efforts. You will have to be patient, as the deal is not expected until the first half of 2014.

NOV's management even recently said that the distribution business is now strong enough in size and scale to operate on its own without a larger and stronger parent company. After all, it will claim some 415 locations in some 26 countries. It would be easy to say that this aims to add somewhere around 20% if the spin-off is 20% of its sales. Unfortunately straight math does not work, and the lower margin potentially drops that "value add" handily.

Noble break-up
> Total Market Value: $24 billion
> Value Add: 10% to 20%

Noble Corp. (NE) plans to spin off its standard specification or shallow-water drilling unit operations. The move has been coming for a couple years, and this will make it a company that provides rigs for high specification drilling in deepwater, ultra-deepwater and harsh environments.

The second company will be in standard specification drilling and the shallow-water part of the spin-off will own five drillships, three semisubmersibles, 34 jackup rigs, two submersibles and one floating production storage and offloading unit, and it will manage the operations of one platform.

Creating a value add here is complicated in that the spin-off may not take place until the middle of 2014. That being said, Noble will claim almost 80% of its future sales and profit margins from new deepwater and ultra-deepwater equipment after the breakup. Does that add 20%, or is closer to half that amount?

Devon Energy and Devon Midstream Partners L.P., an MLP
> Total Market Value: $23 billion
> Value Add: 5% to 20%

Devon Energy Corp. (DVN) has announced plans to spin off its Devon Midstream Partners operation. This will put it in the master limited partnership (MLP) arena. The Devon Energy-backed midstream MLP was formed to own and operate natural gas assets. We do not have the terms yet, but the IPO filing was for up to $400 million in units versus a $23 billion market cap for Devon Energy.

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The new unit was created just in 2013 and reportedly had $2.2 billion in sales over the trailing 12 months ended last June. The whole of Devon Energy had sales of $9.5 billion in 2012, and the move to create an MLP unlocks income and pass-through via a return of capital for investors in the new units.

Until we get more details, it will be hard to assess a real value add here. The move could be as small as 5% in additional value created, but this is aiming to push more than 20% of revenues into a new entity. Be advised that with MLP spin-offs there are often overlaps in sales counted.

Ashford Hospitality Trust and Ashford Hospitality Prime
> Total Market Value: $1 billion
> Value Add: 10% or maybe more

Ashford Hospitality Trust Inc. (AHT) recently updated investors on the anticipated timing of the Ashford Hospitality Prime spin-off with an anticipated closing in the fourth quarter of 2013. Ashford Hospitality Trust is a real estate investment trust (REIT) focused on all segments of the hospitality industry. Ashford Hospitality Prime is said to be a conservatively capitalized REIT focused on investing in higher-end full-service and urban hotels predominantly in domestic and international gateway markets.

Ashford recently had an equity raise and said that approximately $160 million of cash and working capital will be distributed to Prime upon the spin-off. The company said, "Current Trust shareholders should benefit from Prime achieving a premium valuation multiple to Trust. Also, Trust shareholders should benefit from the management fee income that Trust will receive from Prime."

Ashford Prime hotels had total revenues of $221.2 million in 2012, versus $922 million for the entire Ashford company. With a one-for-five ratio and with it being almost 24% of sales, the most anyone might expect is a 20% combined value bump. Again we are conservative and would point out the ownership and management structures are changing, and there is already a dividend yield of almost 4%. Ashford has also seen a tough drop in the summer, so we will stick with a 10% bump here.

United Online and FTD
> Total Market Value: $760 million
> Value Add: 20%, some already realized

United Online Inc. (UNTD) claims to have attracted a total audience of more than 100 million registered accounts worldwide. This is broken up in a hodge-podge group. Its FTD segment is into floral-related products and services via FTD, Interflora, Flying Flowers and Flowers Direct. United Online’s Content & Media segment consists of Classmates and StayFriends, the online loyalty marketing via MyPoints, and also in its primary Communications segment of Internet access via NetZero and Juno, and even 4G mobile broadband via NetZero Wireless.

Why does a flower company need to be tied to online access and social media? United Online once tried to spin off Classmates, but the rise of Facebook was already afoot and it missed that boat. Now the effective date is November 1, 2013, for holders of record on October 10, 2013. United Online stockholders will receive one share of FTD common stock for every five shares of United Online common stock they hold, but then there will be a one-for-seven reverse split for the new United Online stock.

The company claims that this effort already has unlocked significant value and should add operational and strategic flexibility for both FTD and United Online while further enhancing stockholder value. Its CEO said, "We expect FTD to realize the benefits of being a pure-play, publicly-traded international premier floral and gifts products and services company and to continue to capitalize on the significant improvements we have made to the business over the past five years."

Elsewhere ...

Be advised that there is even an ETF strategy for spin-off companies via the Guggenheim Spin-Off ETF (CSD). This ETF invests in companies that have been spun-off within the past 30 months, but not in spin-offs that are less than six months old. It has roughly 24 holdings. Here are some of the more recent spin-offs that have been completed and that investors should remember with ease.

Kraft Foods Inc. (KRFT) broke itself away from Mondelez International Inc. (MDLZ) to unlock value in late 2012. It resulted in Kraft from getting booted out of the Dow Jones Industrial Average, but the companies are no longer as mixed and unequally yoked. Kraft is now worth $31 billion and the still lesser-known Mondelez is now worth $53 billion.

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Pharmaceutical and medical spin-offs have been seen and more are likely to be seen ahead. Abbott Laboratories (ABT) recently spun off its pharmaceutical operations of AbbVie Inc. (ABBV) as a stand-alone company. Pfizer Inc. (PFE) spun out its animal health business called Zoetis Inc. (ZTS) earlier in 2013. Pfizer is even in the process of dividing its existing businesses into new divisions, and that seems to be the writing on the wall that its growth operations and legacy operations could see future sales or spin-off announcements.

In media, two became one only to become two again. Twenty-First Century Fox Inc. (FOXA) and News Corp. (NWSA) used to be two different entities. Then they merged into one, only to after a decade or so become two entities again. Now the entertainment and cable assets are one outfit under 21st Century and News Corp runs the Wall Street Journal and other media outfits.

SAIC Inc. (NYSE:SAI) just recently completed the breakup and spin-off of Leidos Holdings Inc. (LDOS). This broke up the government contractor operations of SAI and the Leidos operation in technology and IT for health care, engineering and government security.

Vodafone Group PLC (VOD) has seen its shares rise handily since its deal with Verizon Communications Inc. (VZ). This was the sale of the remaining minority stake of Verizon Wireless, and the breakup had been years in the making. It not only unlocked major value but added billions worth of new capital for Vodafone to go do other selective deals.

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