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These Spin-Offs Could Be Pin-Ups

Spin-offs, carve-outs, bust-ups, and all the other corporate weirdness that on Wall Street go by the bland name "special situations" can be a royal pain to understand. They also can prove uncommonly profitable. Chemical company Cabot, for example, last year spun off a unit that makes compounds used to polish semiconductors. Before the deal, Cabot had a $2 billion stock-market value. Today, the market values of Cabot (CBT) and Cabot Microelectronics (CCMP) total $4 billion.

One guy who spotted that situation early is Joe Cornell, who heads Spin-Off Advisors, a Chicago research and hedge-fund firm. Amid the market's new sobriety, the flow of such deals is dwindling a bit, yet plenty of opportunities remain. Cornell told me he expects fewer carve-outs, or two-stage spin-offs. The first step is an initial public offering of, say, 20% of the stock in a unit a parent company aims to divest. In a second step, the parent distributes the remaining 80% interest to its shareholders via a special dividend.

But with a cool IPO market, Cornell is seeing more straight spin-offs that go right to step two. "Those offer more opportunity anyway," he said. "When you get investment bankers involved in the IPO, more people pay attention." A case in point is Roxio, a maker of CD-burning software that parent Adaptec (ADPT) initially planned to carve out via an IPO. Instead, in May, it went ahead and spun off all of Roxio directly to Adaptec shareholders.

Roxio initially traded as high as $17 but soon started sinking; it scraped a bit under $11 before edging back above $12. In its fiscal year ended on Mar. 31, Roxio saw sales jump 57%, to $122 million; cash earnings grew 53%, to nearly $24 million, or $1.45 a share. Roxio's software already comes installed on many new computers.

Johnson & Johnson's (JNJ) move on May 23 to buy most of Inverness Medical Technology (IMA) is creating a fresh spin-off. While J&J will keep Inverness' diabetes-care unit, it aims to spin off other units in women's health, nutritional supplements, and clinical diagnostics. Christopher Schulz, analyst with institutional research service The Spin-Off Report, told me that the spin-off part of Inverness posted $8.7 million last year in earnings before interest and taxes, on $54 million in sales. If J&J finishes the deal as planned, it will pay Inverness shareholders $35 in J&J stock plus new stock in the spin-off. With Inverness near $36, investors give little value to the spin-off, which Schulz sees starting with $1.05 a share in cash.

Some top investors have long dreamed that Canada's industrial giant, Canadian Pacific (CP), would find a way to uncover the value of its many odd parts. That dream seems at last to be realized as CP gets set to split into five pieces this fall. In "the starburst," as the company calls it, investors will get separate shares in petroleum, railway, coal, shipping, and hotel companies, the last of which includes management of such luxe spots as the Fairmont Banff Springs Hotel and New York's Plaza.

Such super-cheapskate investors as Southeastern Asset Management sold CP after the stock got a quick boost from news of the bust-up in February. It's now near $40, but Cornell and Schulz see a bit more hidden value; they estimate CP's post-starburst value range at $43 to $48 a share. That potential gain may look modest, but it's not a riskless proposition. CP awaits a ruling from Canadian tax officials on the plan; any delays would push the payoff further off. Likewise, the Inverness spin-off is in an early stage, and Roxio's challenges include competitors. All the same, these are three lower-risk situations that look, well, special. By Robert Barker

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