Why Divorce Is Paying Off On The StreetPhillip L. Zweig
With merger-and-acquisition activity booming, many investors like to bet on what they hope will be the next big takeover play. But others are discovering that they can earn attractive returns by focusing on companies that are breaking up--through spin-offs, split-offs, and "carve-
Such separations or divorces may actually benefit shareholders in the long run more than corporate marriages, which frequently fail to live up to their early promise. The main reason is that spin-offs tend to be focused, streamlined companies with newly motivated managers. "In the global competition for capital, only the leanest and meanest companies get it [capital] at the best rate," says Rothschild Inc.'s Barbara Goodstein, dubbed the "Spin-off Princess" by Wall Street colleagues because she is apparently the only analyst following this trend full-time.
In each of the past three years, according to Goodstein's data, shares of spun-off companies, on average, have appreciated at least 29 percentage points more than the Standard & Poor's 500-stock index. One prominent star is Alumax Inc., an aluminum company that has surged 50% since its spin-off from what is now Cyprus Amax Minerals Co. in November, 1993. Some spin-offs appreciate handsomely by becoming takeover candidates. Galen Health Care Inc., which was spun off from Humana in February, 1993, was acquired by Columbia/HCA Healthcare Corp. the following September. Total gain to Galen investors to date: 140%.
These attractive returns have been achieved even though shares typically fall right after the deal is completed. One reason: index-fund managers who hold the parent's stock often dump shares of the smaller entity, which usually is not well followed by analysts. That, Goodstein says, presents "a significant buying opportunity." Within a couple of years, the newly liberated managers typically get their act together, causing the shares to take off.
Among her current favorites are Gardner-Denver Industrial Machinery Division Inc., Spacelabs Medical Inc., and Caremark International, despite a federal investigation of alleged Medicare/Medicaid-related violations at the health-care provider. Still, investing in spin-offs isn't a sure thing, she cautions. Some spun-off companies, including Lehman Brothers Inc. and Biowhittaker Inc., haven't yet panned out for holders.
Although Goodstein favors tax-free spin-offs, in which at least 80% of the shares are distributed to holders, taxable spin-offs, where the parent retains control, also grab her attention. When American Cyanamid Co. spun off Cytec Industries last year, it kept more than a 20% interest--"a clue," she says, that Cyanamid still valued the company.
Another device that seems to be enjoying a resurgence is the split-off, effectively a stock buyback in which holders exchange shares of the parent for those of the new company. One advantage of this technique over the spin-off, says Robert Willens, managing director at Lehman Brothers, is that it's less dilutive to the parent company's earnings. In September, Cooper Industries said it would split off its oil-field and industrial equipment activities in the second quarter, 1995. Although Cooper Industries has not yet announced the exchange ratio for the transaction, the plan, says Goodstein, "looks compelling because it promises to facilitate more accurate valuation of the disparate businesses."
CARVING A NICHE. Carve-outs, a type of initial offering in which a company raises capital by taking all or part of a subsidiary public, are also becoming popular. The best known was Sears, Roebuck & Co.'s carve-out of Allstate Insurance Group, which Sears has said will be spun off completely. However, says William C. Nygren, research director at Harris Associates, an investment adviser: "By their nature, carve-outs don't come out at as large a discount."
Few recent restructurings have tantalized investors like the plan, announced by Tele-Communications Inc. in late November, to create four new business units using one or more of these restructuring devices. One reason for the excitement, says Nygren, is that TCI Chairman John C. Malone has a track record of delivering for shareholders. Nygren thinks that TCI shares, Harris Associates' single-largest holding, could rise to $35 a share from the current $23 level. If that happens, it would provide further evidence that breaking up is not so hard to do.