Divestiture/spinoff: My perspective, experience, and analysis

Reasons for digging into spinoffs and divestitures…

During college I was blessed to have Dr. Cusatis as my finance professor and guide. He
performed research into spinoff returns in the mid 90’s and that was cited in Greenblatts “You
can be a stock market genius”. Since that book and other things I think spinoffs and special
situations have become overly popular – which naturally decreases probability of finding excess
returns. For that reason, it is very important to really dig into many factors for each specific
case.

You want to have a subjective probability of the incentive behind the divestiture. Ive come to
notice that the decision is often binomial in outcome

a.(BAD)wants to release a under performing business segment; The rationale from mgmt could
be truthful or BS as they may cite that bureaucratically it doesnt make sense to have segment
under same umbrella, but truth could be that its hurting the stock price that could help put
their options ITM(EXEC COMP ISSUE)

b.(Good)put a over-performing business segment on its own that management believes the
market is not valuing correctly and so it will be valued more fully. The beautiful thing in these
situations are the inferences that the SEC compensation package filings provide. Its fairly
indicative that if the management team of the parent receives and holds onto the equity thats a
good sign. If the new executive team in the child structures there pay heavy in equity and
options and or heavily insider buying then thats a good indicator of their expectations.

c. (Good)In the study restructuring through spinoffs, my ex professors findings showed that
spinoffs provide a low cost method of transferring control of assets to an acquiring firm. There
general conclusion that the primary driver of excess returns was the takeover activity which
occurred 33% within 3 years. Given the frothy merger activity over past few years, identifying
spinoff pure plays will be something I will look for.

After you have a grasp on incentive, you can perform traditional security analysis to come up
with an expected value of share price. The two areas I focus on area fundamental and
opportunistic timing.

a. Opportunistic timing: Investment Advisors often recommend that their clients sell the spin-off
shares due to portfolio allocation reasons. Structural selling of spin-offs happens due to index
fund selling (because the spin-off is not in the index), lack of yield, odd-lot selling and limited
liquidity. Many uninformed shareholders sell for reasons since it is a whole new business from
the one they bought and dont have the time,inclination, or skill to analyze the new security. In
this scenario, the forced selling creates downward pressure on the price for a period of time –
often a quarter to a year

Research process typically contains

 Investment thesis
 Business description – business segments, how safe business model is
 Operational history
 Macro and sector trends
 Rationale for spin-off / carve out – my true opinion, as well
 Management incentives – pay structure, ownership before and after the fact
 Major shareholders, insiders, management ownership
 Structure of business pre and post spin-off – organizational chart
o Conversion rate, assets and liabilities etc...
 Takeover probability

Valuation Approach

1. Accounting for value – anchor on BV for first 1-2 years, then multiple scenarios for
speculative value
2. Sum of the parts valuation
3. EV/EBITDA, P/E, and comparable firms

Expected value analysis, allocating certain probabilities to each valuation.

Beyond advising on certain spinoff transactions while on the special sits desk, ive published
reports and took positions in Penn National gaming REIT spinoff, fortune brands home security,
Lands’ End, and BEAM.