The world of spinoffs is ever-changing. There's always a new company being spun off or a new announcement or a new filing with the SEC. So it's useful to have a place to find the details on some of the latest happenings in the spinoff world. That's what this column is about.
Spinoffs have delivered good returns to investors for years, and it's a great place to search for attractively mispriced companies. But it's not only the spinoffs that could perform well, but also the parent companies, depending on how they're priced. Ultimately, the goal is to use the spinoff transaction to find stocks that are cheap due to reasons that have nothing to do with their business performance.
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Here's some of the most recent spinoff news, including the spinoff company's prospectus, if it's been filed.
The next few weeks are stuffed with spinoffs, but one of the most recently announced spinoffs won't occur until the first half of 2019, when apparel maker VF distributes shares in its jeans and outlet units to shareholders. The new spinoff behind Lee and Wrangler denim is targeting a total shareholder return in the high single digits, including what management calls a "sustainable high dividend yield." Management expects the business to be able to scale and reduce costs by streamlining its operations, allowing it to capture more of its $2.5 billion in revenue as earnings. Scott Baxter, who held the reins of the jeans unit from 2011 to 2015, will become the CEO of the spinoff.
Meanwhile, the parent company looks like it might be the more attractive option, at least over time. Management is targeting a mid-teen total shareholder return, with a dividend in line with the S&P 500. Following the spinoff, VF will become more focused on growing consumer trends, leading to management's expectation of margin expansion. Expect VF to make more acquisitions and build out its stable of brands.
While management can predict long-term returns, what matters for short-term returns is the relative price investors pay for the two companies. With executives signaling higher returns for the parent company, it may trade higher coming out of the transaction, leaving the spun off company relatively cheap and setting it up for better near-term gains.
A sweet Honeywell spinoff
Industrial conglomerate Honeywell is targeting Oct. 1 for its spinoff of Garrett Technologies, a maker of turbochargers and other performance-enhancing products for cars. Honeywell shareholders will receive one share of Garrett for every 10 shares of Honeywell. The new company will trade under the ticker GTX.
Will the spinoff be a good investment? That always depends on the price you pay, but the fundamental business looks solid. Turbochargers are projected to grow 4% to 6% through 2022, and Garrett's products play to a long-term trend toward lower emissions and improved fuel economy. Its products get "locked in" to the supply chain, since manufacturers designate only one supplier per engine.
While the operations look solid, Garrett's financials look a bit strained. The company is going to have substantial debt and paying it down will be a top priority for use of cash over the next couple of years. That and asbestos payments may keep some investors away, but it could be a good opportunity at the right price.
ServiceMaster delivers
Another Oct. 1 debut is Frontdoor, a spinoff of ServiceMaster which is a provider of home services such as pest control and appliance repair. Frontdoor will own the American Home Shield business, and shareholders will receive one share of the new company for every two ServiceMaster shares they own.
Frontdoor owns home service companies, including American Home Shield, the largest provider of service plans in the U.S. by revenue. It offers homeowners a yearly service plan that covers the repair or replacement of major home systems, such as plumbing, electrical, and HVAC systems. Growth has been robust and consistent, with compound annual growth of 8% from 2007 to 2017. The year 2017 saw revenue growth at a strong 13%, while net income surged 29%.
Investors will find Frontdoor's margin especially attractive, and Frontdoor turned in 22.4% adjusted EBITDA margin in 2017. That and the recurring nature of the business -- customer retention is 75% -- should likely make shareholders very interested. At a market cap of $2.7 billion in the illiquid "when issued" market, the stock is trading around 17 times earnings, so it looks cheap for what you get.
Keep your eye on spinoffs
The moment of a spinoff is a great time to evaluate how the two separate companies are priced. Many investors make the too-easy mistake of buying the "better" business without considering how each business is priced relative to its prospects. If investors place too high a price on the spinoff, it makes the parent company cheaper (and vice versa), perhaps too cheap, given its future. Aiming to purchase shares during the transaction can often be a great opportunity to pick up a parent company or spinoff cheaply.
Jim Royal has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
