Thread by @stockspinoffss

5 FULL LENGTH SPIN-OFF CASE STUDIES from You Can Be A Stock Market Genius

If you enjoy/value this, I would immensely appreciate a retweet.

If I can introduce just one fintwit investor to spin-offs, I'd be massively fulfilled.

Thanks!

// MASSIVE THREAD //

// CASE STUDY 1 //
.
.
HOST MARRIOTT spins off MARRIOTT INTERNATIONAL
.
OCTOBER 1992
.

During the 1980s, Marriott Corporation aggressively expanded its empire by building a large number of hotels.

Their strategy, which had been largely successful, was to build hotels, sell them, then keep the lucrative management contracts for those same hotels.

So, at any given time, they had tons of hotels under construction and WITH THAT tons of debt to build those hotels.

Then…in the early 1990s, everything in the real-estate market hit the fan.

Marriott was stuck with tons of debt AND tons of hotels that they were unable to sell.

Enter Stephen Bollenbach.

CFO of Marriott.

Fresh from helping Donald Trump turn around his real estate empire, Bollenbach devised a plan for Marriott:

Spin-off Marriott's management-contracts business, which had a huge income stream but very little assets. Into a company called Marriott International.

In the parent company, management would leave all the hotel properties, the debt, and the low growth business.

It would be called Host Marriott.

Marriott International (the "good" Marriott) would be required to extend to Host Marriott a $600-million line of credit to help with any liquidity needs

The Marriott family would continue to own 25-percent stakes in both Marriott International and Host.

And Bollenbach would be CEO of Host, the parent co.

Now, Greenblatt emphasizes, “no extensive research was required to learn all this.

The Wall Street Journal...laid out all this background information for me”

Now, if you’re anything like me when I first read this, you may be expecting Greenblatt to buy the new "good" company, Marriott International.

But alas, you would be wrong.

“Obviously," Greenblatt says, "I was excited about... the toxic waste.”

"Who the hell is gonna want to own this thing?" Greenblatt thought, expecting tremendous selling pressure on Host Marriott.

Here’s what Greenblatt liked about Host Marriott:

He noticed institutions didn't want it.

For three reasons:

First, the company had tons of debt and real estate (remember R.E. market had just hit the fan)

Second, Host would only be about 10 to 15% of the total value distributed to shareholders, the rest of the value would be in Marriott International.

(Greenblatt notes that it's helpful to think about Host Marriott as the spin-off instead of Marriott International, the actual spin, since it was smaller.)

Finally, institutions did not like it because Host Marriott was in a different business than most institutional investors originally invested in.

Host Marriot would own hotels, while the new spin, Marriott International, would contain the management company, which was what most people invested for.

Further, Greenblatt figured because of all this, most institutions wouldn’t even do any further research past what was already covered in the newspapers.

So Greenblatt vowed to be one of the first to read the Form 10.

The second reason he liked it was he noticed insiders wanted it.

Stephen Bollenbach was going to stay with Host, becoming CEO.

This caught Greenblatt's eye.

Why would Bollenbach want to stay on with this supposed toxic waste?

Maybe, thought Greenblat, Host Marriott might not be a hopeless basket case after all and Bollenbach might be well incentivized to make the new company work.

The final reason he liked it was that he found that a previously hidden opportunity was revealed.

That opportunity was…tremendous leverage.

Host Marriott's stock would trade at $3-5 per share.

But the new company would have somewhere between $20-25 per share in debt.

Greenblatt illustrates this opportunity: assume equity trades at $5 and debt $25. This would leave a total asset value of $30. Therefore, a 15% increase in value of Host’s assets would practically double the stock (.15 * $30 = $4.50).

And, Greenblatt wasn’t too worried about a drop in asset value.

For three reasons.

First, Marriott International (the “good” co.) would be on the hook for a $600 million line of credit.

Second, the Marriott family still owned 25%.

And finally, Bollenbach would be heading the company which Greenblatt found reassuring since Bollenbach had just turned around Trump's portfolio.

So how did it turn out?

Well…

Greenblatt was right.

Host Marriott nearly tripled within four months of the spinoff.

// CASE STUDY 2 //
.
.
BRIGGS & STRATTON spin-off of STRATTEC SECURITY
.
MAY 1994
.

Briggs & Stratton was a manufacturer of small gas-powered engines (mostly for outdoor power equipment).

It announced its intention to spin-off its automotive lock division in May 1994.

From the announcement, Greenblatt noticed that this spinoff looked like a prime candidate for institutional selling for multiple reasons:

First, the automotive lock division was small, representing less than 10 percent of the Briggs & Stratton total sales and earnings.

Second, the parent co, Briggs, was included in the S&P 500 with a market cap of $1 billion.

And lastly, the spin company, Stratton, was unrelated to Brigg’s small engine business.

Greenblatt waited for the form 10 filing so he could dig deeper.

Once the form 10 was filed, he dug in.

Greenblatt explained his first move, “my first move with any of these filings is to check out what the insiders...are up to.”

Under the heading "Reasons for the Distribution," Greenblatt discovered the primary reason for the spinoff:

"provide incentive compensation to its key employees that is equity-based and tied to the value of business operations and performance as a separately traded public company.” They would do this through a Stock Incentive Plan that would reserve 12 percent of new co.

shares for employees.

He liked this. 12% was a lot, which showed that management’s interests would be aligned with shareholders.

He moved on to the pro-forma income statement.
1994 earnings: $1.18/share

Most recent 6 month period looked to be up 10% from period a year before

He moved to the heading "Business of the Company.”

Greenblatt found that Strattec was by far the largest supplier of locks to GM (accounting for 50% of Strattec sales.).

And that it also provided locks to Chrysler (16% of total sales).

Then, Greenblatt saw something that he really liked.

The filing stated, "based upon current product commitments, the Company believes Ford will become its second-largest customer during fiscal 1996.”

With all this information, Greenblatt was ready to value the company.

First, he used Value Line to look at the P/E of other original-equipment manufacturers (OEM) for the automobile industry.
FInding, that the industry average was 10 to 12.

Greenblatt thought, if it were possible to buy Strattec at the low end of industry valuations (nine times earnings or so...$1.18 eps * 9 = $10.62), without taking into account the new Ford business, then the spin-off of Strattec might be a very attractive investment.

So he waited for the spin-off.

He bought in as Strattec was trading between $10-$12 (about 9-10x earnings) for several months.

Again, it was trading at this earning multiple BEFORE taking into account:
The new Ford business
Stratton's market position

And the recent 10% increase in profit in most recent 6 months

Well…

The investment worked out.

By the end of 1995, Strattec had traded to $18/share.
An ~80% increase.

// CASE STUDY 3 //
.
.
HOME SHOPPING NETWORK spin-off of SILVER KING COMMUNICATIONS
.
APRIL 1992
.

This pick was originally found after Greenblatt saw Home Shopping Network mentioned in an article titled “10 Stock for the ‘90s” in Smart Money.

A few things initially stood out to him.

First, it aligned with Ben Graham's value measures (low price-to- earnings and/or cash-flow ratio)

Second, Home Shopping's stock was priced just over $5 per share. Institutions don't like to buy stocks priced under $10.

And third, a spinoff was involved.

So he decided to look into it further.

Once the Form 10 was filed, he immediately went to the section, "Reasons for the Distribution.”

And found that “[Management believes that the financial and investment communities do not fully understand how to value HSN [Home Shopping Network], in part because HSN is both a retail-oriented company and a broadcast company.

Broadcast companies are typically valued based on cash flow while retail companies are typically valued on an earnings-per-share basis.”

Greenblatt saw that HSN was being significantly undervalued because it was being valued as a retail company instead of a retail company AND a broadcast company.

He looked into HSN & Silver King, its broadcast subsidiary.

He found that Home Shopping Network had purchased twelve independent UHF television broadcast stations during the 1980s.
Despite tons of cash flow, the stations didn’t have many assets. This resulted in a large goodwill number.

Amortizing this goodwill left a huge non-cash expense against earnings.

The financials showed that Silver King's operating earnings were slightly over $4 million for the most recent year.
However, its cash flow totaled over $26 million

($4 million in operating earnings plus roughly $22 million of depreciation and amortization)

When combined with HSN, the broadcast properties contributed only $4 million to Home Shopping’s operating earnings. But they added over $26 million to op­erating cash flow.

Since investors were valuing the business on an earnings multiple as a retail company. The stock price SEVERELY understated the value of the broadcast company.

Greenblatt waited for the distribution.

And after a few months of buying around $5, Silver King traded up to $10-$20 range over next year.

// CASE STUDY 4 //
.
.
AMERICAN EXPRESS spin-off of LEHMAN BROTHERS
.
JANUARY 1994
.

When he first started reading American Express’s announcement to spin-off Lehman Brothers, Greenblatt was not too interested.

He did not like a few things:

First, Lehman had highest expenses per dollar of revenue in the investment industry

Second, it had lost money in the prior year.

Third, it had extremely volatile earnings.

And finally, insiders owned almost no stock.

But as he kept reading, something caught his eye.

Newspapers were reporting that large institutional investors did not like the volatility of Lehman’s earnings.

Greenblat concluded the institutional dislike was probably pushing down AMERICAN EXPRESS’s valuation.

Greenblatt explains, “The only thing Wall Street hates more than bad news is uncertainty”

So, Greenblatt decided to look further into not Lehman, but the parent company, American Express.

His initial thinking was that after the spin-off, Lehman’s volatile earnings would be out of the picture, leading to a higher valuation of American Express.

Here’s how he went about valuing American Express.

First, he dug into the quality of the two underlying businesses that would be left after the Lehman spin-off
First, it was American Express’s main business. Whose main product was a charge card requiring full payment every month.

He looked for quality, noting, this required less credit risk. Plus, combined with their brand name, they seem to be positioned well in the market.

The second business was Investors Diversified Services, which had been growing at a 20% rate for almost ten years.

The business consisted of a group of financial planners. Often, the company recommended and sold its own products. To Greenblatt, IDS also seemed like a valuable and fast-growing niche business.

So he dug into the numbers.

Explaining that currently, just after the spin-off was announced, you could buy American Express for $29/share or less. Of which, an estimated $3-$5 was Lehman.

Which left about $24-$26 that would become the new post-spinoff American Express.

Analysts estimated American Express would earn $2.65/share w/out Lehman.

Which meant American Express was trading at about 10x earnings.

Greenblatt then used Value Line to find that other credit card companies were trading with P/Es in the low teens.

So he roughly estimated that American Express was at least 30-40% undervalued on a relative basis.

Looking back to the quality of the business, accounting for the fact that the charge card product was less risky than a credit-card product, IDS was growing at 20%/year, and Lehman’s volatile earnings were no longer going to be in the picture, Greenblatt concluded that American…

…Express warranted at the very least a earnings multiple near the higher end of industry averages.

Greenblatt played this by buying the parent co BEFORE the spin-off occurred. His thought was that there would be institutional BUYING of the parent co after the spin-off.

So, what happened?

As predicted, Lehman rose significantly on the first day of trading and returned 40% over the next year, reaching $36/share.

Also, about 6 months after the spinoff, Warren Buffet ended up buying about 10% of American Express.

// CASE STUDY 5 //
.
.
SEARS partial spin-off of Dean Witter
.
SEPTEMBER 1992
.

Okay, this case study covers a partial spin-off.

So before we start, I’ll give a very quick overview of partial spinoffs

(A more in depth overview can be found in You Can Be A Stock Market Genius. Also, I may do a full thread about this later, if anyone is interested).

Two reasons companies do a partial spin-off:

1. Raise capital without having to make any management changes.

2. Highlight a particular division's true value.

Now, here's the best part for us:

When a company does a partial spin-off, we can work backwards and find the implied value of the other businesses in parent co.

Basically, take the price of shares of the partial spin-off that are trading publicly.

Then USE their price per share and multiply by shares owned by the company.

Subtract the value of all their shares and see EXACTLY what the market is implicitly valuing the rest of the parent cos business.

Now, let's get into Greenblatt’s Sears Case Study.

In Sears' announcement of its intention to distribute the remaining shares of its 80% stake in Dean Witter, Greenblatt found that Sears had used two partial spin-offs of a 20% stake in Dean Witter and Allstate in an attempt to try to reveal its true value.

Greenblatt recognized the beauty of this. By subtracting the market’s value of its interest in Dean Witter and Allstate, he could see exactly what the market was implicitly valuing the rest of Sears assets.

Here’s how he went about finding the implied market value of Sears.

To give some context, before Sears had distributed its remaining stake in Dean Witter, here were the numbers:

Dean Witter's share price $37
Allstate's share price $29
Sears's share price $54

Greenblatt pulled up the announcement and found that for every 100 shares of Sears, Sears would be distributing of 40 shares of dean witter (.4 ratio)

He took the ratio of Sear to Dean Witter shares and multiplied in by the markets price of Dean Witter shares. (.4 * 37 = 15).

This showed that ~$15 of every Sears share was attributable to Dean Witter.

He subtracted $15 from the $54 share price of Sears.

Leaving a net price of $39 for the remainder of Sears.

He then calculated its 80% stake in Allstate.

Since Sears owned approximately 340 million shares of Allstate and Sears itself had ~340 m shares outstanding. There was a 1:1 ratio of Allstate to Sears shares.

Allstate shares were valued at about $29.

So, he subtracted Allstates' price from Sears ($39 -$29)

Leaving $10.

Greenblatt explained that for $10, you got the international and domestic Sears department store business AND Coldwell Banker, its real estate business.

After subtracting the Canadian and Mexican retailer and Coldwell Banker, the domestic Sears retailer was implicitly valued at $5, while it was doing $79/share of sales.

Greenblatt used JCPenny as a comp. It traded at 56% of sales.

In conclusion, Greenblatt found that it was severely undervalued.

He bought in.

The $39 remaining investment in Sears was up 50 percent over the next several months.

Those are the first five spin-off case studies covered.

Now before I end this thread, I need to address something.

Last week in my thread I said I would post EVERY spin-off case study from You Can Be a Stock Market Genius.

I must admit, I had forgotten the length of the last spin-off case study (about 20 pages). Considering this thread is already 87 tweets, that case study really deserves its own thread.

But what I want to address is that I promised something that I did not deliver on.

So I want to apologize to my followers. That was irresponsible of me. Going forward that will not happen again.

If you want to read that case study right now, it’s the Liberty Media spin-off of Tele-Communications which involves a rights offering. It starts on page 107.

I will be releasing another thread Saturday morning about the key takeaways from Graham & Doddsville’s interview of Kingstown Capital Management.

Thank you!

And finally, I must mention one more thing in case anyone is just being introduced to either me or spin-offs.

Spin-offs have changed my life.

For over a decade, I’ve been a student of this area of the stock market.

Early on, I had some successes ($EGL and $FURX) and some failures ($TMQ).

But the whole time, I’ve been learning, evolving, growing. (Not only as an investor, but as a husband and a father.)

Over the last five years, my spinoff recommendations have generated an average return of 24.1%.

Beating the S&P 500 by 8.3%.

I would not have started this newsletter and asked my customers to part ways with their hard earned money, if I did not firmly believe that over the long run their money would be returned tenfold through spin-off investing.

If you are one of the few who’ve read this far, I would like to say please look into spin-offs. Set a google alert to be notified of upcoming spinoffs and search "10-12b" on SEC's EDGAR to read their form 10.

They are a breeding ground for mispriced securities.

And if you would like to subscribe to my newsletter, I’d love to have you as a subscriber.

I’ve added a 7 day free trial so you can do your due diligence before allocating your capital.

Thank you! Have a good day!

Click below if you’d like to subscribe.

stockspinoffinvesting.com/premium/