Finding Value In Spin-offs

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Some of the best trades during the past few years have been spin-offs. Of course, I’m taking about deals like Kraft Foods Group Inc (NASDAQ:KRFT) / Mondelez International Inc (NASDAQ:MDLZ) and ConocoPhillips (NYSE:COP) / Phillips 66 (NYSE:PSX) both of which have continued to achieve record performances year-to-date. What’s more, there are a number of spin-offs upcoming during 2014, which have the potential to put in a similar impressive performance.

DuPont plans to spin-off its chemicals division

DuPont Fabros Technology, Inc. (NYSE:DFT)’s planned spin-off of its performance chemicals division is likely to attract some traders. However, this is an industry that tends to be highly cyclical and growth has slowed during the past few years. Earnings are also extremely volatile with divisional earnings dropping 38% year-on-year for the fiscal third quarter. Unfortunately, you get the feeling that DuPont’s management is disposing of its performance chemicals division because it finds it a liability. Furthermore, which such volatile earnings and low growth I doubt investors will be excited about the new company’s prospects.

Still, while investors may not be excited about DuPont Fabros Technology, Inc. (NYSE:DFT)’s spin-off of its performance chemicals division there are other opportunities out there.

Kimberly Clark to spin-off its Health Care division

Kimberly Clark Corp (NYSE:KMB) intends to spin off its Health Care division, which has sales of approximately $1.6 billion. K-C Health Care sells surgical and infection prevention products for the operating room and a portfolio of innovative medical devices focused on pain management, respiratory and digestive health. K-C Health has the number one or number two market position in several product categories within the United States. Of course, this makes the company highly defensive and desirable for investors. Without a doubt, this is likely to be a highly sought after spin-off.

K-C Health’s prospective peers in the medical appliances & equipment sector currently trade at an average price-to-sales ratio of 2.7, excluding the 20 most under and overvalued companies. This indicates that K-C Health should trade at a market capitalization of around $4.3 billion. The spin-off is expected to be completed by the third quarter of 2013.

National-Oilwell Varco to spin-off its distribution business

Another upcoming spin-off is National-Oilwell Varco, Inc. (NYSE:NOV)’s distribution business. This is a spin-off that is expected to be completed within the first half of 2014 and the new entity will look something like MRC Global. MRC Global Inc (NYSE:MRC) went public at the beginning of 2012 and has performed well to date. Up 53% since coming to market, easily beating the S&P 500, MRC is a good indicator as to what National Oilwells spin-off will do.

Personally, I feel that the spin-off will be a better deal for National-Oilwell Varco, Inc. (NYSE:NOV) as the company is getting rid of its low margin distribution business. Still, National Oilwell will lose some profit from the deal but I estimate that this will only be in the region of $60 million per quarter, or 7% of total operating profit. What’s more, the distribution business reported an operating margin of only 5.5% for the first half of 2013, while the company’s most lucrative division, rig technology, chalked up an operating margin of 21%. With these numbers in mind, I calculate that National Oilwell will see its net profit margin expand 2% after the spin-off, from 15% currently to 17%. Nevertheless, the new distribution business will have stable earnings, no debt and plenty of potential for growth through acquisitions.

Time Warner to dispose of Time Inc

Another low-margin spin-off is that of Time Warner Inc (NYSE:TWX)’s disposal of Time Inc. slated to take place sometime during 2014. Time Inc. is Time Warner’s worst performing division with sales falling 3% for the first nine months of this year and 40% during the past decade. At present, the Time Inc division has been given an enterprise value of $2.3 billion, around $2.5 per Time Warner share but it is unclear how investors will receive this deal, especially with the print industry in what could be called terminal decline.

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