I recently updated the spreadsheet in which I track spinoff pipeline and post-spin stock performance. Next I pulled up stock charts of spins from the past 12 months: I noticed a mix of losers, winners and even some flat-liners. But one thing becomes crystal clear in looking at these charts: A very large majority of spin-offs are wildly mis-priced at emergence. Mind you, when I say “mis-priced”, I am not referring to over or under-valuation but literally talking about the stock price.
Students of Special Situations investing à la Joel Greenblatt already know the usual reasons for this mis-pricing:
- Technical/forced Selling at inception.
- Lack of analyst coverage.
- Lack of historical financial data.
- Initial “noise” in financial results.
to name a few.
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That said, and from what I can tell, Special Situations investing is hardly some obscure side of finance – it’s quite a crowded space. So why does one see this incredible volatility in spinoff stocks when so many institutional investors follow them closely?
I have no idea – it’s a riddle wrapped in a mystery inside an enigma.
I decided to randomly pick one stock that is not a micro-cap, reasonably liquid and has doubled post spin to see if I could glean anything useful. Something that could help me identify the next multi-bagger before it multi-bags (did I just coin a verb?)
Let’s take a look at Ingevity Corporation (ticker NGVT) that was spun out of WestRock Company (Ticker WRK) on May 16, 2016. Am I right in thinking that neither of these companies are a “household” name? I think so.
Here is the stock chart of NGVT:
Ingevity Corp (NGVT)
I suppose there really isn’t a need for me to compare this chart to some stock index return to figure out-performance…
So the first thing that goes through my mind when I look at this chart is: Double in less than a year. WTF!!
I mean, without looking at fundamentals or even what this company does, just look at the price and volume. Do you see any huge trading volume spikes (indicating significant events, surprises etc.) as the stock rose from $20s to $50s? I don’t. Except that spike on June 24, 2016 – the only news I could find around that time was that the company hosted a picnic at Boys Home of Virginia.
In other words, the stock appears to have doubled in price without any significant catalyst(s) along the way. WTF, indeed.
What I can see is tremendous trading volume at and near emergence that kept the stock price pressured. Why would that be? Well, one reason could be that because the parent company was significantly larger than the spinoff, WRK holders were not interested in owning a smaller company stock and punted it immediately. Another reason could have been that the spin was seen as the parent discarding unwanted “refuse” aka garbage-barge spinoff (not the case here). Another reason may have been that stock market participants weren’t paying any attention (I don’t buy that one).
That’s what we are going to try and find out.
First let’s look at the parent company WRK. This is a Richmond, VA- based Paper and Packaging company formed on July 1, 2015, via a merger between Rock-Tenn Company and MeadWestvaco Corporation. Interestingly, MeadWesvaco had already announced the spinoff of its specialty chemicals business (later to be named Ingevity) after being pressured by activist fund Starboard Value.
Here’s what Starboard had said about the Ingevity piece:
Over the past five years, the Specialty Chemicals segment has grown at a 15.4% annualized rate while EBITDA margins have expanded to 26.7%. We believe that these attractive growth rates and margins would result in a premium valuation if this business were sold or spun off. While there is no pure play comparable for MeadWestvaco’s Chemicals business, similar chemical companies trade at an average multiple of more than 10x EBITDA (vs. ~7.5x for MeadWestvaco)… a separation of the chemicals business would result in the realization of $3.5 billion of value, or $22 per share(1), at the midpoint of the multiple range.
You can read the full text of the letter (linked above) but here are some of the companies Starboard had used as the peer group to come up with its valuation argument for NGVT: ALB, CBT, CCC, WLK, Rockwood (acquired) and Norit (acquired).
But before we move on to Ingevity, it might be helpful to take a look at WRK stock prior to spinning off Ingevity.
So total dogshit between July 2015, when the merger took place and up until early 2016. The S&P 500 declined approximately 7% during this period but the decline in WRK is around 50%. I imagine that this stock performance did not endear investors to WRK or pay attention to the pending spinoff story.
Now turning to Ingevity. Here’s a link to a company presentation dated May 4,2016 (just days prior to the spin) in which it shows 2015 EBITDA of $203 million, down from $247 million in 2014. Furthermore, Q1-2016 EBITDA was $43.9 million, down from Q1-2015 EBITDA of $47.6 million. Finally, it provided EBITDA guidance of $175-$195 million for 2016 – again, a decline from $203 million in 2015.
Let’s stop for a second here. All the trends are down. Why would anyone find this inspiring or exciting? This could explain why the stock traded so poorly at the onset of the spin.
The capital structure at the spin was as follows: Net debt of $486 million and total shares outstanding of 42.1 million. The stock initially traded in the mid $20s so total enterprise value of $1.5 billion and EV/EBITDA of 8.3x. Consensus estimate for 2016 EBITDA is currently at $196 million… so where is the surprise that helped the stock price double?
Next, I look at the sell side firms that follow the stock… mostly bucket shops. So it’s not like Almighty Goldman Sachs picked it up and slapped a Buy on it and then the lemmings jumped in. That didn’t happen.
Could it be that a famous investor/fund took a big position in the stock and the rest of the crowd followed and drove the price up? I don’t see any (no offense intended to the holders..).
Maybe this was sector-related? Let’s look at the stock price performance of Starboard’s proposed peer group during the same trading period:
So all flat-to-nicely positive, which is no surprise given how the overall stock market has done recently but nothing like the 100% move in NGVT. And I think it’s fair to say that Ingevity stock has done extremely well due to multiple expansion, not earnings out-performance versus expectations. It began trading at 8x EBITDA at spin and now trades at 13x-14x. In comparison, ALB trades at 16x, CBT 10x, CCC 10x and WLK 7x.
There is a fair amount of consolidation going on in this sector so perhaps that might explain why NGVT trades at such a rich multiple?
My conclusion from this analysis is this: Do pay attention to spinoffs where (1) there is a significant size differential between Parent & spin; (2) that trade at a discount to the peer group and (3) that seem to have some unattractive/repulsive aspect.
I might add that I don’t feel so bad about missing out on NGVT after all. For I wouldn’t fucking touch, with a ten foot pole, a stock in a cyclical industry trading at 8x EBITDA, in what seems to be an earnings peak, come hell or high water.
Is this a candidate to short now trading at 13x-14x EBITDA? That’s the question, isn’t it?
Article by OozingAlpha