When a company decides to spin off a portion of their business, it can create immense value for shareholders who take advantage of this opportunity. The history of past spin-offs has been statistically proven that they create 10% better returns to shareholders than the market as a whole. If just picking random spin-offs can create 10% better returns to shareholders than the market, then intelligently investing in great businesses who spinoff a segment of their business at a margin of safety should, in theory, produce even better gains.
National Oilwell Varco
National Oilwell Varco (NYSE:NOV) is a leading worldwide provider of equipment and components used in oil and gas drilling and production operations, oilfield services, and supply chain integration services to the upstream oil and gas industry. NOV operates in over 1,160 locations, in 65 countries and also in six continents. Modern NOV was incorporated in 1995, but NOV has roots dating back to the 1840s. National Oilwell Varco is such a big player in its industry (over 60% market share), that its ticker NOV has been used as an acronym for "No Other Vendor."
NOV operates under three different operating segments: rig technology, petroleum services and supplies, and lastly distribution and transmission. Rig technology brings in the biggest amount of revenue to the business followed by petroleum services and supplies, and finally distribution and transmission. Since 2012, revenue has increased by 64% as a whole for the business.
Petroleum Services and supplies
Distribution and Transmission
Recently, NOV has announced that the company will be spinning off their distribution portion of their business to create a separate entity called DistributionNOW, or NOW, Inc. The distribution portion of NOV will have operations in over 20 countries with over 400 locations. The size of the spin-off will be equivalent to 85% of the revenue for NOV's distribution and transmission segment for the six months ending June 30, 2013.
Distribution produces the lowest amount of revenue for NOV and it also has the lowest profit margin of 4.7%. Revenue has increased by 154% since 2010 for the distribution and transmission portion of NOV. Analysts have stated that the new spun off company DistributionNOW will have a market capitalization of around $4 billion.
Spinning off the distribution segment of NOV will create value for the business as well as the shareholders. When NOV spins off the lowest margin producing segment of their business, they will be able to create higher margins for NOV. Higher margins equates out to more money to invest, distribute out in dividends, or increase shareholder equity. With only rig technology and petroleum services and supplies left in NOV, management will be able to concentrate more efficiently on those portions of the business, thus creating value.
Spinning off distribution will not only create value for the parent company NOV, but it will also create hidden value for the spinco DistributionNOW. NOW will be able to invest all of the money they make back into their "own" business instead of the money going to other parts of NOV. Using the profit they make from operations to reinvest back into the business will create greater revenues, higher EPS, better margins, etc. in the future.
Statistics on Spin-Offs
According to the Spin-off Report (spin-offs between 2000 and 2010), after one year the stocks have increased in value. The value was significant as well. The parent companies rose more than 17% on average and the spin-offs rose 24% on average. There was also research done at Penn State that stated spin-offs outperformed the S&P 500 by 10% for the first three years after being separated from the parent. The parent companies outperformed the S&P 500 as well by 6%.
One of the many spin-off stories that I have interest in is McDonald's (NYSE:MCD). In 2006, Chipotle Mexican Grill (NYSE:CMG) was spun off by the parent McDonald's Corporation. The spin-off since then has done incredibly well; CMG is up over 600% and the parent MCD is up over 130%. If you bought $1,000 worth of CMG it would be well worth over $6,000 today.
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One of the reasons why spin-offs do so well is because when they are first introduced to the market there is a huge sell off of the companies. There are a few different reasons why there is a sell-off. The first reason is due to the fact that the funds that are specifically designed to hold a certain type of stock can no longer hold this company. The fund managers would then sell it as quick as they can. Institutions sell right away because the size of the spin-off company is not big enough for them to hold it legally. Then there are the shareholders who do not want to analyze the value of the business so they sell and take their cash. This will produce a good buying opportunity for value investors when the spin-off will become depressed.
Future Management for DistributionNOW
The CEO for the new spun-off company will be Robert Workman. Workman started at NOV in 1991 while serving as the vice president of operations for distribution. He also started serving as the president of distribution since 2001. He currently serves as the chairman of Petroleum Equipment Suppliers Association and is the member of IPPA (International Positive Psychology Association), IADC (International Association of Drilling Contractors), as well as API (American Petroleum Institution).
The CFO will be Daniel Molinaro. Molinaro is the vice president and treasurer of NOV, and served as the treasurer since 1987. In 1968 he started his career at U.S. Steel (USX), working as a comptroller of the Oilwell division. Molinaro has held various managerial positions in auditing, accounting, and finance.
The CAO will be David Cherechinsky. In 1989, Cherechinsky started his career in many different corporate roles including internal auditor, credit management, and business analyst. He has been the vice president of finance for the distribution since 2003, and vice president of finance for the distribution and transmission business since 2011. Cherechinsky has an MBA and a CPA.
The current CEO of NOV, Pete Miller, will become the executive chairman of DistributionNOW. Miller obtained his BA in Applied Science and Engineering from West Point, and an MBA from Harvard Business School. He has worked in various executive jobs at NOV such as COO and chairman of the board, and is currently the CEO. In 2012, Morningstar named Miller CEO of the year.
Valuation of NOV
Mathematics is ordinarily considered as producing precise and dependable results; but in the stock market the more elaborate and abstruse the mathematics the more uncertain and speculative are the conclusions we draw there from. Whenever calculus is brought in, or higher algebra, you could take it as a warning that the operator was trying to substitute theory for experience, and usually also to give to speculation the deceptive guise of investment. -- Ben Graham
When I value a company that I want to invest in, I like to look at the company's peers in the same industry to determine if I am buying an undervalued security. I looked at statistics of NOV's competitors and put some of the key statistics together in a graph below. What I found was that NOV is not only very undervalued compared to the industry as a whole, but also very undervalued in the market.
If you take a look at the table above, you will see that since 2003, NOV's earnings have grown an astounding 1,140%. With the trailing P/E ratio of 14.5, that is a lot lower than the industry average of 21.2. Also, the P/B of 1.56 compared to the average of 2.84 is a considerable amount lower resulting in an undervalued security. With a dominant market share, and NOV priced lower compared to its peers, NOV is a good buy at the price it's at right now.
(as of Jan, 6, 2014)
National Oilwell Varco ("No Other Vendor") has been increasing earnings for the past 10 years giving shareholders more and more value for their buck. With a recent spin-off coming up in 2014, which will increase earnings, margins and give shareholders a brand new company, this is a good opportunity to buy. One thing that I did not mention previously is that Warren Buffet (the Oracle of Omaha) has been buying shares in NOV. Seeing that Buffet has given a "yes" to NOV is even a better reason to buy an undervalued security. I am long NOV, and will buy more shares if the prices keep falling.