Verizon (NYSE:VZ) is spinning off its directory business. They are calling it Idearc (IAR). This situation has all the signs of a classic dump of the despised "spinco". Why?
First, at least relative to Verizon, Idearc is a very small company. Large cap funds that hold Verizon will eventually have to sell the shares so as not to violate the Morningstar style boxes, and potentially confuse fund analysts and share owners.
Second, Verizon is in many index funds, including those following the granddaddy of them all, the S & P 500. These holders of Verizon will be forced to dump this spin-off because Idearc will not be included in any index.
Third, this Yellow Pages directories business won't have the dividend yield of the parent company. That means dividend investors, including some large funds focused on providing income for shareholders, will want to sell.
Fourth, directories are "old" media, and thus considered toxic waste for many investors looking for the next Google to turbo charge their portfolios. Idearc will be not even get a sniff from these gunslingers.
Finally, Idearc will have a lot of debt (~ $9b) relative to its equity---more than most institutional money managers will be comfortable with. This will make them want to sell the shares and reduce perceived risk.
All of these factors should serve to put pressure on the shares. But every business, even declining ones, hold the possibility of being a good investment, provided the price is right. Because of their stable operating characteristics, low capital requirements, and high operating margins, directory businesses are coveted by private equity investors. And of course, these investors are flush with cash at the moment, and anxious to forge deals.
Last year, a deal to buy a directory business (Dex) was done by publisher R.H. Donnelley in the 10-11 X ebitda range. Idearc, which initially will have about 146m shares outstanding, begins trading on November 20. At a an expected price of about $27 or so, total enterprise value comes in at around 7.5 X 2005 ebitda of $1.7B.
This is a slow growing business, and there will be some integration costs, at least through 2008. So eibitda will be in this general range for some time.
If Idearc gets a bit cheaper (perhaps 6-7 x ebitda) -- and there is every reason to think it will -- Verizon's toxic excrement may become a value. In this changing world, 11 X ebitda represents a rich takeout value, given the risk that advancing Internet search technologies makes a local directory book nothing more than a waste of thin yellow paper. Therefore, 9-10 X seems a more realistic goal for investors here.
Verizon investors may well be primed to pitch this one overboard. Idearc, then, could well be a winning idea for intrepid, contrary investors.