By Doug Ehrman
A recent yardstick of success for many companies has been their ability to acquire other, smaller companies, using the acquisition as a source for additional growth and revenue. However, a few companies have bucked this trend in 2011, using spinoffs as both evidence of their financial strength and as a catalyst for entering growth periods. Conventional wisdom suggests that a carefully planned spinoff can unlock value. Each of the three companies discussed below has used a spinoff to improve its financial position and, as a result, is a strong candidate for inclusion in a well-balanced portfolio.
Expedia, Inc. (EXPE) – Completing the spinoff of TripAdviser, Inc. (TRIP) this week, EXPE has greatly improved its financial position. We thought something would be in the works, including a potential acquisition. While it may take several days to get a thorough view on the new financial metrics of the company, looking at growth and valuation prospects before the merger paints a favorable picture. Prior to the merger, the stock was trading at a price-to-earnings multiple of 16.7, relative to 24.7 for Priceline.com, Inc. (PCLN) and negative earnings for Orbitz Worldwide, Inc. (OWW). Based on estimates, some analysts are predicting growth in earnings per share of nearly 23%, given the stock a strong growth element, particularly given the attractive valuation. As a final catalyst, EXPE signed a new contract with United (UAL) earlier this month, setting it up for continued success. The two companies have forged a strong 15-year relationship, and the new contract will extend the relationship and be a strong revenue source for EXPE. While there are still a few factors to play out, this spinoff has created a great buying opportunity for the stock.
Kraft Foods, Inc. (KFT) – After aggressively acquiring food-maker Cadbury in 2010 for $18.9 billion, the company turned around and announced earlier this year plans to re-divide the company. It is unusual for a company to be so introspective, or so public about admitting a misstep. While the move does not specifically speak to the Cadbury acquisition being flawed, KFT seems to have really understood that there are structural differences between the snack food segment and the grocery segment. Third quarter results suggest that move has already had a positive impact - although the spinoffs are not expected to be complete until some time in 2012 - revenue was up 11.5% from a year ago and net income was up 22%. Relative to competitor ConAgra Foods, Inc. (CAG), financial metrics for KFT are attractive. While CAG looks slightly cheaper on a price-to-earnings basis, trading at a multiple of 15.4 against 20 for KFT, when growth is included, KFT is stronger with a price-to-earnings over growth (PEG) ratio of 1.53 relative to 2.04 for CAG. A reading below 1.0 is considered favorable, but in such a stable segment, higher readings can still be attractive. With year-over-year quarterly revenue growth of 11.5% versus 9.5% for CAG, and an operating margin of 13.2% versus 10.4% for CAG, the company is well run and has solid growth potential. As further developments on the spinoffs are made public, like the recent announcement as to who will pilot each company, there will be additional catalysts to drive the stocks higher.
Abbott Laboratories (ABT) – The division of ABT into a pharmaceutical unit and a medical device unit is also expected to unlock significant value for investors. On the drug side of the business, ABT’s premier anti-inflammatory, Humira, will maintain its patent protection until 2017. The remainder on the company’s pipeline is also solid, which is somewhat surprising because the company has usually lagged other major manufacturers like Merck (MRK) and Pfizer (PFE). Many analysts predict that the spinoff will make an attractive takeover candidate as soon as it gains independence. The other division, which will retain the Abbott name, will offer investors a more streamlined medical device manufacturer more equipped to compete with rivals Medtronic (MDT), Boston Scientific (BSX) and Johnson & Johnson (JNJ). Financial metrics for the stock are less appropriate for direct comparison because of the bifurcated nature of the business. Overall, ABT is an attractive inclusion in a balanced portfolio; the completion of the spinoff will serve as a further catalyst for positive performance.