The major difference between an IPO and a spin-off is that one gets major media 'spin', while the other can be vastly ignored. The lack of a major financial transaction-- and hence, fees-- tends to reduce the push by investment houses. Just by viewing articles posted on this very website one can quickly derive that the general public has less interests in spin-offs versus IPOs, to their own detriment. This provides a major advantage to alert investors. Outside the major spin-offs, like the upcoming ones at Kraft (KFT) and ConnocoPhillips (COP), the others fall under the radar by the investing community.
Historically, spin-offs have provided solid returns for savvy investors. This is partly due to investors ignoring or not understanding the new security, but also because spin-offs allow both the parent and the spun off company to thrive, with each management team free to focus on its direct business.
A few interesting spin-offs took place around year-end to little or no fanfare.
- TripAdvisor (TRIP) from Expedia (EXPE) - See presentation
- WPX Energy (WPX) from Williams Energy (WMB) - See presentation
- Orchard Supply Hardware (OSH) from Sears Holdings (SHLD) - see presentation
TripAdvisor, spun off from Expedia on December 30th, is a travel research platform which aggregates reviews and opinions of members about destinations, accommodations, restaurants and activities throughout the world.
While the three companies focus on customer reviews to drive advertising traffic, TripAdvisor is the only company that is profitable. Whether it's just the travel sector or that TripAdvisor has a better structure, the company has developed a profitable business model that should get more investor focus than the IPOs.
TripAdvisor has over 50M monthly users and some 50M user reviews which provides an incredibly large moat against competition. No startup can compete with that breadth of user contributed reviews. The first 6 months of 2011 had 33% revenue growth and analysts estimate $630M in revenue for 2011. For 2012, the company sees a further 21% growth to $762M in revenue. At a recent $25, the stock only trades at 18x the estimated $1.41 earnings for 2011.
TripAdivsor also has several additional catalysts including China-- where it operates Daodao and Kuxun, mobile with 10M+ downloads, and vacation rentals where a highly fragmented market awaits. The biggest concern with TripAdvisor is that it's highly reliant on Google (GOOG), and now Google has moved fully into the travel space with Google Flights. While there's always potential for Google to attempt cutting TripAdvisor out of key searches, ultimately users will flock back to the site with the most content, and that will always be TripAdvisor.
Williams Companies has long been known as a natural gas pipeline company, so the spin-off of exploration assets into WPX Energy only made logical sense. While a relatively large independent gas producer, it has hardly been noticed by investors. As with the typical spin-off, the new independence of WPX will allow executives to focus all its energy towards growing reserves and production-- something that probably wasn't always the top focus on the Williams BOD. In fact, per the presentation, WPX cut back on exploration in 2009-2010 to preserve cash for the parents' operating needs.
WPX Energy has a major presence in the Piceance, Bakken, and Marcellus plus several other interesting plays including the San Juan, Powder River, Barnett Shale, and Argentina via a 69% ownership of Apco (APAGF). That last stake is worth over $1.5B based on Apco's current valuation. The company has 4,473 Bcfe of estimated proved reserves as of 12/31/10 and 1,308 MMcfe/d of daily production as of October 2011. Per slide 9 of the roadshow presentation, WPX had the 4th fastest production growth of the major U.S. gas producers over the last 5 years.
The major issue with WPX is that even with a bigger drilling focus on oil and natural gas liquids, the company still only expects 37% of revenues to be generated from liquids in 2012.
The last, and definitely the smallest of the spin-offs, was Orchard Supply Hardware. With a market cap sinking below $100M, Orchard Supply has a surprisingly low valuation for a hardware store with over $650M in revenue. For example, large hardware store stocks like Home Depot (HD) and Lowes (LOW) trade at close to 1x sales.
Naturally, as a small part of Sears Holding, Orchard has likely been overlooked and clearly has not been growing as the store base has been held flat. Growth will pickup as management plans to add 3 stores in 2012 off an 87 store base. The recent announcement of positive comps for the last two quarters and expectations of the same in fiscal 2013 should bolster investors that leaving the grips of Sears has already been positive. However, the stock continues to plunge with the concerns over higher expenses from being a stand alone company.
From reviewing the presentation, Orchard appears set to appeal to the higher end customers in the California area (all stores are in California) with a remodel of existing stores. The new look will be a lot more chic compared to the industrial vibe of Home Depot or Lowes.
The biggest obstacle for the stock is the large debt load and interest expenses. The company recently undertook a sale-leaseback transaction on 5 properties that grossed nearly $58M. For its third quarter financials, Orchard reported $320M in debt and capital lease obligations. After using the above proceeds, it will still have $270M in obligations-- a significant amount considering the $40-44M EBITDA estimate for 2011.
The potential bright spot is that investors will be buying Orchard as the California housing market bounces along the bottom. As with parent Sears Holdings, the housing bust has been a major drag on earnings. Any turnaround in the housing market would have a major impact on fortunes, regardless of the abilities of a relatively new management team.
Investors should always do further research as this report only highlights some potential underfollowed investment options. Spin-offs provide a special situation where otherwise attractive stocks aren't hyped to the market.
Individual investors have a much better ability to buy these stocks at attractive prices than IPOs that open up above the offering price.
The main caution is that investors don't rush into these stocks until the dust settles, and the companies report the first financials as an independent company. Roadshow presentations can be overly bullish and financial reports hard to interpret by the average investor. The picture will be clear for all after reporting Q4.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in TRIP over the next 72 hours.
Additional disclosure: Please consult your financial advisor before making any investment decisions. May initiate long position in OSH, WPX.