On the Tyco Break-Up: Come Up With a Hard Estimate in Advance

Tyco International (TYC) has set a date for its long awaited breakup. Shareholders as of June 18th will receive shares in two new publicly traded entities, Covidien and Tyco Electronics, on June 29th. Covidien is Tyco's healthcare unit.

There's no need to buy the shares before the spin-off, as there will be a greater likelihood of one or more mispricings immediately after the spin-off. There is now sufficient public data for investors to value each of the parts:

Tyco spin-off information

You'll want to have your own estimates in hand before June 29th, so you can jump on any substantial discount that might exist within the first few days. Obviously, you'll want to have three estimates: What is Covidien worth? What is Tyco Electronics worth? And what is Tyco (ex Covidien and Tyco Electronics worth)?. Using a bit of sixth grade algebra, you'll be able to work back and forth from the pie to the slices and from the slices to the pie.

As far as spin-offs go, this one may not present terrific mispricings as each entity will be quite large. However, I'm always amazed by how cheap spin-offs get – even when the spun-off entity is relatively large and well-known. The fact that Tyco is splitting into three different pieces makes this one even more interesting. Also, as a large company, any spin-off discount may be corrected dramatically in a matter of months as comparisons with industry peers will be very easy to make relative to the unwieldy conglomerate that was.

My advice would be to come up with estimates for each of the pieces and the price at which you would buy any of the three stocks before June 29th. A lot of otherwise intelligent investors have a bad habit of waiting for a better price on a spin-off when the price they get is good enough. Generally, I think you can accept a slightly smaller margin of safety on a spin-off, because the spin-off itself is a sufficient catalyst to prevent a wide discount from continuing to exist over a long period of time. In other words, it's somewhat more likely that a spin-off will close the valuation gap within a year or so rather than three years or so when compared to other similarly mispriced stocks.

This last bit of advice is for people like me who tend to be willing to accept a long wait after buying a stock at a wide discount from some clearly ascertainable economic value, because the initial discount was wide enough to allow for an acceptable annual return even after a painfully long waiting period. Spin-offs tend to involve more change both in terms of the company itself and in terms of investor perceptions of the company.

Therefore, a reasonable catalyst allowance might be permissible – so if for instance you are in the habit of buying stocks at half of your intrinsic value estimate, you might want to consider a spin-off priced as high as two-thirds of its intrinsic value. I make this suggestion only because I have seen quite a few investors wait for a better price on a spin-off that they knew was an excellent opportunity, simply because they were convinced it would come down to their price.

Come up with a hard estimate before the spin-off and save yourself the trouble of wondering if the stock price will fall or not.

Just worry about buying something for less than you calculated it to be worth.

TYC 1-yr chart: