Alcoa: Activist-Driven Split

| About: Alcoa, Inc. (AA)


After a week 3Q earnings, shares are just cheap enough to spark interest.

The company is splitting up on Nov. 1.

And has the sanction of activist investor Paul Singer.

by Bradley J. Huber, CPA

Alcoa (NYSE:AA) is trading around $27, down some 20% from its 52-week high. This comes as the aluminum company released disappointing 3Q earnings earlier this month. The earnings miss saw both top-line revenue and bottom-line income fall from the previous quarter.

Still - the results were a significant increase from 3Q 2015 EPS figures of $0.06, with 3Q 2016 coming in at $0.33. Alcoa shares are essentially flat over the last twelve months, but, a major turning point in the company's 128 year history will occur on November 1.

Show me the split

Alcoa will effectively offer a 1-to-3 reverse stock split when it spins-off its value-added business into a new company named Arconic. A split that activist investor Elliott Management supports. The spinoff comes because two "strong" companies have been built under the iconic Alcoa name that can now independently pursue their own strategic directions. The question is whether after disappointing Q3 earnings, are the two business truly strong enough to operate separately.

Proponents of the split - to start - indicate that the operating results of the two businesses will be much clearer, making it easier to make investing decisions, i.e. deciding what you want exposure to and the prospects.

The clear purpose of the split is to breakout the high margin manufacturing and engineering operation from the slow-growth community business of its legacy upstream business. Therefore, the major risk of the split is whether shareholder value will actually be created once Alcoa and Arconic (NYSE:ARNC) trade separately.

Which very well means, will the value-added high-margin Arconic be able to trade at levels high enough to absorb the most likely dismal performance of the legacy upstream business, Alcoa?

We're at six year lows for aluminum prices, and steady competition from China, puts the legacy company Alcoa in a position to face a tough road as a pure raw and basic materials producer. The structure of the 1-for-3 reverse stock split is indicative that the new Arconic is the most valuable business. In addition, the aerospace industry in which the Arconic will be heavily focused on has positive growth prospects as far out as ten years.

Furthermore, Alcoa has announced that a $0.09 per share dividend will be paid to shareholders of record as of close of business November 11. The date of record was revised from November 4 to November 11 just this week. The dividend will be paid on November 25 and will be paid from the newly formed Arconic. Further cementing Arconic's overall investor appeal over its counterpart, Alcoa, post-split.

If Alcoa's disappointing 3Q earnings report were not enough, the stock is down an overall 11% in 2016. Ahead of a major split, the bearish earnings report and YTD results could have come at a better time. However, would a major 3Q earnings report that handily beat estimates improve the investment prospect of Alcoa ahead of its November 1 business separation? In the short-term Alcoa probably would have not seen the 16% haircut from its share price that it did in the week following the 3Q miss. However, the miss created a tremendous buying opportunity for investors not owning Alcoa prior to the miss that are or have shown interest in the new Arconic brand. As it is, the Arconic business represents a strong long-term investment in an engineering manufacturing firm closely tied to the growing aerospace industry. Furthermore, the legacy Alcoa business post-split may decrease in share price to values that may make since to investors looking at getting into some commodity-driven stocks. Sometimes you take the good with the bad. In this case, the good being Arconic business, while the "bad" really isn't all that bad considering the legacy Alcoa business is priced fairly cheaply.

Disclosure: I am/we are long AA.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.