Potential Spin-Offs To Consider (Part 1)

| About: Cincinnati Bell (CBB)

As Joel Greenblatt writes in his classic book You Can Be A Stock Market Genius, it can be hard to outperform the market using the same techniques as everyone else, but if you look at special situations you may be able to find value in areas where others are simply unaccustomed to looking. One such area is spin-ffs, where a company sells off part of its business to investors. Often separating a company in this way can unlock value because of greater management focus and autonomy for the separate company. The possibility of the spin-off being acquired or simply greater investor attention being applied to the business are also there. Here are three upcoming spin-offs to consider.

Cincinnati Bell (NYSE:CBB)
Cincinnati Bell is likely most regional telcos, except that it owns a datacenter operation that is growing revenue 47% and operating income 36%. Typically that sort of growth commands a premium rating as similar company Rackspace (NYSE:RAX) demonstrates trading at 96x earnings and 7x sales.

Below is my analysis of a sum of the parts, which generates a value of $4.40, 10% above the current share price on representative earnings multiples for the different businesses. I should note that this this is an extremely volatile valuation given the company's high debt. For example, one can create a more pessimistic valuation of $1.74 (60% below the current share price) looking at comparable sales multiples. The issue is that CBB has very high debt relative to its market cap so the equity valuation is extremely sensitive to relatively small changes in the overall enterprise valuation.

However, we should also consider that if the data center business continues its current growth of 37% in operating income this year (fiscal 2012) without changing any of the other assumptions, then the corresponding valuations using the same model as below would be $6.44 and $4.13 respectively.

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Management is exploring strategic alternatives, which could be a catalyst to unlock CBB's value over the next year. For example it seems possible that management may IPO at least part of the data center business and use the proceeds to pay down debt:

Source: company presentation Feb '12


Given the high leverage, CBB is risky and much hinges on the fast growing data center collocation business, but there appears to be a reasonable chance of good upside if the growth continues and management can further highlight it through a full or partial IPO in the next 12 months. Of course, there are downside risks too if the growth fails to materialize due to competitive pressures or capacity constraints. In addition, it worries me that management have generally been net sellers.

Hartford (NYSE:HIG)
This is the most speculative of the names on the list, because a spin-off is pure talk at this point, but activist investor John Paulson has made the case that splitting out life and property and the property casualty business would create value. However, the company has argued it may not be possible to split the company in two and maintain an efficient credit rating structure:

source: Hartford earnings presentation Feb '12


Given the lower likelihood of a spin-off event, HIG should be invested in on its own merits as an insurer, with the opportunity for a spin-off presenting an outside chance of upside. Since HIG currently trades at similar multiples to peers in the sector it is not clear that a spinout would generate much value, especially given risks to the credit rating.

See Part 2 of this article for further spin-off ideas.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CBB over the next 72 hours.