There are several big sum-of-parts value plays featured in the financial news. Research In Motion (RIMM) and Nokia (NYSE:NOK) have valuable patent portfolios which investors should note as rivaling or exceeding their market capitalizations. Procter & Gamble (NYSE:PG) and Johnson & Johnson (NYSE:JNJ) are interesting from a sum-of-parts perspective because many of their branded products could become spin-offs or divestitures. Like Research In Motion and Nokia, their brands have values which are typically not captured on the balance sheet.
Investors must ask which of these stocks, if any, are investible based on their component businesses and assets.
The Value of Mobile Device Patents
Big companies use patent portfolios like the ones held by Nokia and Research In Motion to fight each other in court or as leverage to settle out of court. Currently, there is an intellectual property war being waged in many different legal systems between many companies in the mobile device space. Apple (NASDAQ:AAPL) has won a major battle, but it the intellectual property war rages on. As long as these companies have stockpiles of cash and legal systems as battlegrounds, relevant unexpired patents will be valuable.
The purchase of patents for legal scuffles is a very real phenomenon. HTC's current conflict with Apple relies on patents that it purchased from ADC Telecommunications in April 2011. This year Google purchased Motorola Mobility for almost $13 billion in order to gain access to its many patents.. This purchase has allowed Google to claim that Apple has infringed on seven of its patents including interactive voice commands, email notifications, location reminders, and video/phone players.
Research In Motion's intellectual property is estimated to be worth near $1.3 billion, which is substantial relative to its $3.4 billion market capitalization. Nokia's patents are estimated to be worth $7.5 billion, which is the majority of its $10.6 billion value of its shares.
Too Many Products
Companies like Johnson & Johnson and Procter & Gamble take ideas for new products and turn them into brands which are part of our everyday lives. This is a great way to make a profit, but a company's products can become so numerous that they become unmanageable.
Clearly, there are differences between these firms and their competitors in terms of being able to deliver returns on invested capital and earnings growth:
EPS Growth Past 5 Years
EPS Growth Next 5 Years
Return on Investment
Procter & Gamble
Johnson & Johnson
Procter & Gamble earnings have stagnated over the past five years and Johnson & Johnson's earnings have declined slightly. Both of these firms have lower returns on invested capital on their peers. These lackluster performances could mean that these firms would be better off if their holdings were spun-off as into different companies.
Procter & Gamble: Is the sum greater than its parts?
Analyst Ali Dibadj noted that Procter & Gamble could consider breaking itself up into separate units if it cannot improve earnings by the end of the year. Based on 2013 earnings estimates, Procter & Gamble would have a market value a little over $208 billion in breakup, which is greater than the firm's $178 billion market capitalization. It is also believed that simplifying the company by selling business units would help improve focus. CEO Robert McDonald has stated that Procter & Gamble will cut back spending in smaller markets, and focus more on spaces where it lost the most market share. Ali Dibadj believes Procter & Gamble has a good strategy, but that the company's current lack of success could be related to recently announced cost cuts, management strategies, or to the fact that the company stymieing complexity.
It was recently announced that Pershing Square Capital Management, Ackman's legendary Hedge Fund, has purchased about $2 billion of Procter & Gamble shares. Bill Ackman's Procter & Gamble stake is a credible threat that could agitate management and prove to be a catalyst for change in the company. Most recently, Mr. Ackman's power as an activist investor was demonstrated in a victorious a proxy battle when he gained control of the board of directors at Canadian Pacific Railway (CPR). This win may allow him to focus his efforts on Procter & Gamble.
Johnson & Johnson Spinoffs
Johnson & Johnson is selling its Reach brand of dental products as part of its effort to prune the number of its brands. Reach toothbrushes sales were over $355 million worldwide in 2011, and Reach dental floss sales were more than $265 million worldwide, with about $55 million of that from North America. Johnson & Johnson has a history of selling business units to smaller companies or private equity firms. In 2011 Johnson & Johnson sold its Monistat and e.p.t brands to Insight Pharmaceuticals, a company owned by Swander Pace Capital, a private equity firm. It also sold St. Joseph's Aspirin to Ilex Consumer Products Group, and in 2010 sold Purell, hand sanitizer products to Gojo Industries.
Corporate Restructuring: Hatching an Egg
There are no guarantees that management will sagely sell non-core assets or solicit bids for a takeover. Management tends to resist such actions. For this reason, we have to consider the downside of business as usual while individual investors wait for agitators or outside bids to help management see the light.
Consider the following financial metrics:
Research In Motion
Procter & Gamble
Johnson & Johnson
Johnson & Johnson is probably the least risky investment on this list. It has a long history of dividend increases. Moreover, it is selling business units, while there could be a long, drawn-out power struggle before Procter & Gamble's management embraces spin-offs and divestitures. Analysts expect acceptable annualized earnings growth of 6.69% over the next five years. Therefore, it is the least risky because it pays investors to wait (dividends) and because it has demonstrated its ability to prudently divest from non-core assets.
The biggest payoff to investors could come from Research In Motion. Investors who speculate on this stock would gain big because of its low price-to-sales and price-to-book ratios which reflect the value of its current business and accounting assets. But, its internally developed intellectual property (patents and trademarks) are not captured in this number, and could be a source of additional, unexpected gains. This easily makes RIMM sum-of-parts play with the most upside, but also with much higher risk than Johnson & Johnson.