One of the quickest ways to benefit from a company and its stock is through a breakup of the company's business segments. Alcoa (AA) and Hewlett-Packard (HPQ) were recently featured as sum-of-parts plays without any nod from management or board members that either firm is considering or would consider a break-up. Alcoa was recently dissected to see whether its four business segments would be worth more than the company as a whole. Analysts at Bloomberg found that Alcoa could add nearly 63% to its current share value of around $9.18 by breaking up.
Similarly, there has been a lot of talk about unlocking huge value in HP through a breakup. Specifically, analysts think that HP should separate its business solutions division from its printer and personal computer divisions. Such moves are thought to unlock over 25% of share value.
However, since corporate leadership is resistant to giving up power, this is putting the cart before the horse. Instead, investors interested in following corporate actions should wait for an executive to announce such intentions or for investor activists to accumulate shares and press for restructuring.
Management Versus Spin-Offs
More often than not, management does not want to sell or otherwise cede control of a business segment. It's too much like giving up or admitting defeat for most managers, and as a group they tend to fight asset disposal. Why not go double or nothing instead of admit you were wrong? (This is classic prospect theory.) It is also theorized that executives refuse to give up control because having more assets under their control helps justify high salaries and lofty egos. The idea is that a CEO of a $3 billion company seems to have more clout than a CEO of a $2 billion company. This motivation is the manifestation of owner/manager conflict of interest.
Since motivation is necessary, value alone is just not enough to justify a sum-of-parts analysis. Consider how UBS analysts concluded that Hewlett-Packard ought to separate business solutions division from its personal computers and printer operations. HP shares would be worth $20 or more per share if the businesses were run separately. This is much higher than the roughly $14 price of shares today. The analysts led by Steven Milunovich stated, "HP, with its fully developed enterprise and consumer businesses, should split up in order to realize greater value." Any loss in purchasing power would be more than made up for by an increase in management focus.
Right on cue, Hewlett-Packard refuted the concept that it would break up. CEO Meg Whitman said that she would not spin off the personal computer business though this course of action was considered by her predecessor Leo Apotheker. According to spokesman Michael Thacker, Hewlett-Packard is stronger together than they would be apart and the customers believe in one HP.
However, the UBS analysts suggest that HP could break up if "prompted by activists or private equity." Whitman said the enterprise business and the software business would be the only growth engines for HP. Milunovich believes that at current share prices HP investors are actually getting the printer and PC business for free.
Such hypothetical scenarios are great fodder for analysts, but without a management decision a spin-off or business sale will not happen. The value of a company's parts cannot be unlocked without a key.
A similar study turned to Alcoa and investigated whether the firm as a whole is worth more than its parts. Bloomberg averaged the work of four different analysts who each used a sum-of-the-parts valuation of Alcoa's four divisions as separate businesses. Their average value per share for the parsed entity would be $14.82. This is almost twice the value of Alcoa shares which trade near $8.70 today.
More likely than not, this result may not matter any time soon. Not surprisingly, Alcoa CEO Klaus Kleinfeld said that keeping the company together makes sense. His rationale was based on how the firm is a global, large company with sophisticated intra-company purchasing. This environment is thought to let the business segments flourish.
Can you blame these executives? If I had worked hard to become the head honcho of a giant corporation I wouldn't want to carve it into pieces either.
Real Spin-off Candidates
There are unusual occasions where management is more likely to accept the disposal of assets as a viable course of action. For example, Yahoo (YHOO) is much more likely to sell off business units. The ascent of new Yahoo CEO Marissa Mayer has increased the odds for the sale of other non-core assets and the return of capital to shareholders. She has demonstrated that she is not afraid to shake things up by implementing major changes in the firm's upper management line-up. Essentially, she has the freedom to make big changes to the company since she would be correcting the mistakes of others instead of admitting her own. Moreover, activist investors are well represented among shareholders and the board of Yahoo. Mayer would have their support to sell more non-core assets.
Even more certain than potential Yahoo spin-offs, ING Group (ING) announced the sale of its Malaysian insurance unit for 1.3 billion Euros to AIA Group. is going This transaction would increase AIA's profit percentage to 13% which would be a 5% increase in overall scenario.
This deal is likely to go through. Mark Tucker, AIA's Chief Executive Officer took it upon himself to re-imagine the company's future after it had suffered a huge setback during the financial crisis after its parent company American International Group (AIG) was bailed out in 2008. Tucker said that AIA is so strong now that it can grow while simultaneously acquiring new assets calling it an "excellent strategic fit."
The valuation multiples of these companies reveal that Safeway and ING are particularly attractive:
Clearly, investors seeking to play corporate events should consider ING and Safeway as potential buy candidates. On a price-to-book basis, ING is arguably cheaper than Alcoa or Hewlett-Packard and yet is vastly more likely to sell any business unit. Similarly, on a price-to-sales basis, Safeway is much more attractive than any other company on this list, and yet it is much more likely than Alcoa or Hewlett-Packard to actually go through with an asset sale.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.