ITT: Spinoff Opportunities

| About: ITT Corporation (ITT)

Recently, ITT's board announced plans to break the company into 3 separate parts, which caused the stock to jump something like 16%.

ITT is a global engineering and manufacturing company that operates under 3 segments - Defense, Fluid, and Motion and Flow. The breakup looks to be along these lines with the company spinning off two new publicly traded companies, one for defense and the other for water (fluid segment). The motion and flow segment will continue on as the leaner ITT's core business.

Here's a quick look at the newly formed companies.

Defense Segment

Currently the defense segment accounts for a little over 50% of ITT's current revenues, but those revenues have been declining along with the operating profit margin. For 2011 ITT expects the defense segment to see revenues decline a further 2% with operating profit margin staying stable at 12%.

I think that might be optimistic. The writing is on the wall at the DOD that budget cuts/tightening is coming and this of course affects defense contractors. ITT produces the SINCGARS radio system, which is being phased out of the US military and I'm sure the draw down in troop levels in Iraq and Afghanistan will hurt contracts for their IED jammers and the information systems support they provide in theater. It does see some night vision goggle sales to international customers and can see some growth in cyber warfare support segments (cyber warfare might be the only "safe" area in realm of defense right now as it's kind of a hot issue).

The reality though is that the company's number 1 customer just isn't going to be throwing around as much cash in the near future as it has for the last decade and so there's no way this segment doesn't shrink. Conglomerates with strong defense business segments can weather the lean times by offsetting shrinking defense monies with income from their other sectors. "Pure" defense plays though (unless they're cyber heavy) are probably all in trouble in the short term to medium term (next few years).

However, these negatives may be overplayed once the spinoff occurs. I'd keep a close watch on this. You may be able to get a decently run business being affected by (possibly) negative industry trends at a terrific price. I think many of ITT's existing shareholders will be privy to immediately selling off the ostensibly worst company of the outstanding three.

Fluid Segment

In contrast to the defense segment the fluid and motion and flow segments have both seen revenue and operating profit margin growth and ITT expects to see continued growth for both of these segments in 2011.

Of these two business segments the one that interests me the most is the Fluids (water) business. Some reasons that I like this business the most, other than the fact that I just love infrastructure plays, are:

  • Their are very few pure water plays (at least that I know of) running around
  • They expect 55% of their revenues to come from international markets which diversifies them and shields them some from economic downturns in the US or any one other country
  • Water is the most important resource on the planet, no one really talks about it, but I expect it to be a huge issue in the medium and long term future.

A lot of companies, when they spinoff segments, tend to load up those segments with a more than fair portion of the parent company's debt and it will be interesting to see if ITT does this. Barring a big overall stock market downturn I kind of think ITT will trend a little bit lower in the near term just because the 16% pop was probably a little excessive.

Once the split takes place, I'd be bullish on ITT (the parent company) in the short term (especially if they manage to ditch a good proportion of their debt), cautiously bullish/bearish depending on how many people decide to dump their shares (which I believe most will, creating short-term downward pressure), and long term bullish on the water company.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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