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A Potential Spinoff And Special ~16% Dividend: Computer Science Group

|Includes: DXC, HP Inc. (HPQ)

Summary

It is estimated that the Computer Science Group spinoff will be finished by the end of October.

What makes the spinoff interesting is that there is a $10.50/share special dividend attached to the deal.

Once the spinoff is complete, it will be much easier to sell the Government Solution side of the business.

Want to make a quick buck or ten? First, buy Computer Science Group (CSC) and wait for the anticipated spinoff (expected to be complete by the end of October). After the spinoff is complete, you will effectively own two companies for the price of one. What makes the deal interesting though, is that shareholders will receive $10.50/share in dividends concurrent with the spinoff. At the current price, this is a ~16% yield for only having your money tied up for a few weeks. Finally, after the spinoff, sell the parent company, and keep the spinco, with hopes that it will either; appreciate in price (due to unlocked valuation from the spinoff) or get bought out.

Summary

On May 19th, 2015, CSC announced that they are planning a tax free, corporate spinoff. If the deal goes through, one portion of the company will serve the public sector in the US and the other will serve government clients on a global basis. As stated in the deal, the spinoff of the public sector business will be a one for one deal with a $10.50/share special dividend attached, at the closing of the spinoff. After the spinoff, there will be two pure play companies. Finally, the spinco will be named Computer Science Government Services (NYSE:GS).

Note: CSC anticipates using $1.5 billion to finance the dividend.

GS will focus on mission-specific IT, infrastructure and other business services to government agencies such as the US Federal government, state, and defense agencies. Estimates suggest that the spinco, GS, will have ~$4.1 billion in revenue. The man running GS's show after the spinoff will be Lawrence B. Prior III (as CEO and President). As of right now Prior is the VP and general manager of CSC's North American Public Sector (NPS).

The commercial business, or parent company will resume operations with the same name. Thus, the Information Technology services and solutions will stay with the parent (All non-government clients). Finally, the current CEO, will continue managing this business.

What Are the Risks?

The biggest risk of this spinoff is if the board of directors decides to not go through with the spinoff, or they go through with the spinoff and opt out of the dividend. If board decides to not go through with the spinoff, you will be stuck with an underperforming company (super low margins, and an unprofitable history). If this happens, there may be downward pressure on the stock price, due to the investors who were banking on the spinoff. However, if the spinoff goes through, but at the last minute, the board of directors decides to opt out of the dividend, that quick easy 16% will be lost in the wind. The good news is that you will have two companies for the price of one, you will just not have that quick dividend.

The other risk is if the market turns sour. Currently CSC is trading for a decent premium. Its P/E is an astounding 1,496, and its EV/EBITDA is 9.18. What I am trying to say is that CSC is not a cheap security to buy. You must weigh the risks and rewards and have a good understanding on what could happen if the stock market turns sour, or the deal goes through.

What's the Strategy or Plan of Attack?

I believe that the best way to effectively take advantage of this special situation is to buy CSC, wait for the spinoff, collect your dividend, sell the parent and then wait for either a rise in the stock price of GS or wait for GS to be bought out. The question remains; why would GS be bought out? To answer that question, let's step back in time for a minute.

  1. In 1998, Computer Associates International offered a buyout at $108/share (more than 130% the price at the time), CSC declined.
  2. In the early year of 2005, CSC was getting close to selling itself to a variety of different buyers (Blackstone, Warburg Pincus, TPG Capital Management and Lockheed Martin). All negations failed.
  3. In 2006, CSC was exploring options to sell itself to several different parties. Nothing transpired.
  4. In 2013, Lockheed Martin and three other private equity firms were talking about buying out CSC. As you can guess, the deals fell through.

The reason why CSC has been an ideal target for potential buyouts is due to its GS business segment. The government segment or GS is attractive for potential buyers because of the high barriers to entry. Thus, after the spinoff, the GS side of the business will have a much higher chance of being bought out in the future. For as we know, the reason for the spinoff is due to the failed attempts of CSC selling itself over the past several years.

As I have said before, the best way for investors to take advantage of this situation is to buy CSC, wait for the spinoff concurrent with the special dividend, sell the parent company and wait for the GS segment to either get bought out or appreciate in price.

Note: There are current buyout interests from Cap Gemina SA (CAPP.PA), Hewlett-Packard (NYSE:HPQ), CGI Group (GIBA.TO), and other private equity firms.

Is the Spinoff Really Going to Happen?

Is this spinoff going to happen, or is this a very risky bet, that has a huge chance of falling through? To make things clear, CSC has filed an Initial Form 10 Registration Statement with the SEC. Although, there has not been an announcement of the distribution date, yet. However, there has been some positive and ongoing information that suggests that the spinoff is still going to happen.

First, on August 31st the company announced that after the spinoff is complete, GS will combine itself with SRA. It has been speculated that the combination of these companies will be complete by the end of November, thus suggesting that the spinoff is still anticipated to be complete by October. After the combination of these companies, GS will be the biggest pure play IT service provider in the US government sector.

Because there has not been any other announcements on the spinoff since August, and it hasn't been approved fully by the board (only a form 10 filed), there is risk that the spinoff may not go through. However, it is in CSC's best interest to have the spinoff go through. I would find it rather odd and irrational if it does not go through..

Conclusion…

The CSC spinoff is a special situation that investors can take advantage of to make a quick buck, or ten. If the deal goes through, investors will make a very decent return in a relatively short period of time (I am anticipating it will go through in 1-2 weeks). Because of managements failed attempts of creating shareholder value in the past (by potential buyouts), I have a high conviction that the deal will go through. If the spinoff does not go through, you will be stuck with an overvalued security that has potential for more downward pressure. In my opinion, the rewards outweigh the risks.

Author's Note

Thank you for reading my article on the CSC spinoff. If you liked what you read, I urge you to follow me, and more importantly, reach out to me. I am always up for meeting and talking to other investors who are interested in investing and knowledge. Also, feel free to comment and criticize my work, in the comment section below. Positive criticism will help me improve my work for me and more importantly, my readers. As for the comments, sometimes, they can provide more value than the entire article, so start a discussion. And aren't we all just looking for more value? Once again, thanks a lot for reading and good luck fellow investors.

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

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.