Spinoffs — they’re hot right now.
Companies from all kinds of industries are divesting subsidiaries that don’t fit by spinning them out into independent, separately run businesses. Generally, spinoffs outperform the S&P 500 in their first 12 months of trading, making them very attractive to investors. Especially interested are existing shareholders of the parent company. They’re wondering whether they should sell the new shares they receive, keep them, or sell their shares in the parent and reinvest the proceeds in the new company.
It’s not a slam-dunk decision.
Let me make it a little easier. Here are my three choices of spinoffs that will outperform their parent over the next 12 to 18 months.
Top Spinoffs: Lands’ End
InvestorPlace contributor James Brumley believes Eddie Lampert’s move to spin off Lands’ End from its parent – Sears Holdings (SHLD) — is simply a $500 million lifeline. While I agree the dividend is burdensome, it isn’t life-threatening. The interest expense in 2014 on the $515 credit facility used to pay the dividend is estimated to be $25 million. Lands’ End’s operating income in 2012 was $82 million; in the first three quarters of fiscal 2013 it’s 35% higher year-over-year. It will be fine.
Before making any investment it’s smart to assess the business and its financial underpinnings. In that regard Lands’ End doesn’t fare too badly. The company’s operating profits have been in decline in recent years, falling from $194 million in fiscal 2010 to $82 million in fiscal 2012. However, that’s likely to bounce back in fiscal 2013, coming in somewhere north of $100 million.
Its direct segment, which includes internet and catalog sales and represents 82% of its overall revenue, is highly profitable. For the first 39 weeks of fiscal 2013 ended Nov. 1, the direct segment’s revenue was $861 million with operating profits of $76 million. Revenues and operating income grew 1% and 9.6% year-over-year respectively. More important, its operating margins grew 80 basis points to 8.8%. It’s the heart of the business.
The fly in the ointment is its retail segment, which had an operating loss of $4.5 million on $172 million in revenue. Its retail business consists of 275 Lands’ End Shops at Sears and 16 stand-alone Lands’ End Inlet stores. When you consider this revenue was generated from 2.2 million square feet (a dismal average of $80 per square foot), it’s not hard to understand why it lost money. Lands’ End’s No. 1 priority as an independent company is to improve the sales productivity at its Sears locations. If it can double the sales per square foot to $160, you can be sure the segment will be profitable.
Regardless of the retail segment’s troubles, I believe SHLD shareholders should sell some or all of their shares once Lands’ End is spun off, using the proceeds to buy more. Spinoffs usually outperform. This one will do so by a country mile.
Top Spinoffs: Gaming and Leisure Properties
Although Penn National Gaming (PENN) completed the spinoff of its real estate assets on Nov. 1, 2013, Gaming and Leisure Properties’ (GLPI) shares have traded since mid-October. The only pure-play Casino REIT was created to provide PENN shareholders with two investments: gaming and real estate. Both businesses would be able to focus on what they do best with shareholders better off as a result. I can’t argue with the rationale.
PENN shareholders received one share of GLPI for every share of the gaming operation. In order to qualify as a REIT, GLPI was required to purge itself of all accumulated earnings. It did so by paying $210 million in cash and 22 million shares to existing shareholders. The special dividend amounted to $11.84 per share, or $1.05 billion. Even though this is a great gift for the shareholders of record and many have likely sold their GLPI shares, I believe the best is yet to come.
Think about the state of U.S. gambling at the moment. Although Las Vegas and the rest of the gambling hot spots across the country are slowly pulling themselves off the mat, we all know the real money right know is in Asia and other parts of the world. All you have to do is look at the share price of Las Vegas Sands (LVS) to know that the Macau operators are the ones winning at the moment. At some point the U.S. will bounce back as more states accept the reality that some tax revenue from gambling is better than none.
For all we know, PENN will be the winner when it comes to the domestic gambling scene. Then again, maybe it won’t. GLPI’s announced in December that it was buying the real estate assets of the Casino Queen in East St. Louis for $140 million — the first indication of how it intends to grow its business. Up until then all of 19 casino facilities were formerly owned by PENN, with 17 still operated by them. The Casino Queen deal screams, “We don’t know who’s going to win on the U.S. gaming front so we want to own as many of the potential winners as possible.” If you bet on PENN and it doesn’t do so well, its stock goes down. GLPI, on the other hand, continues to collect the rent. The cash flow continues whether or not Penn is operating the casino.
You can bet on Penn — or you can sell PENN, hang on to your GLPI stock and buy LVS stock with the PENN proceeds. That to me seems like a much smarter bet. But I’m no gambler.
Top Spinoffs: Ashford Hospitality Prime
It seems there are two price points that win in this world: high and low. Ashford Hospitality Trust (AHT) came to the conclusion that its revenue per available room (RevPAR) of $102 was primarily from middle-of-the-road hotels. Nice, but generally inexpensive. The eight hotels it rolled into Ashford Hospitality Prime (AHP) are of a higher price point, averaging a RevPAR of $145 — double the national average. Investors would easily see the difference between the two portfolios, making both stocks more attractive.
Shareholders received one share of AHP stock for every five shares of AHT. Since AHP stock started trading on the NYSE (Nov. 20) it’s down 26% through March 20. Meanwhile, AHT stock is up 33% in the same period. Clearly investors see the split as a good thing for the parent.
Long-term it should be good for both.
Since becoming a separately run, independent company, AHP has acquired two additional hotels — The Sofitel Chicago Water Tower and Pier House Resort and Spa — for $246 million. It paid $653,000 per room for the Pier House, which is located in Key West, Fla., the second-highest RevPAR in the U.S.. The Pier House was acquired from AHT while the Sofitel was purchased from an affiliate of Blackstone (BX). It has an option on 12 more hotels currently owned by AHT whose RevPAR skew higher. Long-term, AHP’s RevPAR is only going to go higher, setting it apart from the rest of the public lodging universe … including AHT.
In this particular example I’d recommend you hang on to both AHT and AHP stock because they address separate markets. You also might want to pick up more AHP given its decline since November. Long-term you’ll be happy you did.
As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.