Perhaps big and bulky isn’t the way to be anymore, when it comes to corporate structures. In the past few months, we’ve started to see some major companies splitting themselves in two.
The whole thing kicked off when Meg Whitman took the plunge last November with the spinoff of the iconic tech company into two pieces: HP Inc (HPQ) and Hewlett-Packard Enterprise (HPE).
Then, thanks to prodding from Carl Icahn, Xerox Corp (XRX) announced in January that it would split into two businesses, hoping both the document technology and business process outsourcing divisions would thrive under their own separate management.
It seems more CEOs and their boards are deconglomerizing in an effort to generate maximum value for shareholders. The question now is who’s next? Here are three S&P 500 stocks worth cutting in two.
Darden Restaurants Inc. (DRI)
Darden Restaurants Inc. (DRI) CEO Greg Lee’s answer to its critics was to spin off Four Corners Property Trust Inc (NYSE:FCPT) in early November, a real estate investment trust that would own a bunch of Darden’s real estate and restaurant assets. Why not split off some of your valuable assets in an income-producing investment vehicle that’s attractive to income investors while reducing the debt hanging over the operating company? It’s business 101.
The problem is it didn’t go far enough.
Darden’s unraveling began in 2014 when it sold Red Lobster to Golden Gate Capital for $2.1 billion. Originally, it was looking to spin off Red Lobster into its own publicly traded company before opting for the private equity firm’s buyout offer. One activist investor, Barington Capital, had argued that Darden should create two separate companies with Red Lobster, Olive Garden, and LongHorn Steakhouse in one and its faster-growing chains in another.
It’s not too late.
A quick look at Darden’s Q2 numbers show that revenue at LongHorn Steakhouse grew 5.6% year-over-year to $365.1 million. It’s Darden’s second-largest chain by sales. Olive Garden, its biggest, generated a 1.2% revenue increase to $892.3 million on a same-restaurant sales increase of 2.8% taking into account fiscal 2016 is 52 weeks, not 53. That’s not gangbusters but it’s enough to justify a split.
The remaining five chains would then operate as a second stand-alone company whose Q2 revenues were just shy of $700 million with most exhibiting same-restaurant sales growth of 3% or more.
It’s not a new plan, but it’s a good one.
Walt Disney Co (DIS)
Three years ago I told investors that Walt Disney Co (DIS) should spin off ESPN into its own publicly traded company where its shareholders would own 80% of the stock and Hearst Corporation, ESPN’s 20% minority shareholder, the rest. At the time, analysts valued the sports network anywhere between $40 billion and $66 billion. Today, that valuation could be in jeopardy as there are signs it is losing its grip on cable subscribers — losing 7 million (7%) in just the past two years — so the current number might not be quite so frothy.
So, maybe a standalone ESPN isn’t the best thing for Disney at the moment.
A better solution is to separate its entire media business (ABC, ESPN, and A&E) from the three other segments of the business (Parks and Resorts, Studio Entertainment, Consumer Products and Interactive Media) into two publicly traded companies. If you’d done this at the beginning of fiscal 2015, the media company would have generated $7.8 billion in operating income on revenue of$23.3 billion. The rest of its businesses brought in $29.2 billion in revenue and an operating profit of $6.8 billion. Clearly, its media business is the most profitable piece of the pie.
But as I said earlier, the hold ESPN has on cable is slipping. By spinning off the media business, Disney could focus on acquiring other cable networks and specialty broadcasters to further diversify revenue while protecting DIS shareholders from further weakness in its sports powerhouse.
TJX Companies Inc (TJX)
If it isn’t broke, why fix it? Nowhere would that apply more than at TJX Companies Inc (TJX), one of the world’s best discount retailers, who’s turned someone else’s problems into a massive $50 billion business, adding significant shareholder value in the process.
Why mess with success? Because the easy, low-hanging fruit from apparel has already been picked. In fiscal 2015, TJX generated 57% of its overall revenue from apparel including footwear, by far the most significant contribution by a product category. Next highest was home fashions at 29% and lastly, jewelry and accessories, at 14%. Its a product category mix not unlike many department stores these days.
For me, the most obvious split would be to separate the home fashions from the rest of the business where HomeGoods and HomeSense would operate on their own terms with almost 600 stores in the U.S., Canada, and Europe. That’s a tiny fraction of TJX’s overall store network, which numbered 3,395 at the end of fiscal 2015.
It could be bigger.
HomeGoods has been growing same-store sales at a 7% clip for the past three years, compared to a steady decline from 6% to 1% for its Marmaxx business (T.J. Maxx and Marshalls in U.S.). And while HomeGoods doesn’t generate the same segment margin as Marmaxx — 13.6% versus 14.6% — it has grown 140 basis points over the past two fiscal years while Marmaxx’s remained flat.
On its own, the home fashions business could really blossom. A second benefit for TJX itself is it could figure out what to do next to ignite growth. Perhaps creating “footwear” stores separate from apparel, jewelry and accessories is the answer. Maybe it buys DSW Inc. (DSW).
In 2014, TJX stock had a total return of 8.7%; in 2015, it saw a 4.6% return; and year-to-date it’s up 1%. For a stock whose annualized total return over the past 15 years was 16.2%, it sure isn’t living up to its billing.
A spinoff should definitely be up for discussion.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
