Saturday, August 23, 2014

Some good comments on spinoffs

On Twitter, Credit Bubble Stocks writes that, "If anything, spinoffs will now probably underperform because they are too popular and being used as 'garbage barges'."

"Garbage barges" is a great turn of phrase, up there with  "value pretender" and "stuckvestor."

I think spinoffs have always been garbage barges to some extent, with many companies using them to separate a low-growth or low-ROIC division from one that has better metrics. But CBS is right that a lot of companies have taken advantage of hedge funds' (and other investors') enthusiasm for spinoffs to offload poor securities at rich prices.

One recent example is Murphy USA (MUSA), a gas-station owner that was spun out of Murphy Oil. Gas stations seem to be a bad business: paying credit- and debit-card fees on tons of small-ticket purchases really eat into returns. A bullish writeup on VIC even tacitly admits it's a bad business:

"Murphy recently entered into an agreement with Wal-Mart to build an additional 200 stores on Wal-Mart locations over the next three years...  Wal-Mart experimented with doing their own fuel sales but ultimately did not find it attractive, which led to the Murphy relationship."

Despite that, MUSA spun out at a high EBIDTA multiple and trades at an even higher multiple today.

I'm also wary of RESI and HLSS, which are dividend-paying spinoffs from Bill Erbey. I think Erbey is taking advantage of investors' thirst for yield to issue overvalued securities. A VIC writeup on RESI argues that "RESI aggressively reports earnings so that it can pay dividends.  Paying dividends allows RESI to pay huge fees to AAMC (payments to AAMC are determined by dividends).  AAMC is 28% owned by Altisource Residential’s Chairman Bill Erbey.  Effectively RESI is raising money from the capital markets (debt & equity) and paying it to AAMC as fees to enrich insiders, namely Bill Erbey."

Beware of "great capital allocators" bearing spinoff gifts.

Elsewhere on VIC, someone named aubrey makes a cogent argument that spinoffs don’t automatically generate higher returns:

"This is slightly off topic but it is interesting that you cite 'it is a spin off' as the first of your reasons for buying [Sears Hometown & Outlet Stores]. I have seen this in a number of places on this site. Why do 'we' think that a spin off is, prima facie, an attractive characteristic? My memory of Greenblatt's excellent book is that a spin off was supposed to deliver excess returns because of the possible presence of ignorant/indifferent institutional selling, lack of information and, quite possibly, attractive incentives for spin off management. I'm not saying that these characteristics might not be attractive but it is the presence of those things that would make a spin off attractive, not the fact that [it's] a spin off.

In this case the stock has gone up since the spin (so no forced/ignorant selling I guess), there is pretty good information (from memory) from the prospectus on float and I can't see anything in your write up to suggest that managment benefited from depressing the price (unless they got lots of rights other than those from holding SHLD shares?).

I wonder whether we are falling into the trap of looking at historic spin off returns (which may well have had these nice characteristics) and assuming it is the name 'spin off' which delivered them, not the characteristics. I think investors (and the parent company management) has got wise to this 'hidden' value. I haven't found a straight spin off attractive in 3 years. Though I am pretty hard core value it has to be said."

I think spinoffs have become the beneficiaries of a self-fulfilling prophecy: hedge funds pile into spinoffs because they expect them to outperform the market, and the act of piling in sends them higher and makes them outperform. This may continue for a little while longer, but it isn’t sustainable.

5 comments:

  1. I think spinoffs are silly but they aren't that awful.

    If anything I think hedge funds will lose money in junior mining, independent oil and gas, and pharma. Look at all the resource-related writeups on VIC for resource stocks. I'm glad these people exist because they lend out their shares and create good opportunities for shorting.

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    1. I agree that there are worse investments out there, but the enthusiasm for spinoffs is interesting because of what it says about investor psychology. People are blindly extrapolating spinoffs' historical performance into the future and using "it's a spinoff" as a due-diligence shortcut.

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  2. SHOS was a bad buy at $55 or when it was spunoff, but at $19 it doesn't look like such a bad idea. Maybe the idea here is to buy when the hedge funds spinoff the spinoff.

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  3. Great point that it is the spin off characteristics that are key.

    "Maybe the idea here is to buy when the hedge funds spinoff the spinoff." - Nice

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  4. "buy when the hedge funds spinoff the spinoff."

    Haha well put.

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