Performance in Three Recent Spinoffs Offers Insight Into Future Spinoff Successes
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The global equity markets see hundreds of spin-offs in a given year, and many investors make a good living off of the arbitrage and growth opportunities inherent in some of these situations. Although some spin-offs are ill-advised or actively designed to saddle spun-off companies with high levels of debt, others offer tremendous opportunities for their employees, investors and customers. Three recent spin-offs of U.S. companies fall into the latter category: Phillips 66 (NYSE: PSX), Fortune Brands Home & Security (NYSE: FBHS) and Howard Hughes Corporation (NYSE: HHC).
These firms split from well-capitalized parent companies and have strong, diversified asset portfolios. In addition, they appear to be fairly well-run. However, it is difficult to paint them with the same brush. Investors who might be interested in these spin-offs or their former parents should start by comparing the companies against one another and delving deeper into the specifics of their spin-off transactions.
Although these companies operate in very different industries, their financial statements are instructive. For starters, each of these firms enjoys a solid operating margin. Like many of its oil industry peers, Phillips 66 has an understandably modest operating buffer of about 3.4 percent. Hughes Corporation has an operating margin of just under 20 percent. For its part, Fortune's margin hovers around the 6 percent mark.
In 2012, Hughes did suffer a substantial after-tax loss of about $39 million on revenues of $391 million. However, this was likely due to a one-off charge that should not affect its fortunes in the future. The company did post an encouraging quarterly revenue growth figure of more than 12 percent. For comparison, Phillips 66 earned $4.9 billion on 2012 revenues of $161.7 billion to produce a final profit margin of about 3 percent. Fortune earned $143.5 million on revenues of about $3.7 billion for a profit margin of 3.9 percent.
All three of these firms have acceptable balance sheets. With debts of $703.5 million and cash reserves of $200.5 million, Hughes has the widest debt-to-cash ratio. Fortunately, its operating cash flow figure of over $170 million seems adequate to replenish its reserves. Unlike many of its downstream peers, Phillips 66 has a solid cash hoard of $4.8 billion and debts of about $7 billion. Its cash flow of nearly $7 billion is more than adequate to sustain this balance sheet. Meanwhile, Fortune has a cash flow of about $254 million to offset a debt load of $326.4 million and an existing cash reserve of $259 million.
The Phillips 66 Situation
Phillips 66 split from ConocoPhillips in early April of 2012. Since then, its stock price has roughly doubled in value and exceeded the overall market's rise by a substantial margin. Whereas its former parent operates primarily as a drilling and exploration firm with a global reach, Phillips 66 acts as a downstream refiner and retailer that specializes in bringing crude oil and natural gas products to market. In addition to its refining and chemical production operations, it maintains a vast footprint of gas stations and convenience stores in North America. In fact, the clear operational gulf between Phillips 66 and ConocoPhillips was a principal catalyst for the spin-off and ensured that the split occurred neatly and efficiently.
Fortune Brands Home & Security's Spin-off
In late 2011, Fortune Brands spun off its home goods division and re-branded itself around its core distilled spirits business. Known as Beam Global (BEAM), the new firm focuses exclusively on marketing and distributing well-known spirit brands like Maker's Mark, Jim Beam, Canadian Club and others. Fortune Brands continued on as a home goods and security company that sells security products like padlocks and bike locks as well as recognizable appliances under trade names like Moen, Martha Stewart Living and Kitchen Craft. The company has clearly benefited from a recovering economy: As homeowners finally tackle long-delayed home improvement projects, the company's core lineup of fixtures and appliances has seen brisk sales. Since the spin-off, Fortune Brands has delivered a lifetime return of over 230 percent.
Howard Hughes' Ride
Howard Hughes Corporation was spun off during the tumultuous bankruptcy of former commercial real estate giant General Growth Properties (GGP - defunct). The company controls many of General Growth's most attractive assets, including much of the real estate in the planned communities of The Woodlands, Texas and Columbia, Maryland. Although it can trace its roots back to its eponymous founder, the company's current iteration as a real estate investment firm did not take shape until relatively recently. Like other firms in the space, the company looks poised to benefit from a recovering real estate market as well as its presence in affluent areas that escaped the worst effects of the recent recession. Since spinning off from its parent, Hughes has delivered a return of over 175 percent and looks poised to notch additional gains in the coming months.
Long-Term Outlook and Implications for Future Spin-offs
Each of these companies looks poised to grow in its own way. For its part, Phillips 66 is a well-capitalized, well-run company that looks to benefit from an existing energy distribution infrastructure. Although falling demand for gasoline could hurt its bottom line, it nevertheless exists in a relatively stable niche. Meanwhile, Fortune and Hughes can bet on a recovering housing market to support their bottom lines and may well deliver additional value in the months and years ahead. While these firms do not offer arbitrage opportunities, they do hold out the promise of market-beating performance. More importantly, they offer clear examples of the ways in which successful spin-offs should be structured. Keen-eyed investors would do well to take note and continue to look into new spin-offs coming out every month.
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Mike Thiessen has no position in any stocks mentioned. The Motley Fool owns shares of Howard Hughes. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!