Corporate Spinoffs Surge

‘Break them up’ strategy entices Kraft, Marathon Oil and ITT.

Corporate spinoffs are headed for the most active year on record as companies including Kraft Foods Inc. and AMR Corp. look for avenues to unlock value from units.

Companies announced 145 spinoffs in the first half of 2011, the most of any half-year period since Bloomberg began tracking the data more than a decade ago. At least 17 more have been disclosed since June 30. The tally, which also includes decisions by Marathon Oil Corp. and ITT Corp., exceeds the total from all of last year and is rising at an annual pace of 274, setting the stage to eclipse the record of 230 set in 2006.

“It’s a revision of the corporate business model where companies would grow to balance out their businesses,” said Peter Sorrentino, a senior portfolio manager at Huntington Asset Advisors in Cincinnati, which oversees $14.8 billion. “Today there’s a market-implied impediment to that. And if you can’t get paid for the businesses, you break them up.”

The 162 announcements through yesterday comes as the market for mergers and acquisitions remains slow, removing one route for companies to shed unwanted divisions. Excluding spinoffs, companies are on pace to announce about $2.5 trillion of takeovers this year, down from a peak of $3.8 trillion in 2007, according to Bloomberg data. There were $2.2 trillion last year.

A global rout in equities that has driven the Standard & Poor’s 500 Index to its worst slump since 2009 also is creating some incentive to act now as well.

“Companies feel more pressure to review their portfolios in this environment,” Sorrentino said.


Breakup Game
Kraft, the world’s second-biggest food company, said last week it plans to separate its $16 billion North American grocery unit to give the Northfield, Illinois-based company’s larger snack-foods business flexibility to acquire or divest brands and expand in emerging markets. Chief Executive Officer Irene Rosenfeld said the split is the “next logical step” in the company’s evolution.

Alexia Howard, an analyst with Sanford C. Bernstein & Co. in New York, said the “strategic rationale for such a move is strong.”

“Given the different investment priorities and growth trajectories of the two businesses, it makes a lot of sense,” Howard said yesterday in a note to clients. “It seems as though everyone is at the breakup game these days,” she said.

Sara Lee, Ralcorp
Sara Lee Corp., the Downers Grove, Illinois-based maker of Ball Park hot dogs and Douwe Egberts coffee, decided in January it would split in two after failing to agree to takeover offers from suitors. Ralcorp Holdings Inc., the St. Louis-based maker of Raisin Bran, found itself in a similar position, saying last month it plans to spin off Post Foods after failing to sell the unit to rival foodmakers or private-equity firms.

“We wonder if there is any read across here for companies like” Campbell Soup Co. or HJ Heinz Co., Howard said.

“You could use one business to fund the other, but the market just isn’t paying for it,” said Sorrentino. “These companies want to focus resources and management talent on faster markets and better products.”

Some of the companies choosing to spin off divisions are doing so under pressure from activist shareholders.

Ralph Whitworth’s Relational Investors LLC pushed for changes at industrial products maker ITT and defense contractor L-3 Communications Holdings Inc. before those companies announced spinoffs this year. William Ackman’s Pershing Square Capital Management LP did the same with liquor and sporting- goods company Fortune Brands Inc., as did Barry Rosenstein’s Jana Partners LLC with natural-gas pipeline owner El Paso Corp., and Dutch mail carrier TNT NV. Jana is now pushing for a breakup of textbook publisher McGraw-Hill Cos.

ITT, American Eagle
ITT is well past the midpoint of its three-way split, CEO Steven Loranger said in a July 29 call to investors and analysts. The board approved in January plans to spin off the water and defense businesses so the White Plains, New York-based company can focus on the industrial segment.

“Spinning the companies out provides more clarity for investors of what these businesses generate separately,” said David Rose, a Wedbush Securities Inc. analyst in Los Angeles.

American Airlines parent AMR Corp. decided last month to divest its American Eagle regional carrier through a planned spinoff. Fort Worth, Texas-based American, the third-biggest U.S. carrier, aims to reduce the cost of ferrying passengers from smaller cities to its hub airports. A separation also would let Eagle grow by bidding to fly for other major airlines.

“With this deal, American has some understanding of where they are going to be five years from now and Eagle has a chance of being a stand-alone company,” said Mike Boyd, president of consultant Boyd Group International Inc. in Evergreen, Colorado.


Largest Spinoff
The largest separation to be completed this year has been Marathon Oil’s $13.9 billion spinoff of its Findlay, Ohio-based refining business. ConocoPhillips also announced plans to spin off its refining units as energy companies seek to recast themselves as “pure-play” exploration and production companies as oil prices in New York earlier this year surpassed $100 a barrel for the first time since 2008.

“Investors that want to have the commodity-price exposure can own the exploration and production company,” said Brian Youngberg, an analyst at Edward Jones in St. Louis. “Those who want to invest around an economic rebound and an improvement in refining margins over time can invest in that business without having the exposure on the other side.”

BP Plc, the London-based operator of the Macondo well that blew last year in the Gulf of Mexico, “screams most loudly in terms of needing to be broken apart,” said Ted Harper, who helps oversee about $6.8 billion in assets at Frost Financial Management in Houston. BP CEO Robert Dudley has said he is “open to all kinds of ideas” to build shareholder value.


Alcoa’s Potential
Two pipeline companies, El Paso and Williams Cos., are also planning to spin off exploration and production businesses. El Paso, owner of the largest U.S. network of interstate gas pipelines, said May 24 that it plans to spin off that unit by the end of the year partly to reduce borrowing costs.

At least 50 of the spinoffs announced this year were in basic materials industries, including Mondi Plc, Europe’s largest maker of office paper.

Lloyd O’Carroll, an analyst with Davenport & Co. LLC in Richmond, Virginia, said Alcoa Inc., the largest U.S. aluminum producer, would make a good candidate for separation. Alcoa, an integrated aluminum maker involved in every stage of production, has dropped 56 percent in New York trading in the past five years while the Bloomberg World Mining Index has advanced 53 percent.

“It would be a value-creation event to separate the downstream businesses which have substantial growth in front of them,” O’Carroll said.


European Action
The majority of the spinoffs, at least 100, are for companies based outside the U.S., including 20 in western Europe, according to Bloomberg data. Rheinmetall AG, the Dusseldorf, Germany-based machine parts and weapons company, announced July 29 that it was considering spinning off its car- components unit to focus on the defense industry.

Fiat SpA, the Turin, Italy-based carmaker that controls Chrysler Group LLC, spun off its industrial division in January to allow CEO Sergio Marchionne to focus on the integration of the two carmakers and foster other auto industry alliances. Fiat also said at the time that different earnings cycles, capital requirements and returns on capital argued for the separation.

TNT, now named PostNL NV, in May split off the express service business, the second-largest in Europe, from the mail delivery division as demand for traditional mail services declines.


‘Greater Reward’
Spinoffs may create opportunities for investors hunting for mispriced securities, said Joel Greenblatt, who runs Gotham Asset Management LLC in New York and who writes about investing in spinoffs in his book, “You Can Be a Stock Market Genius: Uncovering the Secret Hiding Places of Stock Market Profits.”

In a spinoff, in which a company hands each shareholder a new share in a divested business unit, “no one has an incentive to tout it or sell it,” Greenblatt said. “Usually they’re ripe for mispricing when they come out. Some are overpriced and some are underpriced.”

That risk, however, can pay off.

“A spinoff isn’t a universal panacea for an underperforming company,” said Huntington’s Sorrentino. “But the riskier it is, the greater the potential for reward there will be.”


Bloomberg News



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