Upcoming Spin-off: Vishay Precision Group

by: valuestocks - May 24th, 2010   5 Comments

Vishay Precision Group (VPG), a proposed spin-off of Vishay Intertechnology. Upon completion of the spin-off, VPG will trade on the NYSE under ticker symbol VPG.

VPG is in the business of designing, manufacturing and marketing Foil Technology Products (strain gages, ultra-precision foil resistors, and current sensors) and Weighing Modules and Control Systems (transducers/load cells, instruments, weigh modules, and control systems) for a wide variety of applications.

Unlike First American Financial Corporation (FAF) which I wrote about recently, there will not be any retention of stock by any of the newly independent companies. Instead this will be a more typical spin-off transaction where a distribution of VPG stock will be made to holders of Vishay Intertechnology on the effective date.

After reading up on Vishay Precision Group, I will be passing on the opportunity. There are simply a number of things that I don’t like about this particular spin-off.

Looking at Morningstar, we see the following stats on insider ownership of the parent company:

Equity Ownership VSH

Market Cap (Mil USD) 1,728
# of Institution Owners 327
# of Fund Owners 497
% Owned by Institutions 82.61
% Owned by Funds 33.96
% Owned by Insiders 0.33

Chances are things will remain very similar with regard to insider ownership at VPG. The one thing we will probably see however, is a large number of funds/institutional investors dump their shares onto the market (from the chart above we see that institutions own 80%+ of the stock of the parent). This will almost certainly cause a lot of forced selling by those institutional investors.

Even with all of the selling that I expect, I still don’t want to touch VPG after the spin-off. Why? Because the way I see it, VPG is like a family business. From the preliminary form 10 we see that many of the insiders are related in some form or fashion to the company founder. This is a huge red flag for me.

Another thing that I really don’t like about this spinoff is that the founder of the company will retain almost all of the class B shares after the spin off. According to the form 10, he will retain approximately 45% of the voting power of all shares outstanding (class A shares entitled to one vote; class B shares each entitled to 10 votes). This will again make owners of VPG owners of a family business without a real voice to get anything changed should it be required.

For those of you still interested in this spin-off it might be worthwhile to know how to measure the success of the business. Since many of us might not be familiar with the business of VPG the guidance we are given in the information statement is quite useful:

We utilize several financial measures and metrics to evaluate the performance and assess the future direction of our business. These key financial measures and metrics include sales, gross profit margin, end-of-period backlog, the book-to-bill ratio, and inventory turnover.
Gross profit margin is computed as gross profit as a percentage of net revenues. Gross profit is generally net revenues less costs of products sold, but could also include certain other period costs. Gross profit margin is clearly a function of net revenues, but also reflects our cost-cutting programs and our ability to contain fixed costs.
End-of-period backlog is one indicator of potential future sales. We include in our backlog only open orders that have been released by the customer for shipment in the next twelve months. If demand falls below customers’ forecasts, or if customers do not control their inventory effectively, they may cancel or reschedule the shipments that are included in our backlog, in many instances without the payment of any penalty. Therefore, the backlog is not necessarily indicative of the results to be expected for future periods.
Another important indicator of demand in our industry is the book-to-bill ratio, which is the ratio of the amount of product ordered during a period as compared with the product that we ship during that period. A book-to-bill ratio that is greater than one indicates that our backlog is building and that we potentially will generate increasing revenues in future periods. Conversely, a book-to-bill ratio that is less than one is an indicator of declining demand and may foretell declining sales.We focus on our inventory turnover as a measure of how well we are managing our inventory. We define inventory turnover for a financial reporting period as our costs of products sold for the four fiscal quarters ending on the last day of the reporting period divided by our average inventory (computed using each quarter-end balance) for this same period. A higher level of inventory turnover reflects more efficient use of our capital.
Disclosure: The author has no position in any stock mentioned at the time of writing
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Checking In On Questar

by: Spin Doctor - May 21st, 2010  
Questar Corporation logo
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One potential hurdle for Questar’s (STR) proposed spinoff was cleared earlier this week as the company’s Board of Directors approved the transaction. The new company, QEP Resources, Inc is expected to trade on the NYSE under the symbol “QEP” and will be comprised of the natural gas and oil exploration and production (E&P) and midstream field services businesses. Both parent and spinoff are expected to have $1.2b in debt on their balance sheets after the transaction is completed.

Interestingly, there will be a managerial shakeup at the two companies as a result of the transaction. Keith Rattie, Questar’s current CEO, President and Chairman will serve as Chairman of the Board for both Questar and QEP while Charles Stanley and Ronald Jibson will take the helm as President and CEO of QEP and Questar respectively. The CFO of QEP will be Richard J. Doleshek while Martin Craven will be be named CFO of Questar. The rationale behind these moves and the resulting relationship between the two companies will need to be examined in depth, especially considering incentivized management is one of the traits investors often look for in spinoff transactions. Additionally, the company provided an updated timeframe for the event and expect it to be completed within the next three months. Other hurdles to the transaction remain though, including: the market environment (seemingly deteriorating) and the ability to negotiate new credit facilities (not a given in this day and age).

Read more about Questar’s proposed spinoff in one of our earlier posts here.

Disclosure: Author holds no position in STR.

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First American Financial Corp.

by: valuestocks - May 14th, 2010  
The First American Corporation
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First American Financial Corporation is scheduled to be spun-off from First American Corporation later on this year (from the proxy filed 4/26/10 the targeted date is June 1st 2010). Spin-offs are some of my favorite investments because some of them offer distinct advantages over other investments:

1. When they begin trading, they are more prone to see downward pressure on stock price. Oftentimes this is due to forced selling by institutions because of restrictions based on market cap or selling of the stock because the investors receiving the spinco’s shares are simply not interested in owning the spun-off business.

2. Incentivized management i.e. compensation structure aligns management’s interests with the interests of shareholders.

3. More focus and attention to improving the business by management as they are no longer stymied by the parent company’s use of resources on other businesses within the organization.

Let’s run through First American Financial Corp’s spin-off and whether this offers us an excellent opportunity for achieving healthy returns.

The Planned Transaction

The plan for a spin-off will split the parent company into two separate entities. From the information statement filed with the SEC:

As a result of the distribution, First American’s shareholders will own all of the outstanding shares of FinCo and will continue to own all of the shares of First American. First American following the distribution, which we refer to as the “Information Company” or “InfoCo”, will continue to operate the information solutions businesses of First American. The Information Company will change its name to CoreLogic, Inc. and will change the symbol under which its common shares are listed on the New York Stock Exchange from “FAF” to “CLGX.” FinCo will adopt First American’s stock symbol after the distribution and have its common stock listed on the New York Stock Exchange under the symbol “FAF.” Following the distribution, FinCo will own and operate First American’s financial services businesses, which consist primarily of First American’s current title insurance and services segment and its specialty insurance segment. The Information Company will own and operate First American’s information solutions businesses, which consist primarily of First American’s information and outsourcing solutions, data and analytic solutions and loss mitigation and business solutions segments.

In other words, the parent company which currently trades on the NYSE will be changing its name and ticker symbol to CoreLogic Inc. (CLGX) and the spin-off will go by the name First American Financial Corp. (FAF). From the form 10 filed with the SEC we also learned that after the transaction, it is expected that approximately 103.9 million common shares of First American Financial Corp. will be outstanding with an adjustment of fractional ownership shares which are to be cashed out.

Business

First American Financial Corp will operate 2 lines of business:

1. Title insurance and services segment: title insurance, escrow/closing services and other related financial services for residential and commercial real estate transactions. Also maintains, manages and provides access to automated title plant records and images and provides thrift, trust and investment advisory services.

2. Specialty insurance segment: Will provide P&C insurance including homeowners insurance and home warranty policies.

CoreLogic, Inc. on the other hand will operate the information, outsourcing solutions, data and analytic solutions and risk mitigation businesses. Since we are focusing on First American Financial Corp. as a potential investment target, we will disregard CoreLogic Inc. for the moment. However, it should be noted that studying the investment merits of the parent company (in this case CoreLogic, Inc.) is always a good idea when looking at spin-offs because they too can offer promising investment opportunities.

Above we mentioned some attributes that can make a spin-off investment lucrative for patient investors willing to put in a little bit of work. Let’s address those attributes one by one so that we can determine whether this spin-off meets our checklist.

Will there really be selling pressure on the shares?

According to the Form 10 filing with the SEC, the company foresees the opportunity risk:

We expect that some First American shareholders, including possibly some of its larger shareholders, will sell the shares of our common stock received in the distribution because, among other reasons, our business profile or market capitalization as an independent, publicly traded company does not fit their investment objectives. Moreover, index funds tied to the Standard & Poor’s 500 Index and other indices hold First American common shares. Unless we are included in these indices from the date of the distribution, these index funds will be required to sell shares of our common stock that they receive in the distribution.

This seems to indicate that it is very possible that the exclusion of the FinCo from the S&P 500 or other indices will cause index funds to dump their shares. This may result in the ability to pick up shares cheaply once the selling gets underway. The magnitude of any drop remains to be seen.

Another thing to look at here is who the top shareholders in the pre-spin-off company are. Specifically which investment funds own the stock. You may be able to look into specific funds and their requirements for holdings i.e. the market caps of investments to see what type of institutional forced selling may come.

What about the alignment of management’s incentives with shareholder interests?

As I mentioned above, spin-offs often incentivize managers to perform by allocating performance based awards. One of the most important things to look at in a potential spin-off investment is to what extent management’s financial incentives are tied to creating shareholder value. This can be assessed by seeing how many shares of stock they actually own and how many shares they would be eligible to acquire through performance-based awards.

According to the Form 10, the table gives us a rough idea of how many shares directors and management will own at the time of the spin-off transaction:

Shares Beneficially Owned
Name of Beneficial Owner Number of
First
American
Common
Shares		 Number of
FinCo
Common
Shares		 Percentage
of
Class (if
greater
than 1%)
Directors
George L. Argyros 1,103,252 (1) 1,103,252 (1) 1.1 %
Bruce S. Bennett 7,038 7,038 *
Glenn C. Christenson 55,438 55,438 *
Hon. William G. Davis 2,989 2,989 *
James L. Doti 16,144 16,144 *
Lewis W. Douglas, Jr. 35,399 35,399 *
Dennis J. Gilmore 38,239 38,239 *
Parker S. Kennedy 2,945,730 (2) 2,945,730 (2) 2.8 %
Frank E. O’Bryan 39,759 39,759 *
Herbert B. Tasker 18,183 18,183 *
Virginia M. Ueberroth 107,539 (3) 107,539 (3) *
Named executive officers who are not directors
Kenneth D. DeGiorgio 9,353 9,353 *
Max O. Valdes 5,342 5,342 *
All directors, named executive officers and other executive officers as a group (13 persons) 4,384,405 4,384,405 4.2 %

As you can see, approximately 4.2% of the shares (~103M outstanding) are owned by directors and management. The question at this point becomes, how many more shares will be granted for performance and what type of vesting schedule will they have.

Assets

First American Financial Corp will be retaining a number of assets as part of the spin-off including:

1. Approximately $250M of CoreLogic Stock (CLGX) which First American Financial plans to dispose of over the course of 5 years.

This is a good thing in my opinion because by buying First American Financial Corp. after the spin-off, you are basically buying FAF and a large percentage of CoreLogic stock which gives you exposure to both the parent company’s and the spin-off’s performance over the next couple of years which is the time frame that most spin-offs tend to perform well relative to the rest of the market .

Liabilities

New senior secured credit facility with available borrowing capacity of approximately $400 million, of which $200 million is expected to be drawn and transferred to InfoCo in connection with the separation. FinCo will also be responsible for the outstanding loan on its main offices in the amount of $43.9M.

Additional Notes:

  • According to American Land Title Association data, First American maintained approximately 27.3 percent of the domestic title insurance market as of December 31, 2009.
  • Following the distribution, FinCo expects to pay approximately $25 million per year in dividends to holders of its common stock.

DISCLOSURE: I don’t own shares in First American at the time of this writing.

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Can McDermott(MDR) Spinoff Babcock & Wilcox Generate Power For Your Portfolio?

by: Spin Doctor - May 14th, 2010  
The old B&W company logo, showing the world as...
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By the time United Technologies(UTX) offered to purchase Babcock & Wilcox for $42 per share in March 1977, the company’s storied history already extended over a century.  Founded to manufacture and sell the water tube boiler invented by Stephen Wilcox, the company’s products powered the first New York City Subway, Teddy Roosevelt’s Great White Fleet and the company had been a supplier to the Manhattan Project and the first nuclear submarine!  It was an attractive prize and soon after it rejected UTX’s bid, McDermott(MDR) entered the fray.  A furious bidding war ensued and when the dust finally settled, McDermott had acquired Babcock & Wilcox for over $62 per share or $750 million. Unfortunately for McDermott, Babcock & Wilcox also had a history of asbestos use and over the next two decades, McDermott would spend $1.6 billion settling asbestos claims until the Babcock & Wilcox unit was forced into bankruptcy.  McDermott was able to retain control of the company as it emerged from bankruptcy in 2004.

Fast forward to December 2009 when in the latest chapter of B&W’s long history, McDermott (market cap of just over $6 billion) announced that they will be spinning out the Babcock & Wilcox unit into a fully independant operation. During their recent Q1 conference call, McDermott talked about the spinoff and the plan is to spin out its power generation systems unit along with its government operations segment as Babcock & Wilcox, which will then trade under the ticker BWC. McDermott will retain their Offshore Oil & Gas operations.

According to the company, Babcock & Wilcox, the Power Generation Systems segment:

“supplies fossil-fired boilers, commercial nuclear steam generators and components, environmental equipment and components, and related services to customers in different regions around the world. It designs, engineers, manufactures, constructs and services large utility and industrial power generation systems, including boilers used to generate steam in electric power plants, pulp and paper making, chemical and process applications and other industrial uses.”

…while McDermott, the Government Operations segment:

“manufactures nuclear components and provides various services to the U.S. Government, including uranium processing, environmental site restoration services and management and operating services for various U.S. Government-owned facilities, primarily within the nuclear weapons complex of the U.S. Department of Energy.”

In 2009, these businesses generated revenues of $2.9b and operating income of $270m, down from $3.4b and $444.5m respectively, in 2008. In their Q1 earnings report the downward trend continued as the power generation systems segment had a 22% yoy reduction in revenues. The government operations segment held relatively firm though, with revenues declining only 1.5%.

In its Form 10 filing, the company listed its reasons for pursuing the spinoff and not surprisingly, it is filled with the usual ‘management speak’ such as better allocation of capital, management’s increased ability to focus on the individual businesses and the potential for more accelerated growth in their respective markets. I am sure there is some truth to these assertions – cutting out layers of bureaucracy and having one goal instead of two or three definitely improves efficiency. Additionally, the cyclicality of their business units could make balancing the growth and risks a challenge.

One interesting listed reason was that by spinning off these divisions they would prevent the possibility of losing new government contracts. Apparently, recent modifications in the law prohibit awarding contracts to ‘inverted’ companies, a category into which McDermott International would fall into. Considering the government (via the Department of Energy) is the government operations sole client, that could have been a serious problem. The concentrated client base is one risk that is difficult to ignore, but at least government spending can be fairly consistent, especially when it comes to our nuclear arsenal and waste.

Unfortunately, through ever changing legislation, the government impacts earnings for the power generation segment as well. In fact, one of the reasons for the segment’s Q1 revenue decline was a result of “a decrease in orders…as a result of the Federal Appeals Court’s overturning the Clean Air Interstate Rule, the Clean Air Mercury Rule and the industrial boiler rule on Maximum Achievable Control Technology.” Additionally, proposed greenhouse emissions and other legislation will have a meaningful impact on the power and utility industries and all of their underlying components.

CONCLUSION:

Aside from sounding like a porn movie title, the new Babcock and Wilcox will face significant risks . In addition to client concentration, economic and operating risks, the company also faces significant regulatory risk. Additionally, the terms of its new credit agreement will need to be analyzed in depth. This business can require immense amounts of credit and without the safety net of McDermott’s other businesses, the company could find it difficult to raise capital without onerous covenants. Obviously, that could negatively affect its growth potential as strong bondholders are rarely an equityholders’ friend. That said, there appears to be significant potential for this spinoff. The power and utility industries are undergoing tremendous changes in the US and around the world creating a lot of opportunity. Diversification of energy portfolios has led to immense interest in renewables and so called ‘smart grids’. The need for new infrastructure and equipment could play right into the company strengths. Favorable environmental legislation could be a tremendous positive for the company. Additionally, the company’s expertise in nuclear power could be very beneficial as nuclear energy is gaining favor throughout the world.

The management team appears strong and almost all senior members have held key positions at the Babcock and Wilcox subsidiary. The CEO, Brandon C. Bethards, has been with the company for over 30 years. The company’s compensation plan has historically been heavily tied to results, which means they should be highly motivated to generate returns.

While there are many risks and likely increased volatility, there is also the potential for a profitable investment. Obviously, much of that will be determined by the company’s valuation. Hopefully, we will get a chance to dig into some of the financials (which can be found in the Form 10) and come up with an idea of what it will be worth.

Disclosure: The author holds no position in any stock mentioned

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Academic Research Shows- Spinoffs Have Higher Rate of Return

by: Inelegant Investor - May 9th, 2010  

CXO Advisory recently reviewed the literature regarding spinoffs, and brings several relevant studies which detail positive returns for spinoffs.  The abstracts presented describe some interesting results, we hope to take some time to review the papers themselves in the near future.

Stock Spinoffs Discussion Board

by: Inelegant Investor - May 9th, 2010  

Just wanted to call everyone’s attention to the new discussion board we launched last week. There has already been some early activity. Please head over and join in!