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.
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
|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.
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 .
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.
- 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.