Tag Archives: earnings-center

Stock Market Genius Made Easy: Spinoffs

Summary Empirical evidence would suggest spinoffs outperform the market. Prior research gives us a rough guide to investing in them. You can simplify the process with online tools and/or an ETF. More than 15 years ago, Joel Greenblatt wrote his masterpiece: You can be a stock market genius. Several other contributors here on Seeking Alpha have sung the book praises. I will be brief: If you haven’t read it, do so. (You could even read it for free by signing up for a free month at Scribd ) Among the strategies Greenblatt discusses, investing in spinoff stocks is one of them. A spinoff is when a company takes a division and separates it, creating a free standalone company. The strategy still works, however, the book was written 15 years ago. In this article, I will: Review briefly the papers proving empirical evidence that spinoff stocks tend to outperform. Rehash a few of Greenblatt’s pointers. Explore tools and strategies, which can simplify the process in 2015. The Empirical Evidence A while ago, John Mcconnell and Alexei Ovtchinnikov wrote a paper studying stocks of both parents and subsidiaries straight after a spinoff occurred between 1965 and 2000. They took the approach of buying the stocks straight after the spinoff and holding them for 36 months. They then computed excess returns in comparison with each stock’s industry, and with stocks with similar size. The results were impressive: The subsidiaries generated substantial ex-post alpha, especially within the first two years of holding the stocks. Source: Predictability Of Long Term Spinoff Returns Even after having adjusted the returns to a Fama-French-Carhart four-factor model, the sample still generated ex-post alpha. If you are interested in the nitty gritty details, I strongly suggest you read the paper. Here are a few points concerning the economic reasoning behind spinoff outperformance: Initial overselling of the security: Following a spinoff, the stock tends to be oversold as institutions which are unable to hold the stock for various reasons (They require dividend-paying stocks, they can’t invest in small caps, etc.) sell the stock. Many individual investors might also sell the spinoff because they want to be invested in the parent only. This depressed price creates an opportunity to find value. Better allocation of resources: Splitting a company into two entities allows each company to focus on creating value through their independent businesses. The destruction of the conglomerate discount: It is a well-known fact that the stock market tends to undervalue conglomerates because of the added complexity in analyzing them. Separating entities often creates pure play stocks in two different businesses. It can therefore be expected that this discount corrects within the first years after a spinoff. Or as Mr. Greenblatt says “Sometimes, Capitalism works” : In other words making the managers of each individual company more responsible, more accountable, and more directly incentivized, often plays out nicely. Greenblatt’s Strategy Throughout his career, Greenblatt has used this market inefficiency for personal gain. In his book, he recounts a few reasons why companies spinoff divisions, other than the obvious “to be better appreciated by the market”: To separate a “bad” business, so that the “good” one can show more of its value. Often they might leave the bad business with massive amounts of debt which can create a leveraged bet, for better or for worse. To create value for investors when a business can’t be sold as a whole, at least not at a reasonable price. To avoid being taxed on the sale of the business. Spinoffs are not taxed when the shares are distributed to the shareholders of the parent company. He also gives a rough hand guide to finding interesting spinoff opportunities: Read the WSJ looking out for upcoming spinoffs. (Don’t worry we’re in 2015 now, it needn’t be that hard, more on that later) Once you’ve found an upcoming spinoff, get your hands on the Form 10 also called general form for registration of securities, and look for some of these cues: Institutions don’t want the spinoff. Questions to ask are: Which current institutions hold the stock? What is their mandate? Are they going to be obliged to sell the spinoff? Insiders want it. Here the focus is on management incentives, including stock options. The idea behind these is that they make managers act like shareholders. There has been quite a debate concerning the effectiveness of such options but when combined with the right elements, they should work. Questions to ask are: Are managers going to be compensated with options? How far out of the money are these options? (Far enough is what you are looking for) Who is going to manage the company? How is management talking about the spinoff? (Watch out they may be talking it down to depress the price) Is what they are saying congruent with their various incentives? If not why not? Finally, usual fundamental analysis must be conducted . Questions to ask are: Is a great stock at a cheap price being uncovered? Has a leveraged bet with an interesting risk/return profile been created? Tools And Strategies in 2015 The economic reasoning for spinoff outperformance seems sound, and the empirical evidence of ex-post alpha is robust. If investors can generate alpha through investing in spinoffs what tools and strategies can they use today to simplify the process? Remember, how I mentioned you didn’t need to read the WSJ every day to find spinoff opportunities? As you might have guessed there is now a website on which you can find all upcoming spinoffs as well as all recent spinoffs . It’s a valuable tool which can be used to find interesting opportunities. Granted, you still need to do the hard work of looking up companies and picking your spots, but at least it is a lot easier. Source: Stockspinoffs.com As you can see, they even named it appropriately. I do want to disclose that I have no business with the website, and am only sharing because it’s an interesting tool. It is also useful to use it to see how spinoffs have performed over time. I will use this tool as a warning. NAME data by YCharts I picked three stocks randomly which spun off in August last year. As you can see these stocks aren’t a promise for riches, and investors should keep that in mind. You can’t just throw darts at a list to pick your spinoffs. You have to do the hard work. Or… you can invest in a quant spinoff ETF. Guggenheim Spin-Off ETF (NYSEARCA: CSD ) The Guggenheim Spin-off ETF seeks to reproduce the returns of the Beacon Spinoff Index before fees which will set you back 0.66% a year. The fund is constructed very similarly with weights changing only modestly. Here is a peak at CSD’s top 20 holdings vs. the index. These account for over 75% of the portfolio in both cases. Source: Guggenheim Investments What is interesting is how this index is constructed. Potential Index constituents include all equities trading on major U.S. exchanges of companies that were spun-off during the two year period beginning 30 months prior to reconstitution and ending 6 months prior to reconstitution. This time frame may be extended to compensate for periods where there are too few new spinoffs to populate the index. The Spin-off Index is comprised of up to of the 40 highest-ranking stocks chosen from the universe of spun-off companies. Each company is ranked using a 100% quantitative rules-based methodology that includes composite scoring of several growth-oriented, multi-factor filters, and is sorted from highest to lowest. Up to 40 stocks are chosen and given a modified market cap weighting with a maximum weight of 4.5%. The constituent selection process and portfolio rebalance is repeated semi-annually, however, if there are not enough new Spin-offs to populate the index, a rebalance may be delayed. What this means is that you will own stocks at the earliest 6 months after they have spun off, and they will be removed at most 36 months after the spinoff (Selection process happens semiannually, and stocks can be included if spun off up to 30 months prior to constituent selection). I have not found any information about their so called rule based ranking. Whether this ranking generates value or not might be questionable, but it can’t be worse than simply ranking stocks by market cap, can it? The index gives each of its 40 stocks a maximum weight of 4.5% whereas CSD weights stocks as high as 5%. So here you go, a no hassle, sleep well at night way to get exposure to spinoffs and their inherent inefficiencies through the first years. How has it performed? This year just as bad as the overall market, over time, a lot better. CSD data by YCharts CSD data by YCharts I will be allocating money towards the CSD ETF as soon as the next transfer makes it to my trading account. Conclusion Spinoffs have beaten the market. Empirical evidence proves it. Sound economic reasoning would suggest they might continue to do so. Great results can be attained by picking your spots. You’ll probably do okay with passive exposure. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CSD over the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Black Hills’ SourceGas Acquisition Provides Patient Investors Good Entry Point For Current Income

Summary Black Hills recently announced the acquisition of privately-owned SourceGas. The company is financing most of the acquisition by taking on additional debt. The market is punishing the company for the acquisition. The stock dropped 14% over the two weeks following the announcement. I believe the stock will decline further, but this will provide investors looking for current income a good entry point. On July 12th, Black Hills Corporation (NYSE: BKH ) announced the acquisition of SourceGas Holdings LLC from investment funds managed by Alinda Capital Partners and GE Energy Financial Services. David Butler has a nice article on the acquisition , and I’ve written previously about Black Hills Corporation’s business and dividend growth history. The acquisition increases Black Hills’ coverage in its existing service area in Colorado, Nebraska and Wyoming, and expands the company’s service area into Arkansas. The combined company’s customer base will expand by 55% to more than 1.2 million, and Black Hills claims the purchase will “meaningfully” increase earnings in the first year after closing the acquisition. Unfortunately, the company was not more specific as to how large of an earnings increase it expects. Market Sells Stock on Announcement Despite the benefits of the acquisition, the market did not react well to the news. BKH stock fell 2.4% the day after the acquisition and kept going, losing over 14% over the next two weeks. (See chart 1 below.) I believe the reaction is due to the large amount of debt that Black Hills will take on for this acquisition. While Black Hills has shown the ability to integrate acquisitions into their business, many of the past acquisitions have been less than $100 million. The SourceGas acquisition is twice as large as the $940 million acquisition of five Aquila utilities in July 2008. The bulk of the $1.89 billion cost of SourceGas will be a combination of the assumption of $720 million in SourceGas debt and an additional $450 million-$550 million in debt, which will increase Black Hills’ long-term debt by 80% to $2.76 billion. According to Bloomberg , Fitch Ratings placed Black Hills on credit watch negative due to the “material increase” in debt. Will the New Debt Impact the Dividend? I don’t expect Black Hills to stop growing its dividend. The company has increased dividends for an impressive 44 years and it isn’t likely to break this streak despite the debt burden. However, the increase in debt will limit the available funds for dividend growth. With a 55% increase in its customer base, the company should see an earnings increase from the acquisition, but will likely need to work off at least some of the new debt over time to see the full effects of the earnings growth. Over the last 5 and 10 years, Black Hills has compounded the dividend at a slow 2.4%. From 1998-2014, Black Hills increased its quarterly dividend by less than a penny a share. In 2015, the company increased the quarterly dividend by a larger-than-normal 1.5 cents. It would be difficult for the company to slow the dividend even further, but I believe that is exactly what the company will do. Until Black Hills works off the debt from this acquisition, I expect quarterly dividend growth of no more than half a cent a year. What this means for investors is that Black Hills will remain an investment for people looking for current income and not for dividend growth. Wait for BKH to Hit Support Before Buying A technical analysis of the stock movement shows that BKH was in a downtrend even before the merger announcement; the announcement only accelerated the downtrend. As shown in chart 1 below, the stock had set up a pattern of lower highs and lower lows. While the stock may currently be oversold, there is little support until $33, with stronger support at the prior consolidation around $28-$31. (See chart 2.) I think it’s likely that BKH will move to that support zone, which would give the stock a yield of 4.9%-5.2% (based on a stock price of $30-$33). I would consider selling a put or purchasing BKH outright at those levels. (click to enlarge) Chart 1: BKH was in a downtrend prior to the acquisition announcement. (click to enlarge) Chart 2: After breaking into the low $40s on heavy volume, the next major level of support is in the high $20s-low $30s. Source: Stockcharts.com The Bottom Line: The acquisition of SourceGas sets Black Hills up for future growth, but the debt overhang will limit near-term dividend growth. The market’s (over)reaction will provide investors looking for current income a good entry point as the stock moves to support. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BKH over the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: As noted above, I may take a position in BKH in the near future.