Thoughts from our Domestic Equity Team
An increasing number of companies are currently involved in or considering corporate spinoffs of a part of their operations. While there are numerous methods to achieve a separation of activities, ostensibly all of them are designed to “enhance shareholder value”, the leading title in the corporate hymnal that is heard with resounding frequency and volume. The reasons for this strategy can range from a genuine belief that focusing and narrowing corporate activities can lead to a more generous valuation and a better targeted management structure to a desire to thwart any possible shareholder activist noise or even to satisfy the corporate raiders who are already circling their prey.
Historically, the golden age of the conglomerate has long passed into oblivion, with astute investment bankers having reaped the rewards of that structure only to tear it apart. But now, even companies with operations that clearly have some synergies are hearing the siren call to separate, stretching from consumer goods to industrial behemoths to a rising number of energy concerns. Just as health care has evolved into a field of minute specialization, so has the corporate world. Whole milk production gets separated from soy milk; jackup drilling rigs apparently do not belong in the same portfolio as ultra-deep drillships; oil production and retailing gasoline have become as separate as oil and water; and limited partnership units in a Master Limited Partnership are becoming distinct from general partner distributions. These are but a small sample of seemingly related activities that are being separated, all through the formation of distinct corporate entities which are being distributed to shareholders either following an Initial Public Offering or as direct entries into a new public ownership vehicle.
Some of this new wave is designed to give the investment world an easier time in valuing a pure-play company, hoping of course that previous mixing of somewhat disparate activities resulted in obscured value for one or both parts. It also can create better management incentive to excel in their chosen field without the distraction of another, somewhat unrelated business. And it can perhaps satisfy the numerous activist shareholders who will take large positions in a company and then lobby for change. They believe, perhaps incorrectly, that if they know how to accumulate capital and invest it, they must know better how to run corporate entities. The jury is still out on many of these investment titans becoming active in management, but Wall Street seems to almost always delight in the initial moves, many of which get communicated now through social media, rather than a regulatory filing as in days gone by.
As investment advisors, we have observed many of these corporate restructurings, and aside from the initial appreciation of the shares which may occur, our job is to understand the nuances of the new structure and whether it will in the long run benefit all of the parties or just one. Generally, we do applaud more efficient use of capital which these situations can entail, but we are also wary of shareholder activists who can put their interests ahead of other public owners, including our clients.
While it is not usually our primary motivation in adding a company to our portfolios, we look at under-leveraged balance sheets in companies without significant capital needs and unrelated business combinations as potential creators of additional value. However, first we need to believe that the basic risk/reward parameters of the company (excluding any reorganizational benefits) warrant our investment. Only after that would we consider possible restructuring gains. At present, our portfolios include several companies in this category and we are evaluating others that we believe could benefit from such changes if they were to occur.
Submitted by: Robert L. Meyer, CFA – Managing Director and Portfolio Manager
This information is intended solely to report on investment strategies and opportunities identified by Roosevelt. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. References to specific securities and their issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Please contact us at 646-452-6700 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions, or if you would like to request a copy of our Code of Ethics. Our current disclosure statement is set forth on our Form ADV Part II, available for your review upon request, and on our website, www.rooseveltinvestments.com.