3 Real-World Case Studies: How Spinoffs Unlock Shareholder Value - Sure Dividend Sure Dividend

Sure Dividend

High Quality Dividend Stocks, Long-Term Plan
Get Top 10 Stocks in Sure Dividend Newsletter NowGet The 5%+ Yield Sure Retirement Newsletter Now

3 Real-World Case Studies: How Spinoffs Unlock Shareholder Value


Published by Nicholas McCullum on April 25th, 2017

Investors sometimes face the peculiar scenario of one of their holdings spinning off selected assets as a new, publicly-traded security.

Often, there is uncertainty surrounding these new estimates. Since markets hate uncertainty, one might expect that spinoffs underperform the market…

This is not the case.

There is a statistically significant body of research to support the belief that spinoffs outperform the market.

Managers that with strong capital allocation skills have recognized that mispriced assets can often appreciate in value when trading as independent entities, and have acted accordingly.

This article will analyze three notable dividend stock spinoffs within the past decade that have successfully unlocked shareholder value:

Each is analyzed in detail below.

Philip Morris International Inc. (PM)

Philip Morris International and the Altria Group are two of the world’s largest cigarette companies with market capitalizations of $164 billion and $138 billion, respectively.  The cigarette industry and Philip Morris have been around for a very long time.

That’s why both Philip Morris International and Altria Group are members of the exclusive blue chip stocks list – reserved for stocks with 3%+ yields and 100+ year operating histories.

Philip Morris International was a wholly-owned subsidiary of the Altria Group until the company was spun-off in a special one-for-one stock dividend on March 28, 2008. The following diagram shows the appreciation of both stock prices since then.

Altria and Philip Morris International Stock Price History

Source: Yahoo! Finance

The PM spinoff was an example of the superb capital allocation skills of Altria management. For every one share of Altria held before the spinoff (which was worth $73.83 on its last day of trading), an investor would now hold:

For a total value of $225.99, or cumulative total returns of ~206% since the spinoff in 2008.

For context, this represents an annualized rate of return of ~13% per year. These total returns would have been even higher if dividends were reinvested to purchase more MO and PM along the way.

Almost a decade after the spinoff, Philip Morris International continues to be a highly profitable business.

Philip Morris saw constant-currency adjusted diluted earnings-per-share increase by an impressive 11.8% in 2016.

PM 2016 Strong Financial Results ex-Currency

Source: Philip Morris International 2017 CAGNY Presentation, slide 7

The company also continues to generate substantial free cash flow.

In fiscal 2016, Philip Morris’ free cash flow was negatively impacted by the strong U.S. dollar but still remained constant compared to the year prior. Excluding currency, free cash flow actually increased by 4.9%.

PM 2016 Free Cash Flow in Line With Prior Year

Source: Philip Morris International 2017 CAGNY Presentation, slide 8

Philip Morris uses this free cash flow in the best interest of its shareholders. The tobacco giant has increased its annual dividend payments every year since the spinoff from Altria. Rising dividend payments are a key sign of a shareholder-friendly stock.

One might think that Philip Morris International is also an active repurchaser of shares, given that their dividend history suggests they put their shareholders’ interest first.

However, Philip Morris has not repurchased shares since its $18 billion share repurchase plan that concluded in 2014.

This is because the stock is trading at a premium valuation right now, and repurchasing shares would actually destroy shareholder value.

Looking ahead, Philip Morris’ growth will be largely driven by its portfolio of reduced-risk products (RRPs), which are key to growing sales in a world where consumers are increasingly aware of the negative health effects of cigarette smoke.

Philip Morris is a leader in the RRP industry. The company’s product offering is depicted below.

PM RRPs - Our Product Platform

Source: Philip Morris International 2017 CAGNY Presentation, slide 17

The market leadership of Philip Morris International in the RRP industry is driven by the company’s active research in this segment.

The company has built an impressive RRP intellectual property portfolio and has been filing an increasing number of RRP patents in each of the past three years.

These patents are long-lived, with the majority expiring post-2030. This reduces competitor risk for Philip Morris’ RRP products.

PM RRPs PMI Published Patents

Source: Philip Morris International 2017 CAGNY Presentation, slide 43

Philip Morris is expecting 2017 to be another strong financial year.

Management is guiding for adjusted diluted earnings-per-share to increase by approximately 9%-12% ex-currency. Currency will continue to have a profound effect on the company’s GAAP earnings, with a ~$0.08 earnings-per-share impact from foreign exchange.

PM Increasing 2017 EPS Guidance For Currency Only

Source: Philip Morris International 2017 CAGNY Presentation, slide 12

The Philip Morris International spinoff has generated substantial shareholder value. However, right now might not be the best time to initiate or add to a position in this stock.

The company’s current stock price of $109,62 represents a 24.5x multiple of 2016′s adjusted diluted earnings-per-share of $4.48. The company’s rich valuation suggests investor would be better off waiting for a better buying opportunity.

Philip Morris International remains a strong hold for existing shareholders because of its durable competitive advantage, shareholder-friendly management, and high dividend yield.

For investors looking for more information about AbbVie’s investment prospects, read the following Sure Dividend article:

AbbVie Inc. (ABBV)

Abbott Laboratories and AbbVie are both large healthcare companies with market capitalizations of $75 billion and $104 billion, respectively.

AbbVie was spun-off from Abbott Laboratories at the beginning of 2013. Abbott investors received AbbVie shares as a special one-to-one stock dividend on January 2, 2013.

The following chart shows each company’s stock price since then.

Abbott Laboratories and AbbVie Stock Price History

Source: Yahoo! Finance

Investors who have held Abbott since before the spinoff have been rewarded handsomely.  For every one share of Abbott held before the spinoff (which was worth $65.50 on its last day of trading), an investor would now hold:

For a total value of $120.16, or cumulative total returns of ~83% since the spinoff in 2013. For context, this represents an annualized return of ~15%. These total returns would be even more attractive if reinvested dividends were accounted for.

AbbVie’s strong shareholder performance since the spinoff has been driven by strong business performance.

The company has grown its adjusted net revenues and adjusted earnings-per-share every year since inception.

ABBV Outstanding Track Record of Execution and Top-Tier Growth Prospects

Source: AbbVie Presentation at the 2017 JP Morgan Healthcare Conference, slide 4

Unlike Abbott Laboratories, AbbVie operates in a single segment: Pharmaceuticals.

The spun-off company has traded diversification for expertise, though it has a presence in many subsectors of the pharmaceutical industry.

ABBV AbbVie - An Innovation-Driven, Patient-Focused, Specialty BioPharmaceutical Company

Source: AbbVie Presentation at the 2017 JP Morgan Healthcare Conference, slide 5

AbbVie is trading at an absolute bargain right now. The current stock price of $63.82 is only a 13.2x multiple of fiscal 2016‘s adjusted diluted earnings-per-share of $4.82.

The company’s dividend also indicates that it is attractively valued. AbbVie’s current quarterly dividend of $0.64 per share is good for a yield of 4.0% at today’s prices.

The reason behind AbbVie’s low valuation is uncertainty surrounding the future of its flagship drug Humira.

Humira is very important to AbbVie – it is the highest grossing drug in the world and contributed 63% of AbbVie’s 2016 sales.

So why are the markets concerned about Humira?

Like most pharmaceutical companies, AbbVie protects Humira with a web of patents to prevent imitations from competitors.

Humira’s patent portfolio began expiring at the end of 2016, and the markets are concerned that this additional competitive pressure will reduce Humira sales and impact AbbVie accordingly.

Fortunately, AbbVie’s management believes that these effects are overblown. The company expects Humira sales to continue to grow to >$18 billion by 2020. For context, $16.1 billion of Humira was sold in 2016.

These Humira risks are also mitigated by the strength of AbbVie’s drug pipeline.

The company has eight key near-term growth assets that are expected to generate $25-$30 billion of sales by 2020.

More information about these eight growth drugs can be seen in the slide below.

ABBV De-Risked Growth Assets Alone Position AbbVie For Substantial Growth Beyond 2020

Source: AbbVie Presentation at the 2017 JP Morgan Healthcare Conference, slide 13

While the markets are punishing AbbVie right now because of concerns surrounding Humira, it is likely that these fears are overblown. Current shareholders will likely realize considerable upside if Humira’s sales can remain constant – let alone show growth, as management expects.

AbbVie is also remarkably shareholder-friendly.

The company has raised its dividend every year since the spinoff.

Further, AbbVie recently announced a $5 billion share repurchase program, which amounts to ~5% of the company’s current market capitalization.

The willingness of AbbVie’s management to repurchase shares at the current valuation of ~13 times earnings demonstrates robust capital allocation skills that will reward shareholders for years to come.

ABBV AbbVie Offers Both Compelling Growth and Strong Capital Allocation

Source: AbbVie Presentation at the 2017 JP Morgan Healthcare Conference, slide 14

AbbVie ranked as a top 10 stock using The 8 Rules of Dividend Investing in the April edition of the Sure Dividend Newsletter. The company is a buy based on its strong earnings growth, high dividend yield, and attractive price-to-earnings ratio.

For investors looking for more information about AbbVie’s investment prospects, read the following Sure Dividend article:

Adient PLC (ADNT)

Johnson Controls is a global multi-industrial company with a market capitalization of $39 billion.

Adient is an automotive seating manufacturer with a market capitalization of $6.5 billion. Adient was spun-off from Johnson Controls last October, making it the ‘youngest’ spinoff to be discussed in this analysis.

Unlike the other spinoffs in this article, Adient stock was not distributed on a one-to-one basis.

Instead, shareholders received 1 share of Adient for every 10 shares of Johnson Controls. The following diagram compares the growth of 1 share of Johnson Controls and 1/10 of a share of Adient since the spinoff.

Johnson Controls and Adient PLC Stock Price History

Source: Yahoo! Finance

For every 10 shares of Johnson Controls owned before the spinoff, an investor would now hold:

For a total value of $494.915. Given that shares of Johnson Controls was trading at $43.76 on the last day before the spinoff (so $437.60 for 10 shares), this represents a total return of ~13% since the spinoff on October 31.

For context, this is equivalent to annualized returns of ~30%. It’s safe to say that the Adient spinoff has unlocked shareholder value, at least in the short term – this high rate of return is unsustainable in the long run.

Investors might be curious if there is still upside remaining for this stock.

This does appear to be the case. Adient is attractively valued right now, although valuing the company is difficult because of its lack of independent operating history.

Fortunately, Adient has already filed its first 10-K, where it provided the following snapshot of its earnings-per-share trend as a subsidiary of Johnson Controls:

ADNT Statement of Operations

Source: Adient 10-K, page 26

In 2016, Adient reported a GAAP loss of $1.533 billion after a profit of $475 million the previous year.

The reason behind this substantial lack of profit is the large one-time charges incurred by the company due to the separation from Johnson Controls. These charges are outlined in the following table.

ADNT Special Costs

Source: Adient 10-K, page 26

The impact of significant items on Adient’s fiscal 2016 was $2.6 billion, compared to just $409 million the year before.

I believe it is more reasonable to back out this $2.6 billion charge and replace it with last year’s $409 million to get a better sense of the current earning power of Adient.

Doing so, I arrive at net income of $694 million for fiscal 2016, which gives earnings-per-share of $7.41 after dividing by 93,641,810 diluted shares outstanding.

Adient’s current stock price of $69.24 is just a 9.3x multiple of 2016’s adjusted earnings-per-share after making the adjustments I described above. Adient is a screaming bargain right now.

Determining a ‘right’ valuation is tough because of the company’s lack of independent operating history.

One way to determine a fair value for Adient is by looking at Johnson Controls’ long-term average price-to-earnings ratio.

The average price-to-earnings ratio of Johnson Controls since 2000 is 14.9, with the annual trend depicted below.

ADNT Johnson Controls (JCI) Valuation Analysis

Source: Value Line

If Adient were to appreciate to Johnson Controls’ average price-to-earnings ratio of 14.9, investors would experience upside of ~60% without accounting for any expected earnings growth.

With that said, earnings growth is highly likely for Adient.

The company is a leader in the automotive seating industry and supplies many of the world’s leading automotive manufacturers.

Selected stats about Adient’s business can be seen below.

ADNT Adient Today

Source: Adient Presentation at the 2017 BAML Auto Summit, slide 5

Adient has a strong competitive advantage that comes from its market leadership and business diversification. Adient has a 33% market share in its industry.

Being the market leader in global automotive seating production means that Adient generates revenues from many different geographies. Only 34% of Adient’s revenue comes from the Americas.

ADNT Global Market Leader With Diversified Geographic Exposure

Source: Adient Presentation at the 2017 BAML Auto Summit, slide 7

Adient’s diversification also extends to its customer base.

Adient’s customers are well-known, blue-chip companies like Ford (F) and General Motors (GM), which means robust and stable demand for Adient’s products and services.

ADNT Our Customer Portfolio Is The Envy Of The Industry and Closely Mirrors Our Customer's Global Market Share

Source: Adient Presentation at the 2017 BAML Auto Summit, slide 9

Buying undervalued stocks is especially smart if the company pays a strong dividend. This lets investors be paid to wait for the stock price to achieve a more normalized valuation.

For awhile after the spinoff, investors were unsure how much dividend income they could expect to receive from Adient.

This uncertainty was recently dispelled when Adient declared its initial quarterly dividend of $0.275. The market is pricing Adient at a dividend yield of 1.6%.

Adient is a low yield dividend stock right now, but it is possible that the company is planning to scale up its dividend payments in the near future.

Risk-conscious investors should think strongly before considering an investment in Adient. The company will likely not perform well during the next recession.

This is because the earnings of automotive companies (Adient’s customers) tend to decline precipitously during economic downturns – this was seen in the bankruptcy of General Motors during the global financial crisis of 2008-2009.

However, I still believe Adient offers an asymmetric risk-reward proposition for investors who buy now and are willing to wait for long-term price appreciation.

For investors looking for more information about Adient’s investment prospects, read the following Sure Dividend article:

Final Thoughts

This analysis supports the belief that spinoffs tend to outperform. All three of the spinoffs analyzed in the article have delivered fantastic returns since inception:

When investors can identify a trend in the financial markets that either increase returns or reduces risk, they should look for opportunities to implement this in their investment strategy.

Accordingly, think twice before selling the next spinoff that appears in your brokerage account.


See Our Best ideas
Get Top 10 Stocks in Sure Dividend Newsletter NowGet The 5%+ Yield Sure Retirement Newsletter Now