This teaser ad from the Money Map folks for Shah Gilani’s Spin Trader has gotten a lot of attention from my readers …
… and as with most of the drool-inducing ads for investment newsletters, it promises massive returns and makes them sound even sexier by inventing a new term to refer to this mysterious wealth-making strategy: SIPOs.
Here’s a taste of the ad to get your wallet tingling:
“For 15 Years and Counting… Stocks in This Obscure, Govt.-Regulated Niche Have Returned an Average Gain of 213% in Our Study…
“Federal Law forces most institutions out of these stocks –
and that makes them act in a predictable way…
“This niche I call ‘SIPOs’ is so tiny that I’m surprised most investors… most pundits… most commentators… even most die-hard Wall Street cronies don’t pay enough attention to it.
“But this is very real. And having analyzed years of historical data, its track record is quite impressive.
“In fact, Bloomberg reports that SIPOs have more than tripled the return of the S&P for the past nine years. They’re up 170% as a group.”
As we go a bit further along, it becomes clear (and they eventually admit as much) that “SIPOs” are spin-offs — get it, “Spin-off IPOs“?
Spin-offs are companies that are split from a parent corporation, usually because they represent a division of a larger corporation that doesn’t provide any strategic synergy or because the bulk of the parent is obscuring the growth or potential of a division. There are lots of reasons given for spinning off or carving out a new company, but the basic one is, as you might imagine, that management thinks the parts will be worth more separately than they are together.
And this is largely true on average — spin-offs have outperformed the overall market most of the time over much of the past 25 years or so, according to dozens of academic and professional analyst studies. Though that 170% number teased is extreme compared to most studies (I didn’t look up the Bloomberg report that they cited, nor do I know what specifics they included) … generally, when you see longer-term studies of spin-off performance the indication is that they tend to outperform the market by perhaps 2-5% per year, with the smaller spun-out company generally doing better than the parent but often both of them outperforming the market.
Most of those studies are more than a decade old, but the general idea is pretty well accepted in the marketplace: parent companies tend to get a short-term pop in share price upon announcement of a spinoff, and spun-off shares tend to dip in the months immediately after being separated by their parent, but to substantially outperform the market in the year or two after that initial period.
The most aggressive analysis of this that I’ve seen is from Credit Suisse, you can find a copy of their report (from 2008) here, and they found that the spun-off company outperformed the S&P by 22% in the first year … though that uses a sample of 39 spin-offs from 2001 to 2006 and, to their credit, they note that “The median returns mask what is far from a consistent pattern.”
Which means, yes, the average is good (or has been good), but the distribution of returns is very abnormal — so we should take the “on average this is great” overall statement with a big grain of salt when it comes to individual companies and stocks. There are also more aggressive reports that I’ve heard cited, claims of up to 40-50% annual outperformance, but I haven’t read them and I imagine they must refer to shorter time periods or more aggressive ways of calculating returns.
And, in truth, we should note that aside from the fact that it doesn’t always work for every stock, which we should intuitively know, it also doesn’t work in every market or every year. This is a very, very small subset of the market where the actual character of one or two relatively big spin-offs could significantly change the returns in a given time period — so I’ll tell you that there is, as you might expect, an ETF, Guggenheim Spin-off (CSD), that tries to somewhat mechanically reproduce this spin-off trading strategy (in simple terms: buy the spun off company six months after it’s spun, sell it about two years later) …
… but I’ll also tell you that this ETF has had some periods of beating the S&P and some periods of losing to the S&P over the last five years, but over that time period has generally moved almost exactly in correlation with the broader index and has actually produced almost exactly the same five-year overall return as the S&P 500 if you ignore dividends (meaning, the S&P beat the pants off of the ETF if you do include dividends — spin-offs rarely pay dividends right away — though both SPY and CSD, as you probably know, lost money over five years).
The same correlation is true over the past year, with both the S&P (as represented by the SPY ETF) and the Spin-off ETF (CSD) down by a couple percentage points, though CSD did beat SPY over the past two years thanks to a brief period in early 2010 when it did substantially better — meaning that it was probably one or two spin-offs in 2008 or 2009 that did substantially better than the market when we came out of the financial crisis.
So the academic studies and analyst studies almost all indicate that spin-offs substantially outperform the overall market (depending on the time frame, the strategy, etc.) by anywhere from 2-3% a year to 20-40% a year (with most studies using data that either ends in the late 1990s or in 2005-2006), but the one easy-to-buy mechanical system of trading these spinoffs as an index does not appear to have beaten the market over the last five years.
So that’s the warning up front.
But what we want to know, of course, is which spin-offs will do best — after all, we don’t want to just beat the market by a few percentage points, we want to get those 170% gains that the teaser ad mentions … right?
Well, the attention is certainly returning to the spin-off space after a couple relatively slow years — during the crisis and market crash we didn’t see many IPOs because no one thought the market would fairly value their new company, and for much the same reason we didn’t see that many spin-offs and carve-outs — the market wasn’t lustily looking for new ideas, it was in full panic mode. Now, though, as IPOs have rushed back in the last year or so, so have spin-offs come back to the top of the front page in the newspaper. Now it’s apparently time to “create value” again in the executive suite, (rather than “hide in the bathroom and hope no one knocks on the door,” which would probably have been my strategy as a public company CEO in 2008 and 2009).
And yes, if you’re an outside observer it all starts to sound a little bit silly in the big picture — there are plenty of cases where a company that was acquired five or ten years ago because it would provide “synergy” with the parent are spun off today because it “unlocks value” … to some extent, there is simply a need for CEO’s to do something to make it appear that they’re busily trying to please investors and justify their bloated paychecks or perk up their option portfolios (especially if activist investors are breathing down their necks and trying to get board seats). But that, of course, is what a cynic would say.
And we’re optimists, right? So now that you’ve sifted through this much of our patented Gumshoe blather, let’s look at see which specific spin-offs are being teased by this new newsletter to give you some ideas for further research.
Here’s how the teaser says that spin-offs make better companies — and this is essentially parroting what most investors believe about spin-off investing, and it makes perfect logical sense:
“Corporations ‘spin off’ companies for a variety of good reasons.
- They are (essentially) tax free.
- They directly benefit shareholders – who have the luxury of monetizing their interest by selling those shares if that’s not a business they want to invest in.
- They streamline and focus management, as well as incentivize them in big way.
- They focus the new company on its industry and competition, as opposed to having to play to the needs of a diversified conglomerate.
- Perhaps most importantly, a liberated company can develop its own capital structure, new strategies and products, and thus grow at an extraordinary rate.”
And they also make the loud point that it is ILLEGAL for many institutional investors to own SIPOs — basically, that’s just a wild, hand-waving way of saying that yes, sometimes when a company is spun off the spin-off will not meet the investing mandate of some institutions (ie, too small, not in the S&P 500, in a different sector, too low-priced, no analyst coverage, etc.).
Add in the fact that many individual investors also receive spun-off shares from owning the parent but have no interest in owning the new company, and that’s the logical reason for the selling pressure that newly spun-off companies often face … and the reason that the studies indicate that buying a spin-off somewhere in the 3-6 months after the spin is better than buying immediately.
And I can’t resist sharing one more balderdashy promise with you:
“Whatever the reasons, one thing is crystal clear: SIPOs have significantly and consistently outperformed the market.
“In fact, the elite tier of the 259 SIPOs we analyzed from the past 15 years gained an average of 213% and outpaced the S&P by 192 percentage points!”
So that’s where they get those “average 213% returns” they tease us with … why balderdashy? Because it sounds like they’re just cherry picking some past spinoffs to make them sound more spectacular than the (pretty good but definitely not 213%) outperformance that spinoffs historically generate — of course the “elite tier” did great and outpaced the S&P. You can take any criteria you want, develop your own “elite tier” of that criteria, and tell me that it dramatically outperformed the market (ie, “Travis’ portfolio matched the market over the past 10 years with less volatility, but the elite tier of his picks outperformed the market by 2,000%!”). Did the “elite tier” of SIPOs also outperform the “elite tier” of other stocks? And could anyone predict exactly which ones would be elite? I’d be skeptical about both.
But anyway, the plight of a stock picker is that we lust for fabulous new ideas — so what are the clues for Gilani’s?
“NEW SPIN-OFF PROFIT OPPORTUNITY #1
“This world leader in its core business is a giant by any measure. But Shah may be one of only a handful of people who figured out that this gem is hiding in stealth, pre-spin-off mode.
“This company is a killer SIPO for two amazing reasons:
- It recently announced (without fanfare) that it is refocusing assets within aerospace, ground transportation, packaging, consumer electronics and defense. Translated – it is fashioning a stand-alone unit that can be spun off, or kept if other business divisions are to be spun off.
- This materials company provides the basic building blocks of the global economy. And despite sky-high uncertainty in the marketplace right now, it’s selling a ton of them. That’s why earnings just jumped 136% in the last quarter. And that’s why they’re expected to jump another 144% this quarter.
“Either way the sum of the parts is probably worth as much as 4 TIMES what the whole is worth at this very minute.
“Shah believes the inherent value (now around $10) is low enough that before it spins off it will probably double.”
So who is Gilani teasing us about here? Toss that info into the mighty, mighty Thinkolator and we learn that this is … Alcoa (AA)
Heard of ’em, haven’t you? Yes, the parent companies in spinoffs are almost always household names (at least for investor households), they tend to be multi-billion dollar companies, and there aren’t a lot of $10 billion companies that won’t at least sound familiar.
And likewise, there aren’t many big spinoffs that aren’t precipitated by a company underperforming or being seemingly undervalued for a substantial period of time — and that’s certainly the case for Alcoa, the fact that they are concentrated entirely on a vertically integrated aluminum business means that they tend to have very cyclical earnings (aluminum is a very economically sensitive metal, apparently — truck trailers, airplanes, etc.), and aluminum producers, for whatever reason, haven’t generally seen the great China-led performance that has recently been common to the more diversified mining and metals companies.
Alcoa doesn’t necessarily stand out in the group — performance has been broadly similar for other big aluminum companies like Chalco (ACH) and Century Aluminum (CENX) over the last couple years — but it is certainly been an investor disappointment of late. One of the reasons that we all know the name Alcoa is because they are the informal opening act of earnings season each quarter, reporting before any other big Dow component or “blue chip” companies (why? I dunno — maybe it’s their AA ticker putting them at the front of the alphabet, maybe it’s just tradition).
And, strangely enough for the launch of a spin-off newsletter, this isn’t a way to trade a spun-off company, or even a way to get in before an announced breakup, this is apparently a speculation that a company might spin off divisions or break up in some similar way — Alcoa has announced no such thing as far as I can tell (though they did announce that reorganization last month, which could possibly, theoretically make it easier to spin off divisions at some point in the future — the reorg was also covered in an FT article here, with nary a mention of potential spin-offs).
To be fair, Alcoa has been willing to spin off or sell businesses before — and those spin-offs are an interesting reminder of the cyclical nature of business, they spun off Alcan, their international/Canadian division back in the 1920s (largely, it seems, to escape Justice Dept oversight for cartel participation), and then desperately tried to buy it back in 2007 but lost the bidding war to Rio Tinto … and, in the same year, they sold much of the Reynolds business (including the namesake consumer packaging line) that they had acquired in a merger in 2000. And they spun out their soft alloys division into a joint venture in 2006 … so the company does have some history of reorganizing, spinning, sifting and sorting to try to make itself more valuable.
Still, it’s hard to see a defined spin-off of the sort teased as a “SIPO” in the near future for Alcoa — not that it’s impossible, of course, I just don’t see much chatter about it, nor do I see any agitating hedge funds clamoring for moves by Alcoa. Of course, I might not notice their clamoring.
Is the company itself interesting? Well, I’ve never owned it nor become much of an expert about aluminum or bauxite, but it does look fairly cheap on the face of things — forward and trailing PE ratios around 9, and a prediction from analysts that the growth will continue, albeit at a slower pace (they’re reporting “bounceback” earnings growth of 60%+ this year, including well over 100% some quarters, and analysts predict a bit over 20% earnings growth next year). Of course, this is also the same company that has (according to the compiled Yahoo Finance numbers) had average earnings declines of 30%+ per year for five years, including horrific declines during the meat of the recession.
And while that PE of 9ish looks fairly cheap, it’s really not — not cheap for a blue chip, not cheap for an industrial commodity company, not these days. BHP Billiton (BHP) and Rio Tinto (RIO) are both much cheaper, larger, and far more diversified across countries and products (which is bad if you think aluminum prices specifically will boom, but good if you just think commodities and metals in general are important things to own), and the trailing PE of the whole Dow Jones Industrial average (as measured by the DIA ETF) is just 9. And now that some folks are claiming that one of my faves, Intel (INTC) is a “commodity” producer of chips (how does producing a “commodity” get you 60% gross margins? Good question!), I’ll just throw in that INTC and AA have essentially the same numbers for both trailing and forward PE. And yes, I realize that the two aren’t in any other way comparable — and in AA’s defense, they’re currently growing much more quickly than Intel … if less predictably.
And if you want another opinion, there’s a nice little article over at Investopedia from Stephen Simpson here — similar points, which I’d sum up as “it’s cheap but it’s been cheap before, you might not want to hold your breath.”
So … big is cheap almost wherever you look — that’s not to say that AA is a bad bet, just that it doesn’t stand out for me as particularly unique in a universe of cheap stocks or in the sub-universe of cheap, large commodity producers … though if Gilani’s right (as he seems to be teasing) and AA is on the verge of doing some sort of spinning or carving of itself to “unlock value”, well, you never know what might happen.
That’s already probably too much to read for one day — I’ve got some more thoughts on spin-offs, another pick from Gilani, and a tie-in to Ackman’s talk at the Value Investing Congress to get to in our continuation of this topic … stay tuned!
Full disclosure: I own shares of Intel, and do not own any other stock mentioned above. I will not trade in any stock covered for at least three days.
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