Shah Gilani has been pitching his new service, The Spin Trader, as a way to trade off of the long-observed tendency of spin-off stocks to outperform the market.
We started looking at his picks last week, with the odd result that the first “spin-off profit opportunity” he teased was a company that is currently not doing a spin-off, hasn’t been spun off, and may never spin. You can see that first article here if you like.
So we’ve already had our little conversation about how spin-offs really do generally outperform the market, though that doesn’t mean that the “spin-off index” outperforms the market or that any specific pick will do so.
And we’ve noted that the claims that the “average” performance of spin-offs means they do 200% better (or something like that) than the market are balderdashery. Academics are excited about tracking and trying to measure and monitor spin-offs because they beat the market, but “beat the market” to them means, in most studies, a few percentage points a year — good, but not wet-your-pants good.
So let’s move right on to the second stock that Gilani teased, shall we? Here are the clues:
“NEW SPIN-OFF PROFIT OPPORTUNITY #2
“This recently announced spin-off would separate this blue-chip company into a high-growth business information service and low-growth education-based businesses.
“This is a SIPO that Shah recommends playing 2 ways:
Buying the high-growth business, and Playing the low-growth education business from the short side (with puts).
“The idea here is to play both sides of this spin-off and make money with both.
“The business information services side will likely become a takeover or acquisition target, which, once spun, could easily double in a year.
“The education side will be a good short where we will take profits when we close the put, and then buy the stock as a great value play.”
Even before we get into the “which company is this?” bit, you can tell that it’s an ambitious idea — not only that they have a great investment idea, but that they have a company that will split, with one part doing great immediately and the other part going down for a predictable period of time and then becoming a “great value play” at that point, with profits promised on three different moves.
So what’s the stock? It takes only a few moments in the Thinkolator to tell you that this is … The McGraw-Hill Companies (MHP — free trend analysis here from Marketclub, one of our advertising partners)
McGraw-Hill announced last month that they will be splitting up, in part because of activist shareholder pressure, into McGraw-Hill Markets (the lion’s share of the company — Standard & Poors, JD Power, and Platts, among other brands and services) and McGraw-Hill Education (mostly textbook publishing).
McGraw-Hill has been slowly planning to shed assets and rationalize its businesses for a couple years, you might have noticed some of the other moves along the way that have made media a less important part of their portfolio (selling BusinessWeek, selling TV stations). Despite the horrific beating that the ratings agencies have taken over the past couple years (and rightly so), apparently the world still has need of them — so Standard & Poors (S&P) and their market research and financial data businesses are absolutely still the growth driver of the company, they’re really just shedding the Education division because it’s low-growth and not as sexy, so the theory is that this heavy child is weighing down the parent.
Or, a cynic might say, they feel the need to do something because just operating the business has not moved the share price up. Though, to be fair, you might argue that it’s the markets division that has hurt them more than the education stuff — McGraw-Hill has done worse over the past five years than most of the other big textbook and financial publishers who don’t have ratings agencies under their belt, companies like Pearson (PSO — textbooks and the Financial Times) and John Wiley (JW-A — textooks), and that underperformance is largely because of MHP’s weak performance from 2007-2009 (since the 2008-9 crash they have done far better in bouncing off of a deeper bottom).
McGraw-Hill is a 100 year old company, and is now effectively spinning off what you would have called, until fairly recently, the core of the business — it was started as a publishing concern, gradually becoming the leader in educational publishing in the first half of the 20th century, and sowed the seeds for the future when it bought Standard & Poors in the mid-1960s.
So the basic argument from this tease is that you should buy the parent either before or after the split (it’s not clear which, though the key purchase point would have been before the split announcement if you wanted a more dramatic share price pop), and that you should short the shares of the split-off Mcgraw-Hill Education division until those get to be “cheap,” then buy the shares.
Which makes sense according to the general pattern of spinoffs — usually, when a company spins off a non-core asset both institutional and individual shareholders stop being “natural owners” of that stock and have a tendency to sell it, dragging the price down. The spun-off company also generally does not have analyst coverage on Wall Street and is often not in any indices, so that “orphans” the shares to some degree, which also tends to drive the stock down.
Of course, such is far from guaranteed — S&P has had its share of detractors lately, what with downgrading US government debt earlier this year and upgrading junk mortgages to AAA a few years ago and operating in the highly suspect (I think) business of rating bonds and being paid by the rate-ees, and seems therefore to have some “regulatory risk” associated with the shares, though both Moody’s and S&P have held up better in the post-mortgage-scandal era than I thought they would have. This is still being looked at by the SEC and enforcement folks, to be sure, with the latest note I’ve seen being a plea from S&P for the SEC to drop its case, though I bet we’re closer to the beginning than the end in the legal wrangling over ratings agencies and mortgages.
I kind of like the education business, with both McGraw Hill Education and Pearson seeming to have some good potential with their solid profits in education software and systems to go along with their very profitable textbook (including e-text) businesses — anyone who’s seen a College bookstore in the last ten years knows that there are still a lot of regular old textbooks being bought every year, and they’re still incredibly expensive.
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But it’s going to be hard to put a value on the shares before the spin-off happens (it’ll take a while, perhaps as long as a year), and many of their customers (school districts chief among those) are still tightening their purse strings (part of the reason, along with lower business at S&P, that they issued weaker guidance for the balance of the year when they released the quarterly numbers late last week.
McGraw-Hill’s spin-off of the education division is not a surprise — in fact, it’s arguable that the surprise is that they didn’t break up further, since they’ve been talking about a possible split for well over a year (that’s probably why the stock didn’t specifically go bonkers on the day the split was announced, though it did go up substantially that week). Will it make you rich? Probably not, this is a $10+ billion company that’s calving another big business, and both probably deserve to be trading at a small premium to the market multiple, which is right where the parent is right now — since S&P is part of the mix and this is a well-known parent, we can also assume that the coverage of the details of the spin-off will be wide and deep in the financial press (as it has been so far), so we won’t make huge gains by buying a “forgotten” spin-off … but of course, that’s the big picture look, where the stocks will trade depends on the performance of the segments. Right now both of the main components (Education and Markets) have some problems, with the earnings coming in below expectations and tepid forecasts for the balance of the year — I’d prefer to wait to wade into MHP until after this flurry of attention wears off or after the market has taken a bit of a