Is This Situation Special Enough?

In his book You Can Be a Stock Market Genius, author and investor Joel Greenblatt highlighted the opportunity hidden in mergers and acquisitions, spinoffs, and restructurings. Some deals are so complex that the true value of a stock won't be unlocked until well after the fact, giving savvy investors a chance to get in early and grab hold of shares at a discount. Huge profits are possible, and he achieved 50% annualized returns for a decade investing in them.

We'll look at some announcements presenting an opportunity for profit and pair that with the views of the 180,000 members of Motley Fool CAPS to see what they think of the businesses involved. If the best and brightest in the investment community like these stocks, it may be worth your time to dive in further.

But not every deal is worth your money. It takes diving into the filings to understand the nuances, so don't use the stocks below as a buy list -- more due diligence is needed on your part.

Company

CAPS Rating
(out of 5)

Type of Situation

Terms

L-3 Communications (NYSE: LLL  ) **** Spinoff Tax-free spinoff of Engility government services unit
United Technologies (NYSE: UTX  ) **** Spinoff Pratt & Whitney Rocketdyne, to finance Goodrich acquisition

Again, this is just a starting point for further research. Do your homework before committing real money to these special situations.

No thievery necessary
From AT&T just announcing its intention to sell its Yellow Pages operations to Cisco shutting down its Flip camera division, more businesses are returning to basics these days and focusing on core operations. They're shedding what isn't working and keeping what does.

Although that's the stated philosophy behind L-3 Communications' announcement last summer that it plans to divest itself of its government services unit -- which it will name Engility -- there's more to it than just that.

Defense contractors like L-3, Lockheed-Martin (NYSE: LMT  ) , and Northrop Grumman (NYSE: NOC  ) all had systems engineering and technical assistance units, or SETA, through which retired military personnel on staff helped them procure contracts. But in overhauling the Defense Department, President Barack Obama tightened the conflict-of-interest rules to prevent SETA personnel from having a say in who got what contract awards.

Despite the presence of "firewalls," the reforms made it cumbersome if not impossible for parent companies to easily bid on work that shouldn't have been an issue. Northrop was the first to sell its SETA unit to private equity in 2010 while Lockheed sold its enterprise integration group last year. L-3's spinoff is just the latest progression of this trend.

CAPS member morowulf looks to the spinoff to unlock some shareholder value, though he recognizes the risk in defense spending cuts: "Besides the earnings growth indicating the stock is under valued, this stock is due to have a spin-off next year which I believe will produce more value for shareholders. The only downside that I see is the pending defense cuts over the next year or so, but I believe this is a good long-term investment."

Keep an eye on the deal's developments by adding L-3 to your watchlist and let us know in the comments section below or on the L-3 Communications CAPS page if you think reforms themselves will need to be reformed.

Reaching cruising altitude
Another overhaul is behind United Technologies' decision to spin out its rocket division, Pratt & Whitney Rocketdyne, that it bought from Boeing (NYSE: BA  ) in 2004, along with its non-aerospace businesses of Hamilton Sundstrand.

Because Obama also reformed what NASA's mission will be in the future, one that has a far smaller footprint in space travel, UTC sees the growth opportunities for the units being similarly diminished. Where Rocketdyne was a major supplier of NASA's rockets, Hamilton Sundstrand was a key manufacturer of its space suits, along with other aircraft systems. Without any major leaps for mankind in NASA's future, the units will only serve as a drag on UTC's performance.

The divestiture will help United Technologies pay for its $16.5 billion purchase of Goodrich that it previously announced. Originally planned to be executed with the issuing of tons of new stock, management decided selling off divisions would be better since the dilution would affect how Wall Street views its earnings.

Although avoiding dilution isn't a bad idea, it sounds like management is concerned with short-term issues. Coupled with the diminished prospects for rocketry, this might be a spinoff that will subsequently crash and burn.

Which could be good for United Technologies, after it sheds the divisions. CAPS member RondoAZ sees the potential for a double over time:

UTX is one of a few conglomerates that has stayed true to the businesses. Carrier is HVAC, Otis moves people safely, Pratt Whitney is jet engines. All of them have a service content. All of them are global leaders. All of them have global leaders in their businesses and are managed that way. UTX never fell into the trap of putting too much into side adventures, and their management while confident and competent always has healthy paranoia.

Look for a 5 year double in the price of the stock after a probable split.

Add UT to your watchlist to see whether it will reach the correct orbit and let us know on the United Technologies CAPS page whether you think the spinoff will end up as just another piece of space debris.

Checking the mercury
Digging into these deals is exactly what the analysts at Motley Fool Special Ops do every day, finding the best situations to invest in. It's a special opportunity worth taking a 30-day risk-free trial in.

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Fool contributor Rich Duprey owns shares of Cisco Systems, but he holds no other position in any company mentioned. Click here to see his holdings and a short bio. Motley Fool newsletter services have recommended buying shares of L-3 Communications Holdings. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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