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Engility: Spinoff Causes Forced Sell-Off by Institutional Investors

As famed value investing guru Bruce Greenwald explains in his book, "spin-offs are a wonderful opportunity for investors... because many of the shares are sold for reasons unrelated to the company's prospects." Engility Corporation ("Engility") is one of those value opportunities resulting from such a situation.

Headquartered in Virginia, Engility (NYSE: EGL  ) was crafted from its parent company, L-3 Communications, and launched its IPO as a separate entity in July 2012. It provides training services in engineering, professional support, and mission support to government agencies and allied foreign governments in over 140 countries. In fact, more than 75% of its revenues are generated from the U.S. Department of Defense.

New business opportunities
When Engility was part of L-3 Communications, it missed out on new contracts because of what the federal government deemed as "organization conflict of interest." This prevented the company from bidding on many profitable contracts. As Engility mentions in its prospectus, it "estimates that L-3 ceded or otherwise lost a significant amount of its SETA related revenues due to organization conflict of interest constraints." By operating as a separate entity, Engility is poised to record significant revenue growth.

The spin-off concept is not novel, and many other large-cap defense companies have adopted this model for some time. For example, aerospace giant, Northrop Grupman, sold its government advisory business, TASC, to KKR (a private equity company) in 2009. In late 2010, Lockheed Martin also sold its Enterprise Integration Group division to Veritas Capital for US$815 million.

Spinoff causes forced selling
For every six shares that L-3 Communications shareholders owned, one share of Engility was distributed as part of the spin-off. However, this is where the investment thesis becomes interesting. L-3 had a market cap of US$6 billion, while Engility was only worth around US$250 million. Because many large institutional investors of L-3 had a strict mandate of investing only in large-cap companies, shares of Engility were sold for reasons that had nothing to do with Engility's business.

In fact, approximately 9.2 million shares of Engility switched hands on the first six days of trading. This represents around 55% of the total outstanding shares of Engility (an unusually large proportion of total outstanding shares) and is indicative of massive selling by L-3 shareholders that wanted nothing to do with Engility. An investment in Engility would not only take advantage of the mispricing of the security caused by forced selling, but also represents an opportunity to increase exposure to a fairly stable company with decent growth prospects.

Written by Kapitall's SiHien Goh. The original article can be found here. Click to access free, interactive tools to analyze these ideas.

Motley Fool newsletter services have recommended buying shares of Engility 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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