One of the more interesting special situations in investing is the spinoff, when a parent company "spins off" a subsidiary as a separate, publicly traded company and distributes the shares to its investors. Recent examples include Time Warner's spinoff of AOL and Encana's (NYSE: ECA) spinoff of its integrated oil business, Cenovus Energy.
Studying management's motivations to go to the expense of undertaking such a transformation is always interesting. Usually, the justifications provided in the information statement (sent to shareholders and filed with the SEC) are pretty general: The separate companies will be better equipped to pursue different growth strategies, better incentivize management, or lower their cost of capital. The real reason for the spinoff -- such as dumping environmental liabilities onto the subsidiary, as the bankrupt Tronox has accused former parent Kerr-McGee (now part of Anadarko Petroleum) of doing -- may never appear in print. In the case of McDermott (NYSE: MDR), however, the primary motivation is spelled out quite clearly in the SEC filings.
McDermott, an engineering and construction company focused on energy and power infrastructure, recently spun off Babcock & Wilcox (NYSE: BWC), which has two main segments. The power generation systems business builds boilers, scrubbers, and other equipment for thermal power plants. The government operations segment provides nuclear components and various services to -- you guessed it! -- the U.S. government. Uncle Sam is by far B&W's largest customer, accounting for one-third of revenue in 2009. The firm's next-largest customer, American Electric Power (NYSE: AEP), weighed in at 6% of sales.
Keeping government business is obviously a very high priority for B&W. The government caused a wrinkle last summer when it adopted interim rules that generally prohibit federal agencies from awarding contracts to "inverted" companies and their subsidiaries. McDermott, headquartered in Texas but incorporated in Panama, would likely qualify as an inverted company. By extension, subsidiary B&W would have been prevented from bidding on contracts against competitors Fluor (NYSE: FLR), Jacobs Engineering (NYSE: JEC), and Northrop Grumman (NYSE: NOC), all of whom are incorporated in Delaware.
But B&W as a separate company wouldn't be restricted.
This "significant" factor in favor of undertaking the spinoff is spelled out in the information statement, under the heading "Elimination of the risk to the combined businesses posed by recent modifications to the rules under [Federal Acquisitions Regulations]." It's nice to feel this clued in to management's motivations.
As for the investment merit of the B&W spinoff, consider that an ongoing investigation. I'll share my thoughts soon, but for now I'd like to hear what you think of the firm's prospects as a newly independent company. Share your thoughts in the comments section below, or make a pitch in Motley Fool CAPS.
