You can hear investors' heavy breathing anytime they see someone say, "The company trades for less than the sum of its parts!" And why not? It sounds like a deal. If a company's parts were split up and sold or traded separately, investors gain parts worth oodles more than the original investment.
Emphasis on "if." That's the catch. Every intonation of "sum of the parts" must follow with the question, "What is the chance those parts will be broken out?" You could wait forever. Companies rarely acquire only to peaceably break up later.
For example, Berkshire Hathaway (NYSE: BRK-B) most definitely trades at less than all its businesses together would if traded separately. But Warren Buffett and Charlie Munger have no plans to break up the company. And without dividends, buybacks, breakups, or spinoffs, you don't get paid. Book-value bargain or not, it's worth only -- like gold -- what others say it is. (Here comes the hate mail! Save your breath. I love these guys and thank them for my education. I just won't own the stock.) So "sum of the parts" doesn't help here.
Now let's look at companies that do offer opportunity when (everybody sing) breaking up is fun to do.
Credit where credit's bill may be due
Last month, activist investors JANA Partners wanted McGraw-Hill (NYSE: MHP) to break up into four business units: S&P Ratings, MH Financial, MH Education, and Information/Media. JANA argued that MH Education's poor performance, along with uncertain legal liabilities facing S&P Ratings, were drags on the better MH Financial and Information/Media businesses. JANA asserted that a McGraw-Hill broken into four parts could yield a combined $65 a share versus the then-prevailing share price around $37.
The company recently agreed to split it into two, shedding Education but keeping the rest of the company together. Perhaps half a break-up loaf is better than none, but it's hard to see much upside from Tuesday's $45.25 without the full four-part reinvention. Only buying in the mid-$30s or lower would offer a sufficient margin of safety to justify an investment, depending on a greater value to these two parts.
Beaming with good fortune?
Another upcoming breakup is Fortune Brands (NYSE: FO). At the behest of activist investor William Ackman, the company sold its Acushnet golf biz and will become two separate units, Beam and Fortune Brands Home & Security, trading as BEAM and FBHS, respectively, starting Oct. 4. Apart from Jim Beam, Beam also sells well-known hangover producers Maker's Mark bourbon, Sauza tequila, and Canadian Club whiskey (at least that's what people tell me). The home and security business offers Moen faucets, Kitchen Craft cabinetry, and Master Lock products. A great combination.
While some say that gains on Ackman's involvement have eliminated the upside from the breakup, his Pershing Square Management bought shares as high as $50.85 in his Oct. 8, 2010, filing and $54.49 just last month, versus Fortune Brands' Tuesday $57.06 close. My advice is to wait for the breakup and watch the two units trade. Beam for now appears to have the best assets and may be a buyout target. It's attractive if it doesn't zoom on or soon after Oct. 4.
On the horizon
Several other breakups and spinoffs loom. When Yours Truly began investing in the late 1960s, the conglomerate craze was in full swing. Before the days of massive stock-option grants, companies paid CEOs based on the size and complexity of the organization. ITT (NYSE: ITT) and its CEO, Harold Geneen, were conglomerate darlings then. It first broke into three parts in 1995, and now it's planning another three-part reinvention, with a split into industrial, water, and military businesses by the end of the year.
Conglomerate Tyco International (NYSE: TYC) has announced another breakup plan after the recent market drop erased gains from the one in 2007. And Yahoo! may split off its Alibaba unit in order to … well, who knows? Return to spurned suitor Microsoft (Nasdaq: MSFT)? Merge with other super (not!) online franchise AOL?
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