Breaking up may be hard to do, but it can be very profitable -- provided you're investing in companies that are planning to split. A breakup can unlock shareholder gains, making obvious the inherent value in the newly separated businesses.
Below, I've rounded up three breakups that look poised for profit.
Send in the clowns
Breakups are a type of special situation, an investment that relies on a specific transaction or catalyst to create profit for us. In a breakup, the sum of the newly split companies looks more valuable than what the market is currently pricing.
Businesses split for many reasons, but often it's because the combined company is not being valued appropriately by the market. That's especially true of conglomerates, in which the performance of one division sometimes obscures others' or where managers' attention is focused on one business. A breakup can highlight the good qualities of the separate businesses and allow investors to value them accurately, instead of awarding them a conglomerate discount. In that case, the sum of the parts is worth more than the whole.
In other words, the value in such special situations is obscured by technical reasons, not fundamental ones. As Joel Greenblatt details in his book You Can Be a Stock Market Genius, special situations led him to 50% annualized returns for a decade. That type of return transforms a $1 investment into $52 in just 10 years. These situations can be superficially complicated, but it's this transactional complexity that often creates value for agile investors.
So what are those three investments I'm looking at?
Fortunately for us ...
About a year ago, Fortune Brands
Now the company has sold off its golf division and is using the proceeds to retire debt, providing more potential upside. In the next couple of weeks, the two remaining businesses will officially split apart, leaving two pure-play companies that can be more effectively priced. Each will be able to focus on its core business, and the conglomerate discount should disappear. The home and security business is at a cyclical low now, despite the fact that it was the main profit generator for Fortune as recently as 2006. So that stock could be attractively priced coming out of the spinoff.
Fortune is also an interesting play because of the rumored interest of bigger companies, namely Diageo
Just being expedient
You know Expedia
TripAdvisor competes against a heavyweight in Google
The spinoff is particularly attractive because it earns better than 50% operating margins, has been growing its Web traffic at a prodigious clip, and requires little capital investment. TripAdvisor is now reaching 50 million unique monthly visitors, and traffic has increased 22% in the year ending in July. Some have pegged the valuation of the new company at $4 billion, or half of Expedia's current valuation.
That leaves the core Expedia business, which competes against priceline.com
Marriott rewards investors
You probably know Marriott
In contrast to its hotel management operations, the timeshare business required 36% of Marriott's assets but generated just 13% of its revenues in the last four quarters. The business has been hurt by the financial crisis, overleveraged consumers, and the inability to develop properties.
But that doesn't mean the business is worthless. After all, timeshares are a notoriously bad investment, so someone has to be making a profit on them. I'd like to take that side of the trade. The spinoff also makes the less-asset-heavy hotel-management business all that more attractive.
Want more ideas like this?
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Jim Royal, Ph.D., does not own shares of any company mentioned here. The Motley Fool owns shares of Fortune Brands, Google, and Diageo. Motley Fool newsletter services have recommended buying shares of Fortune Brands, Diageo, priceline.com, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.