Each week, Motley Fool editors cull a top stock idea from the pitches made on CAPS, The Motley Fool's 170,000-member free investing community. Want your idea considered for this series? Make a compelling pitch on CAPS with a minimum length of 400 words. Want to follow our weekly picks? Subscribe to our RSS feed or follow us on Twitter.

Pairs Trade  
Short: Valhi (NYSE: VHI)
Long: NL Industries (NYSE: NL)
Submitted By: Megashort
Member Rating: 97.28
Submitted On: 6/19/2011

Source: Motley Fool CAPS.

This Week's Pitch :

[Valhi] owns 74.9% of [Kronos Worldwide (NYSE: KRO)], 72.2% of [CompX International (NYSE: CIX), and 83% of [NL Industries (NYSE: NL)] (excluding KRO and CIX stakes), 100% of [Waste Control Specialists (Private)], [and a small stake in Titanium Metals (NYSE: TIE)].

At current market prices, the KRO stake is worth $2.15B ($2.87B x 74.9%)
CIX stake is worth $113M ($157M x 72.2%)
NL stake (excluding KRO and CIX) is worth negative $154M

($812M NL
- $861M for 30% of KRO
- $137M for 87% of CIX) * 83%

That's a total of $2.11B in public subsidiaries. So [Waste Control] and [Valhi] corporate would need to be worth $2.71B to add up to [Valhi's] market cap of $4.82B.

[Valhi] corporate is not worth much of anything, since sugar and titanium assets are offset by debt. [Waste Control] has only 144 employees and one large landfill site. [Waste Control] lists [EnergySolutions (NYSE: ES)], [U.S. Ecology], and [Perma-Fix Environmental Services] as key competitors, all of which are worth less than $500M. I don't believe it is worth anywhere near $2.71B.

Additionally, [Valhi] subsidiary pension funds are underfunded, and considering their lines of business they are likely to face more environmental lawsuits. Their subsidiaries are also highly cyclical and earnings currently seem to be on the high end of their range, making valuation suspect.

Thesis: Short VHI, long NL. NL is the real "sum of the parts" story. However, the stronger conviction part of the trade is short VHI.

Follow this!
Want to follow our weekly picks? Subscribe to our RSS feed or follow us on Twitter.