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Crashing Stock Markets Can Provide Opportunity For Longer Term Gains. But Do You Have The Stomach For It?
Sir John Templeton was a twentieth century American-born British investor, banker and fund manager. He entered the mutual fund market and created the Templeton Growth Fund, which averaged growth over 15 percent per year for 38 years. He once said, “To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude.” Warren Buffett also once said that it is wise for investors to be “fearful when others are greedy, and greedy when others are fearful.”
Easier said than done, I hear you say. How do you keep your head around you when everyone is losing theirs? Thinking contrarian has always been a great strategy and one which I have employed extensively over the years. Naturally, to be honest. Thinking differently to the crowd requires patience, discipline, and very little emotion. These are traits that sometimes have to be wired (or indeed forced) into your brain. Especially when you are losing money. Considering every asset class is down, it will pay to be less emotional, have endless patience and more discipline than ever. Testing times with investing. For all of us. Including myself. But I’ve been here before.
Spinoffs are meant to unlock unrecognized value, but a plan by Kellogg Co. might be taking that strategy to new levels. Kellogg’s core business — or what’s left of it after a pair of spinoffs announced on Tuesday — could be worth more than the current value of the combined entity, according to a research firm that specializes in such transactions. The separation plan is just the latest example of large conglomerates addressing the pain of slower growth and higher interest rates that have weighed on stocks all year.
The company’s global snacking business could earn a higher valuation that’s closer to peer Mondelez International Inc. after separating from Kellogg’s North American cereal and plant-based foods units, analysts at The Edge Consulting Group wrote in a note on Tuesday. Based on Mondelez’s valuation of 3.5x enterprise value on its 2021 sales, the remaining snacks business would be worth about $40 billion — at least $10 billion above current levels. “That is a tremendous value unlock for the RemainCo, with the other two businesses literally to be received for free,” according to the note. Others on Wall Street were also positive about the company’s outlook after the announcement.
Investment bankers bemoaning the dearth of large stock offerings this year can take comfort from one relatively robust area of the market: the spinoff of units by larger companies. Tax-free spinoffs are outperforming other newly listed stocks, as well as the broader market, during this year’s volatility. That’s partly due to a lack of selling pressure from retail investors who’ve unloaded other new stocks en masse.
Spinoffs that bypassed an initial public offering were largely overlooked by the hoards of new traders who emerged during the pandemic, said Jim Osman, founder of The Edge Consulting Group, a research firm that specializes in spinoffs. They preferred the fast-growing tech companies, IPOs or the infamous meme stocks — all shares they are now dumping.
Many years ago in London, when store sales were limited to a time period just after the Christmas holiday, the waiting and anticipation game in the run up to these events was exciting. Knowing that those luxury, high-end brands you had been lusting after all year were about to become affordable at 30 to 50 percent cheaper was as good, if not better than Christmas Eve. The catch? You would have a limited time to get them (so you had to make sure what you wanted beforehand) and you had better be first in line otherwise they would be gone before you could take advantage of the sale. That’s if you made it through the scuffles on the door of course. One year, I distinctly remember finding out about the Burberry sale. I desperately wanted to get the industry standard beige colored trench coat. For years actually. I lined up for hours, bored senseless, cold, but also, at the same time, filled with excitement. I eventually got one at a great discount, which I still own to this day. Incidentally it’s one of my better apparel investments and served me through many rainy days.
I’ve been in the financial industry for over 30 years and have seen great times as well as times I’d like to curl up and die when I looked at my returns in the short-term. The hardest part of investing are drawdowns, but even great companies experience them and expecting this should be paramount for investors every once in a while. What’s important is how you manage them in your portfolio. It’s been a rough start to the year as an equity investor. The previous years have been somewhat, let’s say, “easy,” but in my experience, capital preservation and accumulating the right investments in these times are the key to real future wealth creation.
For the past two years, amid a raging bull market, it’s been a smooth ride for stock pickers like Jim Osman. “You just throw a dart at the wall when something goes up and you go, ‘look at me. I’m the greatest’,” said Osman, the founder of The Edge Group, a firm that provides investing recommendations to top money managers and individual investors. It’s a trickier environment this year with the S&P 500 down around 13% year-to-date and some individual names taking an even bigger hit. Popular stocks from the last two years like Netflix (NFLX) and Zoom (ZM) are down 66% and 37% respectively.
Osman admits he’s “one of the losers” who likes this type of environment. “In a falling market, you’re going to see real stock pickers and real people who are going to be smart about making returns on the way down,” Osman said. “There’s a real opportunity to make substantial gains,” he added. “If people can disconnect from the market and macro views and look towards individual stocks, and also refrain from using leverage and keep a bit of cash on the side for these really ugly days then I think you’ve got a great opportunity for the next few years in really get some good companies at some cheap prices,” Osman said.
Here he shares some of the stocks he sees as opportunities in the spinoffs sector.
Bill Ackman’s SPAC has just 6 weeks to find a target — or he’ll have to return $4 billion to investors
Billionaire investor Bill Ackman is running out of time to find a target for his $4 billion special purpose acquisition company. Pershing Square Tontine Holdings needs to identify a company to acquire within the next six weeks, or Ackman will have to return all its cash to his investors. Ackman has subsequently urged the SEC to extend its deadline, but it’s looking increasingly likely that he’ll have to return $4 billion worth of cash to PSTH’s initial investors.
“Unless Ackman comes up with some magic in an extremely volatile and uncertain market, he will be returning the $4 billion,” Jim Osman, founder of the Edge Consulting Group, told Insider. “Bill and Pershing face an uphill battle,” Edge Consulting’s Osman added. “Selling SPACs to investors is now virtually impossible.”
Global deal making may have fallen out of fashion, but breaking companies up never seems to go out of style. Companies including Intel (INTC), XPO Logistics (XPO), Aramark (ARMK), and Fortune Brands Home & Security (FBHS) have announced plans to spin off major divisions in recent weeks, in a bet that it will reverse a decline in share prices and boost shareholder returns. Others, such as Western Digital WDC –4.14% (WDC), have come under pressure from activist investors to hive off a business to exploit its potential value as a separately traded company. Nearly 60 global corporate spinoff deals were completed in 2021, more than the 42 in 2020, according to data from Dealogic, and at least seven more have been announced so far this year.
“Investors should watch particularly how movements of cash and debt in spinoff transactions affect the balance sheets of the two companies post-spin,” Jim Osman, founder of research firm Edge Consulting Group.
In December 2020, Encompass Health (EHC) announced it was exploring strategic alternatives for its home health and hospice business with the alternatives including a spinoff, sale, merger, or IPO, among others. A year later, Encompass announced in December 2021 it will perform a tax-free spinoff of the Home Health & Hospice Business, to be rebranded as Enhabit, Inc. (EHAB).
Enhabit — the spinoff company — is a high quality business. We believe that Enhabit should trade at a premium to its peers Pennant Group (PNTG), LHC Group (LHCG), and Amedisys (AMED), owing to its higher operating margin of around 19% compared to the peer average of around 10.3%. Post-spinoff, Encompass Health — the parent company — will be the market-leading inpatient rehab franchise (IRF). Due to the non-discretionary nature of several conditions treated in IRFs, EHC’s admission trends tend to be more stable than other sub-sectors of healthcare services, providing valuable revenue visibility and positive free cash flow assurance.
If we maintain our assumption of a 1:1 distribution ratio and assume a debt distribution ratio equal to the respective businesses’ EBITDA contributions, we believe Enhabit, the spinoff, will have a market cap of $1.2 billion. We anticipate potential upside for the combined pre-spin company, EHC, of 27% as a base case, and 52% in a more bullish scenario.
The combined Warner Bros. Discovery company has now become the third largest streaming media powerhouse behind Netflix (NFLX) and Disney (DIS). We have now seen insider buying in this situation. Immediately following WBD’s first earnings release on April 26, eight different insiders went into their own pockets and bought shares of WBD at an average of $18.90.
This new catalyst of classic value buying from insiders has prompted us to re-enter and the stock on the long-term synergies and benefits of the merger. Investors are suggested to take a re-look at current levels as well. Associated with John Malone, Robert Bennett (Director) has a history of making good buys, including buying HP, Inc. (HPQ) in May 2020 (making a +148% return to date vs. the S&P 500 Index’s +38%) and Liberty Media Formula One Series A (FWONA) in December 2008 (making a return to date of +1,480%).
CEO David Zaslav holds a targeted compensation of $246.6 million over the next 6 years (through December 2027), with the first tranche being exercisable once it hits $35.65 a share. We see potential upside of 27% as a base case, and a bullish forecast for a 44% gain.
As most investors are aware, AT&T (T) has just undergone a significant change. The telecom firm combined its WarnerMedia with Discovery operations to create a new global entertainment company called Warner Bros. Discovery, Inc. (WBD). Three leading advisors, all contributors to MoneyShow.com, look at the spinoff and suggest what both growth and income investors should do with these new “separate” entities.
From Jim Osman’s commentary: “There have been nine Reverse Morris Trust (RMT) transactions over the past five years (2017-22), with a total of 18 companies resulting from these separations. Of those 18 companies, 11 were S&P 500 Index names, and examining their performance against the S&P 500 Index shows that the opportunities to gain outperformance to the Index typically fall within the first month, though that outperformance is a very slim 0.7% above the S&P 500 Index. More importantly, investors made money on eight of the 11 names by the one-year mark with an average return of 18% (which jumps to a 33% total average return if the three companies that lost money are removed), indicating that while S&P 500 RMTs do not necessarily outperform the Index by the one-year mark, investors can still expect these transactions to result in positive returns around 72% of the time.”