Introduction
My name is Stephane Manos and I run the Special-Situations Department at Valsef Capital. I invest in event driven investments, primarily spinoffs. Most of my investments are time specific. There is something happening in the next 6-18 months in a companys’ timeline and I follow these events closely as things change.
Since I was in my teens, I have always followed the stock market and have been a do-it- yourself investor for the longest time. I began investing full time over 2 years ago and decided to focus on this special part of the market that generally outperforms the market.
I am also a contributor on the richest : http://www.therichest.com/celebnetworth/celebrity-business/men/stephane-manos-net-worth.In January 2013, STARZ was spun off from Liberty Media Corporation and began trading at 14$. STARZ closed the year at 30$, generating a return of over 100% in less than 1 year. Many similar opportunities exist in the investment world of spinoffs.
What is a spinoff
A “Parent” company spins off a division into its own standalone company. This “division” is usually a “bad” asset, dragging down the performance of the parent. Sometimes, management spins off a jewel of a business, that is not being recognized in a huge organization. Companies opt for spinoffs instead of a division sale because it allows them to “get rid” of the unit tax free for themselves and their shareholders.
Performance of Spinoffs
Historically, spinoffs outperform the S&P500 by 22% in the first year. From 2000 to 2010, a study performed by TheSpinoffReport and Deloitte concluded that spinoffs returned 23% on average. It is also important to note, that 1 out of 3 parent companies and/or spinoffs end up being acquired 2 years after the spinoff happens. In the second year, spinoffs also return another 15%. It is important to note that lots of volatility occurs in the first 3-6 months, as the spun off company seeks for a new investor base.
Why do opportunities exist in spinoffs
There are many reasons why spinoffs have outperformed the market and continue to outperform the market. I will outline the main reasons why my company and I believe a market inefficiency exists when it comes to spinoffs.
1) You receive the child, whether you like it or not
Let us look at the dynamics of how a spinoff comes to life. When a division gets spun off from its parent, shares of this company are given to the parent shareholders. The parent shareholders do not choose to buy the spinoff, they receive it tax free. Put yourself in the mindset of a financial advisor/planner that has an income portfolio for his clients. He receives a small amount of shares of a small/mid cap stock which he has no idea what they do and how this company is positioned to its peers. The industry is usually something he/she is not familiar with. If a client asks him about this company, most likely he will not be able to answer because chances are there is little to no research available as spinoffs have no investor base. In addition, most institutional investors are not allowed to own spinoffs. Reasons are they are usually not part of any indexes, they are underfollowed, they are not on the investment companies white list of investments and sometimes the spinoff just does not fit the initial investment criteria of the client (dividend generating for example). Institutional investors need to explain to their clients why they decide to invest in a spinoff and with very limited data available, it is usually easier to sell the spinoff once they receive the shares. The financial advisor is well versed in the parent company and it will make sense to buy more of it as he likes this stock and chances are, his client also likes it.
What I have just described is the uneconomic selling between an unsuspecting seller, and a buyer looking to buy a well priced company which he has studied , he understands and that he CHOOSES to buy. This is almost unfair.
2) Insiders want them
Managers who choose to use a spinoff mechanism are already better than most managers out there simply because they chose to use a value creating event which is the spinoff. These managers care for value creation and care for their shareholders in general. If you follow the story and read the Form 10 which accompanies most spinoffs (this is a document that comes out and shows how the company would have performed pro forma had it been independant), you will be able to see what % the insiders own of the new created company. It is important to also read the form 3s and 4s once the spinoffs occurs to see if the board has given any options to management. High insider ownership of the spin off company and nice options usually means there is a big motive for the new company to perform well. In addition, something most analysts forget is the new opportunity these new CEOs are getting to run their own companies. These ex-division leaders are now getting their own company, their own capital allocation strategy , their own business strategy and their own team. It is very exciting times in the new spinoff company and in the lives of the new management. Better than expected results usually occur than the ones projected in the form 10 and new growth rates and new earnings ratios occur.
3) Lack of information makes investment very difficult
In most of the spin off studies, it takes about 6 months before the spinoff starts outperforming the indexes. Before this, there is usually lots of volatility in the new share price. There is no steady investor base and analyst and investor are still only speculating on how the company will perform as no history exist. After 6 months, new management will report earnings, outline their plan and the street will gain confidence in the new management. This is why we believe spinoff opportunities will always exist. It is almost impossible for analysts and investors to make an investment decision based on limited information provided before the spinoff. No one can feel comfortable making an investment with such a lack of information. Hence most investors need to make an educated bet based on the information they have and how they think the situation will unfold. After a few months, the company will start getting covered by some analysts and price targets will be given to highlight the company. Potential analyst coverage is a huge catalyst. Analysts and financial advisors wait for the spinoff to report earnings in order to invest confidently behind it, as it was earlier impossible due to the lack of information. When I choose a spinoff, I make sure I choose a company where analysts will start covering it. It is important to pick a company that is not to small or niche that it will not attract analysts and hence generate a buzz. If you pick a small company with 50 M Mkt Cap, it will most likely never get covered by any of the major research houses.
Coming back to the Starz investment. Starz came out at 14$ and initially looked unattractive and “ugly”. It was difficult to own it. Starz is a premium cable channel, similar to HBO and Showtime. Subscribers pay a monthly fee to their cable operator and get access to a huge library of movies and some original series. The market cap was very small compared to LMCA (~15 B for LMCA vs 1.5 B for STARZ or roughly 10%). It had also just lost a renewal deal for DISNEY movies to NETFLIX and they were not sure they would renew a big SONY movie deal. By doing some research in the form 10, it was clear to see that insiders were highly aligned to make the new STARZ succeed. Both the chairman and the founder had a significant part of their net worth tied to STARZ. The CEO also had exceptional experience, and actually ran HBO in their heyday of the SOPRANOS, Sex and the city and Entourage. He received options valued at 12.50$ days after STARZ was spun off. It was in everybody’s favor to see STARZ succeed. 2 weeks after the spin, STARZ announced they had just signed a long term deal with SONY, securing their future. A few months later, buyout rumors began circulating and the stock re-valued to closer valuations to its peers.
Starz is still a big position for our special situations department as we still believe it to be undervalued. They are growing their subscriber base, they still have not had a major hit yet (think games of thrones, mad men or breaking bad), they have not entered into any digital deal, they are continuing to buy back their shares and most importantly we believe that we are entering a golden age of content. Watching video content has become easier to do in the past 2 years as you can watch your content anywhere, whenever you want. This has created a huge new demand for video content and a low supply of content. Starz is there to take advantage of this and is riding a big tailwind.
NB:
– Form 10 exist for US stocks only
– Starz actually ended up being the parent in this deal and LMCA was spun out.