As firms break apart their entities on the idea that the sum of
individual parts will be worth more than the whole, some hedge
 funds are getting involved as arbitrage players

SPINOFFS OFFERING NEW INVESTMENT OPTIONS

By Janet Kidd Stewart

TRIBUNE STAFF' WRITER

 Critics of conglomerates beat the presidential candidates to the notion of fuzzy math.

          For years now they have argued that far-flung corpora­tions dilute their value to shareholders by pursuing complicated strategies in several industries, at least one of which is usually in trouble.

          To the critics, when it comes to merger strategy adding two and two often gets shareholders substantially less than four.

          Buried in those calculations is a market for another hedge fund, according to Chicago research and fund firm Spin-Off Advisors LLC.

          Here's how Spin-Off Presi­dent Joe Cornell does the math: He figures the popularity of corporate spinoffs provide lucra­tive fodder for a hedge fund in­vesting in such deals.

          There seem to be plenty of boths--pinoffs and funds.

          Assets in hedge funds--investment vehicles used by wealthy individuals that give managers far more latitude than traditional mutual funds--have ballooned past $400 billion this year, with more than $60 billion In new capital flowing in from 1994 through the first half, according to Tass Investment Research.

          And 90 corporate spinoffs have been announced so far this year, lip from 71 last year, according to Cornell, as companies try to sharpen their operational focus and capitalize on trends in particular industries. That's the opposite of the strate­gy of the 1970s, when the push was to amass far-flung operations into conglomerates.

          Mergers are still de rigueur, but they usually involve compa­nies strengthening their core holdings rather than diversifying.  Hence today’s opinion that adding new lines dilutes the power of the core business, but spinning off one benefits both.

          "It’s been a record year for spinoffs, both in quantity and in the dollar volumes involved," Cornell said.

          Put that together with record growth in hedge funds, and you have the Spin Off Fund, a tiny year-old player in the hedge fund universe, but one that is capitalizing on an interesting--and accelerating phenomenon in the corporate world. Many hedge funds use merger arbitrage strategies in their investing mix, but Cornell be­lieves he is the first to focus ex­clusively on spinoffs.

       The fund was up 6.08 percent through the third quarter, Cor­nell said, a respectable gain during a volatile period. The fund has only a handful of investors; its advisory research, which it sells to other hedge funds, is its bread and butter.

   As with other funds, the Spin­Off Fund is an investment part­nership for sophisticated inves­tors who give their fund manag­ers wide discretion to use complex trading techniques.

   Minimum investments in the funds have been coming down, however.  Where they used to re­quire several million dollars as an initial investment, the rising number of hedge funds means more investors are getting in, at times with minimum invest­ments of as little as $100,000.

   And the number of hedge funds has been growing, so that trend is accelerating, said Jo­nathan Bloom, a principal with Banc of America Securities in Chicago, which handles back-office and other functions for hedge fund clients.

   "Hedge funds are becoming more accepted and known by investors. The press reports, good and bad, have made people more familiar with them," Bloom said.

     Those "bad" reports chroni­cled the spectacular 1998 fall of Long-Term Capital Manage­ment, which led other specula­tive funds out of the business as well.

          And despite the industry's maintained position that it acts as a buffer--or hedge-against market volatility U.S. hedge funds under performed the Dow Jones industrial average and the Standard & Poor's 500 index last month, one survey found.

          The average U.S. hedge fund lost 1.5 percent in October as short sellers took control, ac­cording to Van Hedge Fund Advisors International of Nash­ville.

          So where do spinoffs fit in the hedge fund world?

          Record merger activity in recent years will provide continual fodder for more corporate spinoffs as corporations streamline their operations, Cornell said.

          "This whole pure-play trend is here to stay" he said. "It's a process that feeds itself: A re­cord year for mergers will lead to a record year for spinoffs."

          And the trend is in its infancy abroad, Cornell said, where many more future mergers and spinoffs await shareholders.

            Initially shares of spinoffs often decline, he said. With ever increasing amounts of money invested in index funds, it is dif­ficult for a spunoff unit of, say, a giant automaker to weather downward pressure when fund managers sell its shares be­cause it doesn't meet the fund's market capitalization require­ments.

          That selling creates a buying opportunity and a potential ar­bitrage scenario for investors like Cornell, who initially buy the parent organization and short the spinoff to capitalize on spinoffs' tendency to fall.

          Later, the hedge fund takes a longer position in the spinoff, because once it finds its legs and a more entrepreneurial, fo­cused management team is in charge, the combined value of the now-separate firms is often higher than if the company had remained a single unit, he said.

          "Spinoffs often result in a higher aggregate value for the constituent pieces," Cornell wrote in a recent essay on the topic. "Because they are new and often unfamiliar corporate names with no independent history sparse sponsorship from brokers and the media initially generates little enthusiasm. Therein lies the value."

          The idea that the parts are worth more than the whole is just what officials at FMC Corp. have in mind with the Chicago-based company's decision to split its businesses into two publicly traded companies.

          Since announcing Oct. 31 it will distribute the shares of FMC's machinery business to shareholders in 2001, shares of FMC have stayed above $70, af­ter trading below $50 in March. The day of the announcement, shares surged nearly $5 to $76.

          That's just one opportunity

          Cornell's firm keeps a watch list of other potential spinoffs. Among them: Best Buy's ecommerce subsidiary; eToys' European unit; British Telecom­munications' Internet busi­ness; DuPont's Life Sciences unit; Hilton Group PLC's gam­bling operations; Litton Indus­tries' electronics division; Om­nicom Group's Career Mosaic subsidiary; Targeted Genetics' cell therapy division, and a lit­tle Northfield-based unit of Phi­lip Morris called Kraft.

          Look for tax-free spinoffs at companies looking to break themselves into more nimble, manageable--and understandable to investors--organizations, he suggests.