A Different Spin
Brett Nelson, Forbes Magazine, 01.07.02

Some companies are buying back shares of publicly traded subsidiaries on the cheap. Get there before they do.

Telecom gear maker MRV Communications sold shares in its fiber-optic unit, Luminent, when fiber was humming. In November 2000 it raised $144 million for Luminent by selling an 8% stake in the subsidiary at $12 a share. Fiber is out of style on Wall Street now and Luminent trades at $2.10. So MRV is buying in the minority stake, offering 0.43 of its shares for each Luminent share. Once MRV owns all of Luminent, it will get its hands on the subsidiary's $94 million in cash.

That's a great trade for the parent, says Joseph Cornell, who publishes Spin-Off Research from Chicago: Sell high, buy low. But it can be a great deal for investors, too, if they get in on the discounted sub before the parent makes an offer.

When Nasdaq was hot, lots of companies offered minority stakes in subsidiaries to the public. Sometimes it was just a way of raising a bit of cash without losing control of the unit. Often the move was intended to glamorize the parent and improve its own share price.

Deals are being reversed now. If you can anticipate them, you can often make a tidy profit. MRV's offer was at a mere 5% premium, figured from the preannouncement prices of MRV and Luminent. (The announcement was made Sept. 13, during the post-terror market closing and two days after MRV's chief financial officer, Edmund Glazer, was killed on one of the hijacked planes.)

Other parents are more generous: In October Tyco said it would pay a 52% premium for the 11% stake in its undersea cable unit, Tycom, that had been sold to the public. A week later Toronto-Dominion Bank offered to buy back the remaining 12% of its online broker TD Waterhouse at a 45% premium. In November Kansas City's Utilicorp said it would pay a 15% premium to reclaim the 20% of its trading arm, Aquila, which it had sold only seven months prior.

To make decent money from these buy-ins you have to get the subsidiary's shares before any announcement. After the buy-in plan is public, Wall Street doesn't leave much money on the table.

Strictly speaking, a spinoff is the gratis distribution of all the shares in a subsidiary to shareholders of the parent. Speaking loosely, investors use the term to describe public offerings (for cash) of the sub's shares, and they call the reverse transaction a spin-in. Cornell sees a host of potential spin-ins on the horizon that investors can make money on.

Since most spin-ins are paid for with the parent's stock, it's a good idea to short shares in the parent at the same time you buy shares in the sub. That way you are just betting on a narrowing of the spread between the parent and the sub; you can then be indifferent to fluctuations in the parent's share price.

One of Cornell's buy recommendations is on the Orient Express subsidiary of Bermuda-based cargo concern Sea Containers. Orient owns two dozen luxury hotels across the globe and runs ferries in the English Channel and high-speed trains from London to Scotland. In August 2000 Sea Containers floated 35% of Orient at $19 a share. With the collapse in travel after Sept. 11 it's no surprise that the hotel shares are now at $15. But they are worth more. Cornell figures that if Orient were liquidated, it would bring $22 a share.

Cornell looks for publicly traded subsidiaries that are trading at fat discounts to their offering prices and have discernible value, in cash, shareholders' equity or growth potential.

Another stock he likes is Ulticom, which sells switching software to Ericsson, Siemens and Comverse Technology. Comverse owns 75% of Ulticom, which it carved out in April 2000. The Ulticom shares are off 23% from their initial offering price, to a recent $10. Cornell speculates that Comverse might pay $14 per Ulticom share in cash or Comverse stock to get the minority 25% stake back under its own roof.