Spinoffs can be a fertile place for investment ideas. The idea is simple. A stock's price, usually, is an unbiased representation of all expected future cash flows of a company from now till judgment day. Understandably, information and transparency drive this estimate of value.
Charlie Munger amusingly stated that stocks are "valued partly like bonds, based on roughly rational projections of use value in producing future cash. But they are also valued partly like Rembrandt paintings." Well said. Don't pay the Rembrandt premium.
Spinoffs are situations where there is often new information, factors not related to economics (e.g., forced selling by institutions due to lack of index membership of the spun-off company), periods of uncertainty regarding the new spun-off company, and an opaque picture of the recent past--often a guide for forecasting. This implies the market is less efficient; that is, there's a greater liklihood the market's estimate of the company's value deviates from its intrinsic value.
Faro is always on the hunt for these types of investments. In November, Morgan Stanley spun-off its MSCI subsidiary, a purveyor of investment indices and risk and return porfolio analytics. Since November, the stock is up 74% (usually spinoffs go down following initial independence). Why is this up so much and is it still a buy? Revenues grew 19% year-over-year while costs grew less rapidly. Below is a snapshot of the firm.
This is largely an emerging market play to be highlighted more in detail in next week's post. Stay tuned, this could be the 7th best investment you've ever made.
Quick Overview
Pricing power: average
Oligopoly: yes
Recurring revenue: yes
Brand strength: strong
ROIC > Cost of capital: yes
Balance sheet: average
Valuation (buy/sell): TBD
Disclosure: I don't knit.
Image: http://www.icelandicsheep.com/Made-with-TRF-wool-photos/Spin-off.jpg
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