3 Real-World Case Studies: How Spinoffs Unlock Shareholder Value

Investors sometimes face the peculiar scenario of one of their holdings spinning off selected assets as a new, publicly-traded security.

Often, there is uncertainty surrounding these new estimates. Since markets hate uncertainty, one might expect that spinoffs underperform the market…

This is not the case.

There is a statistically significant body of research to support the belief that spinoffs outperform the market.

Managers that with strong capital allocation skills have recognized that mispriced assets can often appreciate in value when trading as independent entities, and have acted accordingly.

This article will analyze three notable dividend stock spinoffs within the past decade that have successfully unlocked shareholder value:

Each is analyzed in detail below.

Philip Morris International Inc. (PM)

Philip Morris International and the Altria Group are two of the world’s largest cigarette companies with market capitalizations of $164 billion and $138 billion, respectively.

Philip Morris International was a wholly-owned subsidiary of the Altria Group until the company was spun-off in a special one-for-one stock dividend on March 28, 2008. The following diagram shows the appreciation of both stock prices since then.

(Click on image to enlarge)

Altria and Philip Morris International Stock Price History

Source: Yahoo! Finance

The PM spinoff was an example of the superb capital allocation skills of Altria management. For every one share of Altria held before the spinoff (which was worth $73.83 on its last day of trading), an investor would now hold:

  • One share of Altria trading at $71.47
  • One share of Philip Morris International trading at $109.62
  • $15.96 of cash dividends from Altria
  • $28.94 of cash dividend from Philip Morris International

For a total value of $225.99, or cumulative total returns of ~206% since the spinoff in 2008. F

or context, this represents an annualized rate of return of ~13% per year. These total returns would have been even higher if dividends were reinvested to purchase more MO and PM along the way.

Almost a decade after the spinoff, Philip Morris International continues to be a highly profitable business.

Philip Morris saw constant-currency adjusted diluted earnings-per-share increase by an impressive 11.8% in 2016.

(Click on image to enlarge)

PM 2016 Strong Financial Results ex-Currency

Source: Philip Morris International 2017 CAGNY Presentation, slide 7

The company also continues to generate substantial free cash flow.

In fiscal 2016, Philip Morris’ free cash flow was negatively impacted by the strong U.S. dollar but still remained constant compared to the year prior. Excluding currency, free cash flow actually increased by 4.9%.

(Click on image to enlarge)

PM 2016 Free Cash Flow in Line With Prior Year

Source: Philip Morris International 2017 CAGNY Presentation, slide 8

Philip Morris uses this free cash flow in the best interest of its shareholders. The tobacco giant has increased its annual dividend payments every year since the spinoff from Altria. Rising dividend payments are a key sign of a shareholder-friendly stock.

One might think that Philip Morris International is also an active repurchaser of shares, given that their dividend history suggests they put their shareholders’ interest first.

However, Philip Morris has not repurchased shares since its $18 billion share repurchase plan that concluded in 2014.

This is because the stock is trading at a premium valuation right now, and repurchasing shares would actually destroy shareholder value.

Looking ahead, Philip Morris’ growth will be largely driven by its portfolio of reduced-risk products (RRPs), which are key to growing sales in a world where consumers are increasingly aware of the negative health effects of cigarette smoke.

Philip Morris is a leader in the RRP industry. The company’s product offering is depicted below.

(Click on image to enlarge)

PM RRPs - Our Product Platform

Source: Philip Morris International 2017 CAGNY Presentation, slide 17

The market leadership of Philip Morris International in the RRP industry is driven by the company’s active research in this segment.

The company has built an impressive RRP intellectual property portfolio and has been filing an increasing number of RRP patents in each of the past three years.

These patents are long-lived, with the majority expiring post-2030. This reduces competitor risk for Philip Morris’ RRP products.

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