This Breakup Could Unlock $105 Billion in Value

By Nick Rokke, analyst,  The Palm Beach Daily


Last week, industrial giant United Technologies (UTX) announced that it’s splitting into three companies. That would make it one of the largest corporate breakups ever…

United Technologies is a $105 billion multinational behemoth. The company makes everything from aircraft engines to elevators and even HVAC systems. It’s also one of the largest defense contractors in the United States.

For more than a century, United Technologies has been a stalwart of U.S. industry. Today, it’s one of the last true corporate conglomerates.

You see, in the 1970s and ’80s, it was fashionable for big companies to buy unrelated businesses… and then house them under the same corporate umbrella.

Back then, management thought conglomeration would diversify earnings. If one business had a downturn, the others would pick up the slack.

However, large conglomerates are no longer in vogue.


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Today, investors like specialized businesses that are nimble and can grow quickly. That’s why large conglomerates are breaking up and spinning off into smaller companies.

For example:

  • In 2016, cloud computing company Citrix Systems spun off its GoToMeeting online video conferencing service.
  • Also in 2016, Yum! Brands—parent company of KFC, Pizza Hut, and Taco Bell—spun off its faster-growing Chinese division.
  • And in 2017, Hilton Hotels & Resorts spun off two units: Park Hotels & Resorts and Hilton Grand Vacations, a new timeshare division.

Here at the Daily, we like to find under-the-radar ways to make money in the markets. And buying companies before they break up is one tried-and-true way to do that.


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Breakups Unlock Value

There are a number of reasons why conglomerates break up. For example, they may spin off a division if it starts to make up a huge part of the overall company.

That’s what happened in 2015, when online auction company eBay spun off its fast-growing PayPal division. Today, PayPal is a $100 billion business—four times larger than eBay…

That spin-off created massive value for shareholders… After falling in price immediately after the September 2014 spin-off announcement, eBay rose 40% during the nine months leading up to the spin-off. And PayPal has risen 136% since July 2015.

Another reason for breakups is when companies have too many unrelated business units. That’s the case with United Technologies, which has three major divisions:

  • United Technologies (defense and aerospace division)
  • Otis Elevator (elevator and escalator maker)
  • Carrier Corporation (maker of heating, ventilating, and air-conditioning systems)

These three businesses have nothing to do with each other… And by having all of them under one roof, investors find it hard to value each one individually. So they end up valuing each company less than its peers.

The enterprise value-to-earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) ratio is a common measure of valuing companies. Private equity firms use the ratio to determine the profitability of firms they may want to take private.

As you can see, United Technologies is undervalued based on that ratio compared to its peers… It’s 20% cheaper than Ingersoll Rand, and over 50% cheaper than Schindler and TransDigm.

Company

Ticker

EV/EBITDA

United Technologies

UTX

11.4

Ingersoll Rand

IR

13.7

Schindler Holding

Foreign

17.4

TransDigm Group

TDG

17.5

United Technologies hopes that after the breakup, investors will value each of its business units higher. That would increase the stock prices of the three new companies… and make the combined value of the new parts greater than the former whole.


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Corporate Breakups Are Profitable

According to a 2015 study by Purdue University, if you invested in every breakup and spin-off soon after being announced, you’d beat the market.

In the first 22 months following a spin-off, the parent company returns 0.85% per month, while the spin-off returns 1.26% per month. Both beat the average return of the market—just 0.72% per month.

Now, you could buy each breakup individually… (United Technologies looks attractive to me.)

But a simpler way to play breakups is through the Invesco S&P Spin-Off ETF (CSD). This fund will buy every U.S. corporate spin-off for you.

And true to the research, over its lifetime, CSD is beating the SPDR S&P 500 ETF (SPY):

Historically, spin-offs have beaten the market. And although past performance is no guarantee of future returns, I’d be willing to bet that spin-offs will continue to outperform the market going forward.

 

 

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