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Cashing In On Buyouts and Spinoffs

On Monday morning, the sun was shining extra bright for one Southern Californian firm. The small specialized health care business of Advanced Medical Optics (NYSE: EYE) experienced a truly perfect day. At least, its investors did.

You see, Abbott Laboratories announced that it intends to acquire AMO for $22 per share in cash. That’s about 149% above its $8.85 Friday close. It took 18 years for the S&P 500 to bring those kinds of gains. Seriously, you’d have had to invest in February 1991 to realize a 149% gain today.

Most investment advisors compare their expected returns to benchmark indexes like the S&P 500 or the Dow Jones. Even small-cap specialists compare their gains to the Russell 2000. But, why in the world would you want to wait 18 years to grow your money, when there are investments you can buy on a Friday afternoon and cash out on Monday for the same return.

So the question before us is: how can you double your money like AMO investors?

AMO is a rare case when investors oversold a company’s stock and a large competitor takes advantage. To benefit from cases like these, you need to find similar scenarios. Let’s walk through AMO’s story…

Finding a Mega Value

AMO sells vision-correction technologies and products for a wide variety of patients. For instance, no one sells more LASIK surgical devices – used in more than 90 percent of all U.S. refractive surgical procedures – than AMO. The company also holds the number two spot in the cataract surgical devices market and the number three position in the contact lens products market.

Now, without serious research there’s simply no way for me to tell you any more than that. Frankly, I don’t know much about this industry, and since the jump already occurred, I don’t need to.

But apparently, Abbott Laboratories did do that research and figured that AMO was still a buy at a 148% premium. The point is, Abbott realized how important it was to control the top spots in these fields.

Over 60% of 60+ year olds have cataracts. In the next 11 years, the number of 60+ year olds globally is expected to increase 43%. Simply put… the older you are, the more chances you’ll need AMO’s technologies. And with more older people than ever, the demand is rising. You don’t have to be an eye expert to realize what Abbott was thinking.

On top of a great looking future, AMO was also incredibly cheap just last week. Abbott is basically paying a total $2.8 billion for a company that produces $1.1 billion in revenue per year. In just two and a half years, the company’s revenue will merit the investment.

Sure, it’s not a highly profitable company yet, but it is in the black. AMO is already turning a profit, which is just another stream of income for Abbott even before synergies are realized.

Back to how this affects you…

If you know what to look for, you can be in on the next AMO. Below is a quick list of criteria to look for when searching for a buyout candidate:

• <I><B>Value</B></I> – are the company’s price-to-earnings, price-to-sales, and price-to-cash flow ratios low?
• <I><B>ROI </B></I>– has the company made smart investment decisions? Will there be a lot of useless intangible assets lying around that would disinterest a potential owner?
• Industry – is the company in a growing or contracting industry? Is it an industry that is conducive to mergers and acquisitions?
• Profit – is the company profiting already, or at least have a profitable horizon?
• Debt – is the company carrying high debt? Would a potential buyer use the debt situation to lower its buying price?
• Synergy – is the company’s business model flexible, and can a potential buyer save costs by synergizing departments?

Of course, each company is different, and each acquisition is different. It takes some serious studying to find great buyout candidates. But done right, and you can save yourself 18 years of waiting around in the stock market. If you find the right candidate, you might just multiply your money in hours, not years.

That’s not to say that buyouts are the only way to watch your money multiply…

What do frozen desserts, designer handbags, and underwear have in common? Two of the best investment opportunities this decade. Allow me to explain…

A single company – one you’re probably familiar with – sold all three seemingly unrelated products. A few years ago, Sara Lee Corp (SLE:NYSE ) – maker of frozen (yet tasty) pies and cakes – owned hundreds of brands, many of which made no sense.

For instance, the frozen cheesecake manufacturer was the sole owner of Coach handbags and Hanes underwear. These two subsidiaries obviously didn’t make much sense to the company. That’s why – during two separate transactions – Sara Lee’s management and board of directors divested them through a process known as a spinoff.

Spinoffs are common in the business world. They can present smart investors with huge opportunities and sometimes, less fortunate investors with even larger losses. Spinoffs are usually as simple as they sound – a parent company decides it can do without one of its business. So, the subsidiary is spun off onto its own.

There are four basic reasons for a parent to spinoff one of its “children”:

• Unrelated Businesses – many times, companies like Sara Lee own certain subsidiaries – like Coach and Hanes – they have no business owning. This happens often in conglomerates when a certain product takes off and is held back by the organization of the parent company.

• Tax Benefits – taxes can be burdensome and confusing. But every once in a while, the mathematicians and financial wizards find a loophole to save on taxes and preserve shareholder value. Occasionally, it takes a spinoff to do it.

• Refocusing – oftentimes, a large company will take a look at its operations and find one of its businesses lagging behind, which inevitably puts a strain on management to fix the problem. The best solution is to spinoff this business so management of the parent company can get back to growing profitable businesses. This often benefits both the parent and “child” company.

• Pinching Off Debt – some spinoffs are created to unload debt and other burdensome liabilities. This is where many unfortunate investors take enormous losses. As you can imagine, a company created out of a need to unload debt is doomed from the start.

It’s important to decipher between the four reasons because if you find the right one, you stand to make colossal gains. Let’s look back at our top example…

As we noted, Sara Lee’s situation fits the first mold – unrelated businesses. Spinning off a perfectly capable business creates earning potential neither the parent nor the “child” even realized.

Sara Lee first spun off Coach in 2000. Almost immediately, the newly formed Coach Inc (COH:NYSE ) began its own marketing program. This turned into an enormous success and unrealized profit potential came to light, which shot shares straight up over the next six years. Coach outperformed its former parent by more than 2,000% to negative 15%.

The same thing happen in round two, when Sara Lee spun off Hanesbrand Inc (HBI:NYSE ) in 2006. Although the gains were not as fantastic, Hanes shareholders watch their shares double as Sara Lee shares stayed flat:

Of course, not all spinoffs work this way. It takes serious studying and an ear to the ground to find out exactly what’s going on.

Many times, when parents spinoff businesses, they keep it quiet. If the media gets a hold of it, shares can crash artificially, or spike prematurely. And, as we mentioned, many spinoffs negatively affect shareholders.

One recent example is InterActiveCorp’s (IACI:NASDAQ ) spinoff of Ticketmaster Entertainment Inc (TKTM:NASDAQ ) . When Ticketmaster was sent on its way, InterActiveCorp left it with a parting gift of about $750 million in debt, just as the credit crisis began to peak this summer. Shares of Ticketmaster, inevitably collapsed under this weight, falling more than 80 %:

Of course, you have to use your best judgment when you discover a spinoff. You’ll have to make the decision on why you think the parent company spun it off.

More than not, however, buying spinoffs when they’re fresh is a pretty good idea. According to Chris Mayer of Mayer’s Special Situations – a newsletter focused on spinoffs and other unique investments – “spinoffs beat their industry peers and outperformed the S&P 500 Index by about 10% per year in their first three years of existence.”

Those numbers account for both spin offs that lead to gains and those that lead to losses. Obviously, this is something to look into.

If you are lucky enough, and have the right inside knowledge, you can easily take advantage of the next Coach spinoff and leave the next Ticketmaster alone.

Sincerely,
Jim Nelson

About the Author

Jim Nelson is the managing editor of Penny Sleuth which offers unbiased commentary from expert analysts and authors about penny stocks .

3/31/10: White House Press Briefing