The spinoff yesterday of the tobacco division of RJR Nabisco Holdings Corp. as a separate company was a mind-boggling maneuver that, in the end, could prove valuable to shareholders old and new. The deal also provided further evidence that pulling companies apart can be at least as interesting as putting them together.
Concerned about the legal risks in its cigarette business, the management of RJR Nabisco Holdings changed its name to Nabisco Group Holdings Corp. (NGH) and spun off the tobacco portion of the company as a separate business called R.J. Reynolds Tobacco Holdings Inc. (RJR).
The principal asset of Nabisco Group Holdings is an 80.5 percent interest in a third company called Nabisco Holdings Corp. (NA), which owns the snack part of the business, including such brands as Planters nuts, Life Savers, Oreo cookies and Ritz crackers. Nabisco Holdings was spun off back in 1995. Got it?
Joe Cornell does. He runs a firm called Spin-Off Advisors LLC in Chicago that follows such intricate moves. He has figured out that the tobacco part will sport a dividend yield of close to 10 percent.
Cornell likes tobacco best of the three pieces -- and not only because of that dividend. "On a fundamental basis," he said, "it looks pretty cheap." Its price is only about five times its cash earnings -- less than one-fourth the valuation of the average company.
Of course, there's that pesky liability hanging out there for making people sick and dead from smoking. But Cornell believes it's been priced into the stock.
If you're squeamish about tobacco, there are lots of other spinoffs to consider. In fact, spinoffs are becoming the most fascinating game in investing.
Take Limited Inc. (LTD), the specialty retailer that operates more than 3,000 stores under the names Lane Bryant, Henri Bendel, Express, the Limited and more. Chairman Leslie H. Wexner spun off Intimate Brands Inc. (IBI), which runs Victoria's Secret and Bath and Body Works stores, as a separate company, but Limited retained an 83 percent interest.
Since Intimate stock has soared 59 percent this year, Limited's stake has become very valuable -- and so, as a result, has Limited's own stock. Let's do the math: Since Intimate has a market capitalization (that is, number of shares outstanding times price per share) of $11 billion, Limited's interest is worth about $9 billion. But Limited's own market cap is only $10 billion.
In other words, if you buy Limited you are getting thousands of Limited, Lane Bryant, etc., stores for less than a billion bucks.
It gets better: Limited is planning in the next few months to spin off Limited Too, a chain of 321 stores targeted at 10- and 11-year-old girls. The value of Limited Too, according to Cornell, is about $3 per Limited share, or $1.5 billion. In other words, Limited's own holdings after this transaction (and another smaller one) could be valued at less than zero -- pretty low for a firm that's profitable and has great brand names. It's no surprise, then, that Cornell thinks Limited stock is a buy.
But tobacco, cookies and frilly underpants are not driving the spinoff boom. The Internet is. Established firms are spinning off the Net parts of their businesses in an attempt to cash in on the craze for high-technology stocks. But, surprisingly, many of these spinoffs aren't working out as well as hoped. On May 25, for example, Barnes & Noble Inc. (BKS) spun off Barnesandnoble.com Inc. (BNBN) to the public at $18 a share; it hit a high of $26.62 1/2 two days later but closed yesterday at $14.37 1/2.
On May 26, Donaldson, Lufkin & Jenrette Inc. (DLJ), the investment firm, spun off its online discount brokerage arm, DLJdirect Inc. (DIR) as a separate stock, which promptly jumped to $45.62 1/2 but closed yesterday at $24.31 1/4.
DLJdirect is an example of the newest spinoff wrinkle -- the "tracking stock." When a parent spins off a new company, that company is a freestanding separate legal entity. But a tracking stock is something else. It is still part of the parent and cannot, for example, be bought out by another company -- though it does trade as a separate stock.
Cornell does not like tracking stocks much: "We prefer to own the `thing' that owns the `thing,' " he writes. But there is no doubt that these stocks manage to raise money for their parents -- though the shareholders are another matter.
ZDNet Group (ZDZ), for instance, is a tracking stock spun off from Ziff-Davis Inc. (ZD), the technology publisher. ZDNet went public in March at $19 and soared to $55.50 but closed yesterday at $16.75. Its market cap is now $1.2 billion. Ziff itself has fallen 27 percent this year and has a market cap that is precisely the same as ZDNet. So if you buy Ziff stock you get Ziff's print and trade-show businesses for free.
At least that is the theory. In practice, these tricky Internet deals are a little too risky for the average investor.
Instead, I would stick with anomalies that are easier to understand. One cited in a recent edition of James Grant's Interest Rate Observer -- and one that has excited Cornell for a long time -- involves AMR Corp., the parent company of American Airlines Inc.
AMR owns 82 percent of the Sabre Group Holdings Inc. (TSG), a separate company it spun off in 1996. Sabre owns the world's largest computerized reservation system, with 150,000 travel-agent terminals used to book flights on 400 airlines, with 200 hotel chains and 50 car rental agencies.
Sabre also owns Travelocity, a popular Internet travel service, which it is highly likely to spin off.
Look at the numbers. AMR, the No. 2 U.S. carrier, has a market cap of $10.4 billion. Sabre has a market cap of $8 billion. Thus, AMR's 82 percent stake in Sabre is worth about $6.5 billion. In other words, the "stub" -- or AMR's non-Sabre business, the airline -- is worth only $3.9 billion, according to the market. Cornell figures that the price-to-earnings ratio for the airline segment is less than 6.
But don't forget Travelocity. Priceline.com Inc. (PCLN), which is similar to Travelocity but has no profits, has a market cap of $11.2 billion. Investors believe it is worth more than all of AMR. Priceline last year had sales of $35 million. Sabre alone had sales of $2.3 billion (and Sabre calculates its sales far more conservatively).
But back to Travelocity: It could easily be worth $4 billion in a spinoff -- in which case, you can buy AMR and get American Airlines for free. No wonder Cornell and Grant like AMR stock.