In last Monday’s Daily (Dec. 1, 2014), we featured Warren Buffett’s purchase of Proctor & Gamble’s Duracell division. Battery-maker Duracell is a perennial “cash cow.” It commands 25% of the world’s battery market. It’s a classic Buffett deal: As he wrote in his 1989 letter to Berkshire Hathaway shareholders, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Duracell is a global, cash-gushing machine (it led all other battery-makers in sales in 2013 at $2.4 billion)… so that takes care of the “wonderful company” part of Buffett’s maxim.
But it’s the “fair price” part of the deal that has Mega Trends Investing (MTI) subscribers buzzing. That’s because Editor Teeka Tiwari recommended they buy battery competitor Energizer (NYSE: ENR) back in October. Energizer expects its battery division (Energizer and Eveready) to bring in $1.8 billion in revenue this year. But Teeka knows there’s more to the Energizer story…
Energizer plans to “spin off” its battery division into its own company in July of next year (its consumer staples divisions will make up the other company). Here’s what Teeka wrote about the profit “tailwinds” spinoffs create…
Most spinoff companies are borne from a larger corporate empire. In that environment, they are just another cog in the machine. Decision-making and budgets are at the whim of internal bureaucrats who are much higher up the ladder.
Often, these executives don’t fully understand the core business of the smaller division. Because of this, these smaller divisions oftentimes fare better operating independently—free of bureaucratic interference.
In addition, the spinoff’s company management team is often very motivated to succeed. Aside from the excitement of running their own show, they often have financial incentives, like liberal amounts of stock options.
They are also free to launch new products and invest heavily in marketing them. That usually translates into fast earnings growth, which leads to much higher stock prices.
Meanwhile, the management team of the parent company can focus on its core business. As proven by a study by Cusatis, Miles, and Woolridge in The Journal of Financial Economics (1993)… greater management focus has led to parent companies outperforming the S&P 500 by 18%.
But the spun off companies have done much better. They’ve outperformed the S&P 500 by 30%. And as a shareholder of the parent company before the spinoff, you receive shares of both new companies when the transaction occurs.
Buffett paid between 7-9 times earnings, before interest, taxes, depreciation, and amortization (EBITDA) for Duracell. He also paid about 1.9 times sales.
Applying Buffett’s multiples for Duracell to Energizer, ENR shareholders will see their pockets widen. The 7-9 times EBITDA multiple suggests Energizer’s battery division will command between $2.8-3.6 billion. Using the sales multiple, the battery division would be worth $3.4 billion.
Energizer has increased 4% since the Duracell announcement last month. Teeka’s subscribers are up 11% on their position… and they’re on track to realize Teeka’s initial goal of over 50% gains in nine months. Expect shares to “pop” further as the July spinoff date nears. MTI subscribers should take this opportunity to review the October issue.
As Teeka notes, spinoffs are a mega trend just picking up steam. In 2010, there were only 20 publicly held spinoffs in U.S equity markets. In 2014, the total should hit 49. On the evening of December 18, Teeka will discuss what other major mega trends he sees affecting markets in 2015—and how to profit from them. It happens in a first-ever LIVE online event: The Mega Trends Investing Wealth Summit. Click here to learn more.