Spin-Off Research In the News

A Divorce With a Tidy Deal for Investors

Posted by Paul McCann on Mon, Jun 14, 2004 @ 09:06 AM


The Barker Portfolio


What is it about Duluth? The Minnesota port city gave birth to Bob Dylan, who has a knack for contradictory imagery, most recently of him and a Victoria’s Secret model. In the stock market, Duluth has given us Allete, positively a master at the odd mixture of businesses, lately an electric utility and an auto auctioneer.

Allete once was known as Minnesota Power & Light. Like Dylan (born Zimmerman), it took a new name, in its case to reflect an opaque strategy that over the years has led it into phone and water service, reinsurance, pulp and paper, even Hawaiian pineapple. While consorting in TV ads with a sexy lingerie model doubtless renewed the 63-year-old Dylan’s brand, Allete’s plunge into corporate schizophrenia has left investors confused and unappreciative. That may soon change, as Allete aims to clarify its identity by spinning off the auto unit into an independent company called Adesa.

ALLETE, ADESA-THESE are companies with nil sex appeal. Yet odds are good that people who hold Allete shares now will wind up next year owning two stocks with a noticeably higher total value. Divorce proceedings are expected to start as soon as underwriters led by UBS bring an initial public offering of stock in Adesa. In a series of deals due any time now, Allete will sell about 7% of Adesa’s equity to the public for an estimated $150 million. By September’s end, Allete expects to give its shareholders the rest of the stock in Adesa. That will leave Allete with major operations in electric power and Florida real estate, plus that goofy stage name. CEO Donald Shippar told me that the electric utility operation may see growth of just1% to 1.5% a year. But Allete also will be in the market for an acquisition into which it might invest its free cash flow-and which, in turn, might boost its earnings, expected this year to reach $32 million or so.

More intriguing is Adesa, which is in the zippier business of used-car auctions and financing. Last year, Adesa matched wholesale buyers and sellers of more than 2 million used vehicles, making it No.2 behind privately held Cox Enterprises’ Manheim. It also has an expanding book of business in financing dealers’ inventories. All told, sales grew to $912 million last year from $380 million in 1999, while income from continuing operations raced ahead even quicker, to $114.8 million last year (table). One risk: The Securities & Exchange Commission is informally investigating its accounting for loan losses. Adesa says Allete’s audit committee found nothing serious amiss.

The potential reward would come in how the market may value Adesa at a higher multiple once it emerges from Allete’s shadow. Joseph Cornell, president of the Chicago research boutique Spin-Off Advisors, thinks Allete plus Adesa, valued separately in the market, may go for a total of 46 a share, or 33% over Allete’s recent price near 35. That estimate doesn’t include any contribution from Allete’s sideline in sales of the 20,000 Florida acres it owns. If the SEC were to force a big change in Adesa’s loan-loss reserves, the value in Allete would be trimmed, but Cornell reckons the effect would be minor.

Naturally, the market may decide differently. But the last favorite Cornell idea that I shared here, the October, 2001, split of Conglomerate Canadian Pacific into five separate stocks, worked out splendidly. According to portfolio tracker Gains Keeper, a pre-spin-off stake in CP has gained 78%, plus dividends, while the Standard & Poor’s 500-stock index has risen 7%. Now wouldn’t that get anyone to focus on Duluth?

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