Lynne Marek | Crain's Chicago Business | June4, 2016

R.R. Donnelley & Sons is splitting up, and the man who knows the 152-year-old company best is casting his lot with one of the new, smaller spinoffs.

Thomas Quinlan III, 53, who has been Donnelley CEO since 2007, will become chairman and CEO of LSC Communications, a $3.5 billion-a-year business serving Donnelley's retail and merchandise clients, when the 68,400-employee commercial printer atomizes into three parts in October.

The biggest printing company in America—and one of the top 25 corporations by revenue in Illinois—has been gobbling up rivals for a decade, amassing $11.26 billion in revenue last year. Now, however, it says different management teams focused on niches will yield more value for shareholders. That's the conventional thinking behind a trend that cleaved Abbott Labs, Kraft Foods and Motorola, too, but it won't change the declining demand and price competition battering the commercial printing industry.

“There might be advantages to splitting it up, but, in the end, the growth prospects are the same,” says Gimme Credit analyst Dave Novosel in Chicago.

The industry's revenue peaked in 2000 at about $165 billion and slipped to $160 billion last year, according to trade group Printing Industries of America, though the recent figure is inflated by ancillary services.

Donnelley, twice as large as the industry's No. 2, Quad/Graphics of Sussex, Wis., strides above a field of small shops. As the need to print catalogs, magazines, brochures and documents shrinks in an increasingly paperless era, all these competitors are lowering prices in a scramble to retain customers.

SHRINKING MARGINS

Donnelley's revenue has remained fairly steady over the past five years, fluctuating between $10.22 billion and $11.60 billion. Acquisitions helped the company buoy income and, at the same time, eliminate rivals, close plants and cut workers, all to lower costs.

Still, profit margins are shrinking. Exclude the benefit of the acquisitions, and the margin on earnings before interest,taxes, depreciation and amortization declined to 10.7 percent last year from 11.9 percent in 2011, says Charles Strauzer, an analyst at CJS Securities in White Plains, N.Y. Management says it will decline slightly again this year. “Printing has been in secular decline for years now,” Strauzer says. “When revenue is declining, you have to offset that with cost-cutting.”

In addition to LSC and the R.R. Donnelley core business, the split will create Donnelley Financial Solutions, with $1 billion in annual revenue. All three businesses will be based in the Loop.

R.R. Donnelley & Sons will be the biggest, with $7 billion in revenue and 42,000 employees, providing legacy printing services for direct mail, labels, forms, and other commercial and digital printing jobs. Donnelley Financial, the smallest, will focus on printing work for the financial, investment and legal industries, while LSC, with a headcount of 20,000, will cater to publishers, merchandisers, catalog companies and retailers.

“When the transactions are complete, each company will have an enhanced ability to focus more intently on its customers' unique needs,” Quinlan told analysts on the company's first-quarter earnings call in May. A Donnelley spokesman declines to make any of the post-spinoff CEOs available.

Spin-off Advisors contends that spinoffs unlock value, though mostly for the pieces spun off as opposed to those remaining core businesses. The best evidence of that is the Bloomberg Spin-off Index, which measures the performance of companies with valuations of more than $1 billion that have been spun off, says Joe Cornell, who leads Spin-off Advisors in Chicago. The index has jumped nearly sevenfold since it was created in 2003, compared with a more than doubling of the Standard & Poor's 500.

It's a bet that the companies individually are going to be better run, and it's a bonus if they're acquired at a premium, Cornell says. Typically, acquisitions don't happen for at least six months so as not to jeopardize the tax-free nature of the transactions, he says. Drugmaker Baxalta was purchased by Shire for $32 billion only six months after it was spun off from Deerfield-based Baxter International.

Donnelley shares jumped last year when the split was announced, rising to $18 a share on Aug. 4 from $16.98 the day before, but they've slumped 9 percent since then to $16.39 on June 3.

Gimme Credit's Novosel agrees that splitting up could create value, but he notes the company carries substantial debt of $3.43 billion that could be problematic if the economy falls back into recession. That may be part of the reason that Quinlan has cherry-picked leading LSC, the new business that will have the least debt—$800 million—relative to earnings.

To view the article on chicago business.com, click here: Donnelley CEO Quinlan to head spinoff LSC in company breakup

THIS STRATEGY IS UP 100% OVER THE S&P IN THE LAST 10 YEARS

Spin-off investing has grown from a niche strategy to a proven driver of returns. Meet the spin doctor.

Daniel P. Collins | Modern Trader | August 2016

Back in the 1960s conglomerates were all the rage. These large companies encompassing multiple diverse businesses were thought of as strong investments because they had the ability to withstand cyclical weakness in one or more of the sectors represented by one of its business lines and still produce positive returns.

The case for conglomerates is an old and simple one: Diversification. However, this diversification often comes at a cost. Joe Cornell founder and CEO of Spin-Off Advisors (spinoffresearch.com) writes, “The market often applies a haircut to the value of widely diversified companies. Frequently, conglomerates trade at a discount to more focused companies. The conglomerate discount gives investors a good idea of how the market values the conglomerate as compared to the sum value
of its various parts.”

Cornell points out that by the 1970s, the market had begun to turn away from conglomerates, a trend that gained steam in the 80s and 90s. By the time Cornell began his career as an analyst at boutique hedge fund Keeley Asset Management in the early 1990s, he was tasked with researching potential spin-offs. “It was a small firm and the owner, John Keeley, had a couple of little small cap value funds and was a big believer in investing in spinoffs, bankruptcies and restructuring themes,” Cornell says. “I got turned on to spin-off investing and found it to be very inefficient and not covered very well by conventional Wall Street types.” Basically, Cornell saw an open field where he could gain an edge because there were very few analysts researching the space. “I saw a lot of examples of this working out, a light bulb went on over my head [and] I spun myself out of John’s firm,” he says. He adds, “The multiples of conglomerates have been low but you might have a lot of good businesses that would trade at a different multiple if it was separate. That has been a driver, the market is not valuing us properly; let’s get this out in the sunshine and let people decide what the proper valuation is.”

With few analysts looking into spin-offs, Cornell knew he found a unique niche and created Spin-Off Advisors in 1997,
a consultancy that provides research on announced spin-offs. When he launched the advisory he also built a small hedge fund that invested in spin-offs, but found explaining the potential conflicts cumbersome, so he decided to focus on the research side as it was the driver of profit. Cornell still invests proprietary firm money in the spin-off sector.

The spin-off edge
Cornell wrote a book — Spinoff to Payoff: An analytical Guide to Investing in Corporate Divestitures — to help promote his new venture. In it he wrote that spin-offs had gone from a technique to eliminate poor performers to becoming a means of unlocking value. “At the time, 1999-2000, when the tech boom was going on, it was a way to highlight value in stocks,” he says.

He describes two bookends to spin-off drivers. “It could be something that is good that is not being valued properly within the parent company because it is not obvious and if you get it out in the sunshine people can put a valuation on it, or [you] want to get rid of the red-headed stepchild in the portfolio that is taking too much attention and that will enhance the parent’s valuation,” he says.

So, spin-off value could be driven by the new company spun, the parent could be freed from a poor performing asset or a combination of both.

What he found, though, is that there was a lot of hidden value in spin-offs and his research at the time showed spin-offs significantly outperformed the broad market. That outperformance has persisted despite the strategy becoming more popular (see “Spinning off alpha,” right).

“Sometimes you get these fundamentally [strong] businesses that were buried in something else, they kind of wither a bit,”
Cornell says. “Once they are out on their own there is a lot of turnover in the shareholder base. “

In the early days of spin-offs, the play was to wait for a value play as the spun company often initially tanked. “They get kicked out of indexes, there is no street coverage because there wasn’t an IPO and people are confused [because their broker doesn’t cover them],” Cornell says. “This was a way to get parts off of the books. Giving your investors a hot potato — they just wanted toget rid of it and sold it.”

Often the weakness is based on managers getting a new asset that they did not select, did not research and that does not match their selection criteria. For instance, a program could be attempting to replicate the S&P 500 and though the parent qualifies, the spin-off does not. Managers would sell the spun company because it was not something they were mandated to consider — it had nothing to do with the quality of spun stock or an analysis of its value.

“You have a lot of natural sellers, not a lot of natural buyers,” Cornell says. “With that dynamic sometimes you can find companies that trade at a discount to what they are worth. That is what we are looking for. Once they are out on their own, we find the dynamic is a lot different.”

Once free the spun company can act in its own interest, rather than just as a cog in a machine. “Management is better incentivized, they get stock options on that specific stock, that ramps up the entrepreneurial zeal, they bring new products,” Cornell says. “It is typicalthat with a spin-off that in 18 months to two years, the operating performance improves. If they are below their peer group they often get within the peer group. “

And remember that spin-offs often have taken a severe initial hit in value for no particular reason other than they are new and unknown.

“They sunk like rocks for six months,” Cornell points out. “And then if a spin-off could get the ship going in the right direction, get the margins up the debt payed down; [there was value].”

The price of success                                                                                                                                         However, with a decades-long track record of success, profitable spin-offs are not as easy to spot these days. “Those were the garden variety spinoffs back when I first started. The way to play it back then was you waited three to six months until separation because they went down steadily and there was no one who was interested in taking the other side of the trade. You would see these things offered at deep discounts. If you got the debt whittled down there was a lot of earnings leverage. It wasn’t a very popular strategy when I started,” Cornell says.

“Now there are different services that do what we do. As it has gotten more popular, the window has tightened up. When I started, you had three-to-six months to do the work to see if it was something you would want to own. Now, everyone is trying to get a step ahead of everyone else. That is what is happening; people are getting in the game earlier. Instead of waiting on the separation and having to decide [if they want the spin-off, the parent or both]. They are getting in earlier and earlier and there is a way to back into the part they want on the cheap and sell off the parts they don’t want.”

While the world of spin-offs has gotten more crowded and as Cornell says, “more convoluted” his response is often more simple. “Step one is if we think the sum of parts is greater, we buy it now. When the distribution happens we will look at both
parts. Maybe we will like both pieces, maybe we like nothing. We have to look at them as separate pieces now. And follow them for nine months [through] several earnings cycles.”

The ABCs
While Cornell and his team are always on the lookout for potential spins, their work generally begins with an announcement
from the parent. They put out a press release saying that in the next nine to 12 months they will spin-off a part of the company, according to Cornell.

At that point, there is not a lot of information. Cornell’s team reaches out to the firm and asks about valuation and the spin-off’s peer group. Over several months following the announcement, the parent has to provide information regarding the value of the entity to be spun. They must file a Form 10, which includes five years of pro forma valuations, tells you how it is capitalized, goes over the debt, etc.

“We pull that info out of the filing and [find complementary firms] to measure against,” Cornell says. “We ask, ‘Are the sum of the parts traded at a deep discount to what we think the two public pieces would trade at in six months or has the market got it right? That would be step one in finding if there is something actionable. If we think the market is missing something, or doesn’t have proper valuation, we shine a light on that.”

There were seven spin-off announcements this past June. “We decided that Johnson Controls looked cheap,” Cornell explains. “We highlighted it. We think it is worth X and are buying it now with the idea that by the time they spin this off later in the year, the parts will be worth more than the current value of the parent.”

As mentioned above, the anecdote to the growing complexity of spin-off research is sometimes a simple one. “As spin-offs have become more popular that has been a good strategy. Often you see good returns just buying the parent if we value the sum of its parts higher than the current stock price. If you want a simple strategy just buy the parent. After they split you can decide what you want to do.”

Straight spin vs. IPOs
There are many forms of divestitures, but Cornell has always preferred the straight spin-off where shareholders are rewarded stock in a new company (see “Types of spin-offs,” page 33).

“If there is an IPO involved it could be good but it is more likely there is going to be more efficient [pricing] because of the process,” Cornell says. “When you do an IPO you have to hire an investment bank and they have to pitch portfolio managers
and analysts have coverage so you’ve got a little coverage. That is a much different dynamic than if you are just giving shares to somebody. I am more apt to be interested in a straight spin-off.”

It’s not that a split through an IPO is inherently less valuable. “There’s more of a chance to find something that is not priced right. When you have a lot of investment guys involved going around talking up stuff things are not going to fall through the cracks,” Cornell says. “It does not mean you are not going to get a good IPO spin-off, it just means there are guys who have to run the numbers. You get the most bang for the buck on a straight spin-off.”

The impressive growth in Cornell’s business, and others like it, is proof that there are more eyes on the space. But Cornell
doesn’t know of any specific spin-off hedge funds. Typically, the users of his service come from the long/short or special situation funds that are tuned into restructuring.

“A lot of hedge funds — whatever their advertised approach is — are interested in spin-offs because it is a little corner of the
market that has been efficient and provides some good returns,” Cornell says. “At Keeley, it is a big part of what they do. They look at things coming out of bankruptcies and spin-offs. I don’t know of any spin-off fund per se but there is an ETF that does this; it is usually a subset of the main focus of a fund. “

“A third of our client base is more traditional long only that are looking for value buys. A fair amount of those — Pershing Square, Tiger [for instance] —have a lot of resources that we are bringing to the table. “

Activist interest
One sector that has become more interested in spin-offs are activist managers. “The window since I have been doing this has shrunk. It is more of a mainstream investment which has tightened up the window. Things have gotten more efficient. You have to be quick when you see things, you have to move faster. There are guys with buckets of money that are trying to make it happen,” he says. “There are activists now that buy up stocks and lean on management to break up the company. That sort of thing is going on.”

However, like with IPOs, Cornell is less interested in activist-inspired spins. “I prefer that the company thought this out and think a spin-off is the way to go rather than have a gun to their head by an activist shareholder who may not be around six months after the spin,” Cornell says.

Despite the growth Cornell still can pick winners. “It is more of a crowded trade than 20 years ago. If we are grinding through
35 spin-offs a year we are still finding a handful of things we perceive as real good investments,” Cornell says. “In a typical year there are 35. A couple of years ago we got up to 60 (see “Number of spins,” page 34). Out of that we grind through everything; there might be eight to 12 fairly actionable things to do and out of that a handful of gems, four or five really good ideas. We grind through all this stuff and hopefully the process will kick out a few really good investments.”

And the popularity of spin-offs as an investment only helps Cornell’s firm. “Last year more than 40 spin-offs. That turns into 80 companies. That is a lot of work if you don’t have five analysts just dedicated to spin-offs. We have no other products, we don’t manage money. We are one-trick ponies,” he says.

Spin-Off Advisors has covered 500-600 spin-offs since they started and Cornell describes it as similar to ordinary stock analysis. “You look at the same things. The typical bottom up stock analysis that every analyst does. It is no different from anything else.”

However, spin-offs are a unique niche and Cornell’s team has learned some tricks along the way, as Cornell
explains: “We went to a road show and the management team didn’t seem very excited about it, [they] set the bar low talked about transition. When I looked at the filing it turns out that the management team’s options are priced on the first 20 days of trading post separation so they are incentivized to talk people out of the stock,” he says. “If you just went to the roadshow and didn’t read the filling you might think this [stock] is worse than it really is. If you are not doing this over and over again, month in and month out you won’t see this. If I am not accustomed to dealing with spin-offs, I am not going to have that insight.”

Hot picks
Some of the best recommendations over the years have come from complex spin-offs. Cornell explains that the 3Com spin-off of Palm, where it only offered 5% of Palm was such a case. The valuation was so outrageous it valued Palm greater than 3Com despite 3 Com still holding 95% of Palm shares. Cornell recommended buying 3Com and shorting Palm after the initial offering. Clients who put on the spread (long 3Com and short Palm) are still paying for his service on profits from that trade.

Cornell rates the McDonald’s spin-off of Chipotle as one of the best (see “Burritos and burgers,” below). “It was a two-step
spin-off and has been phenomenal,’ he says.

While Cornell prefers to wait for announcements, there are a couple of rumored spin-offs that are intriguing.

The team has already looked into the floated Royal Dutch Shell spin-off of non-essential assets that could be worth as much as $40 billion, but is intrigued by the potential of Amazon spinning- off its Amazon web service which is growing real fast and
a potential spin-off.

“One not on our list that I have a feeling might be a decent spin-off candidate is eBay, which recently broke into two parts by spinning off PayPal, but still owns Stub Hub, which is really growing fast,” Cornell says. “I don’t know if you ever bought a ticket on stub hub but the fees are ridiculous. That is becoming their new PayPal. It is the growth driver of eBay now and it would be an interesting potential spin-off, [though] it might be a little premature.”

Follow Joe Cornell’s spin-off commentary each month in Modern Trader.

Diversified companies continue to look at spin-offs as a way to unlock value for investors. Seven new spin-offs were announced in May (see “May spinners”). Hewlett-Packard Enterprise (HPE), the business services arm of the former tech giant, was the latest high profile company to say it’s spinning off a unit as a way to make itself more valuable.

Medical device maker Varian Medical (VAR), itself a spin-off, also in May announced plans to spin off its imaging business as a stand-alone pubic company. We anticipate about 15 spin-offs will be completed during the next three months, adding to the (12 spinoffs that have been completed year-to-date in 2016
(see “Spun”).

Spin-offs have a history of outperforming the market in their early years. Since 1999, newly liberated companies
outperformed the Standard & Poor’s 500 Index by six percentage points in the first two years after being spun from their parent, according to Goldman Sachs. The Bloomberg Spin-Off Index has beaten the S&P 500 handily for a decade (see “Spinners win”). The index tracks, for three years, spin-offs with a market value above $1 billion. The Bloomberg U.S. Spin-Off Index is up 7.75% through the first five months of 2016, more than double the 3.57% return of the S&P 500. We continue to believe that the spin space will provide lucrative investment opportunities.

Joe Cornell, Spin-Off Research (p 79)

Matt Krantz | USA Today | May 30, 2016

Some companies are looking again to spinoffs as a way to unlock value for investors — but it's been a tough sell.

Hewlett-Packard Enterprise (HPE), the business services arm of the former technology giant, last week was the latest big company to say it's spinning off a piece of a business as a way to make itself more valuable. Medical device maker Varian Medical (VAR) also last week announced plans to spin off its imaging business to a stand-alone public company.

The number of companies making this move has dropped, with 13 companies in the Standard & Poor's 1500 index announcing spinoffs so far this year, well off the pace of 58 that took place in all of 2015, according to a USA TODAY analysis of data from S&P Global Market Intelligence. Earlier this year, Honeywell (HON), Hilton Worldwide (HLT) and Xerox (XRX) all announced spinoffs, says Spin-Off Research.

Shares of spun-off companies hit a rough patch the past year. The S&P Guggenheim Spin-Off exchange-traded fund, which tracks these stocks, is down 17% the past 12 months, much worse than the S&P 500's 0.6% decline.

But there's been a bit of a change of heart this year. Shares of HPE soared 11% to $18.05 following the news last week of its enterprise service spinoff and plans to merge that business with Computer Sciences Corp (CSC). "The strategic combination of HPE and CSC will proffer benefits to both IT giants, with the new company gaining from scale, technological proficiency, versatility, and skilled management," according to a report from Spin-Off Research to clients. Beyond just HPE, spinoff shares have been at least keeping up with the market so far this year as the S&P Guggenheim Spin-Off ETF is up 4%, roughly in line with the rest of the S&P 500.

Spinoffs have had a difficult time since the big boom of these maneuvers in 2014 and 2015, says Joe Cornell, publisher of Spin-Off Research. Back then, many energy companies jettisoned parts of their businesses as oil prices went into freefall — and many of those energy spinoffs have performed poorly.

But while the spinoff market has been difficult lately for investors, they are still a good long-term play for investors, Cornell says. Spinoff companies can focus resources on a specific niche and can tie the compensation of executives to their performance, not to that of a larger organization. Over the past 10 years, the Bloomberg Spin-Off index has returned 174%, compared with the 77.8% return of the S&P 500.

Spin out

The pace of spinoffs among Standard & Poor’s 1500 companies so far this year lags behind that of last year.

Year,  number of spinoffs:

• 2016 YTD, 13
• 2015, 58
• 2014, 55
• 2013, 28
• 2012, 18

Source: S&P Global Market Intelligence, USA TODAY

To view the article on usatoday.com, click here: Spinoffs aren't taking off with investors

BottomLine | July 15, 2016

Stock Opportunity: Corporate spin-offs with strong growth potential, we hear from Joseph W. Cornell, CFA. A spin-off occurs when a company creates a new company by selling stock in one of its businesses to the public. Over the past 10 years, the Bloomberg US Spun-Off Companies index has returned 174%, compared with the S&P 500's 77.8% return. Attractive spin-offs now: Barnes & Noble Education (BNED). the college-bookstore operator spun off from the retail bookstore giant last year...The Madison Square Garden Co. (MSG), which was separated last year from MSG Networks.