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Will Tyco End Up Like ITT? Reviewing a Break-up

March 19, 2012 | About:
It’s now been four and a half months since ITT (ITT) broke itself up into three separate companies. I advocated investing in ITT before the break-up, and I wanted to review the position and see if it met my expectations. It’s also worthwhile to review this investing style since Tyco (TYC) is also doing a three way break-up by the end of the year.

I initiated a position in ITT on July 12, 2011 and completed my buying on August 1, 2011. My average purchase price was $54.30. Some gurus took the same approach that I did. Michael Price had a significant position and has continued to add to ITT post break-up. Joel Greenblatt, Steven Cohen, Jeremy Grantham, Jean-Marie Eveillard, and a few others also purchased before the break-up, probably at better prices than me.

ITT broke up on October 31, 2011 resulting in three companies: the new ITT, Exelis (XLS) and Xylem (XYL). Xylem is the biggest of the three and replaced ITT in the S&P 500. Xylem is a water technology and service company. Exelis is the pure defense contractor. The new ITT is focused on aerospace, transportation, energy and industrial applications and is the smallest of the three companies.

Before the break-up the general consensus was that shares were undervalued using a sum of the parts analysis. While it was difficult to determine the true worth, my assumption was that shares were about 30% undervalued at the time of my purchase. The other positive aspect of a trade like this is that it isn’t necessarily correlated to the overall markets. Certainly the comparisons for the new companies are, but not as much as a stand-alone company. The discount should provide a cushion in a big market drop.

Since the time of my purchase to today, I’ve seen a bit more than a 10% return. The S&P 500 is up 6%. The outperformance is good to see, of course, but isn’t as great as I was expecting. At the same time, each of the three companies appear to be undervalued. In addition to his ITT purchases, Michael Price has also snatched up more Xylem shares and James Barrow owns about 7% of the company. Each of them have also bought Exelis shares as well. I intend to hold all three companies for some time, at least until I can get a better feel on what the future holds for each.

While I haven’t bought Tyco shares yet, I’ve followed along for some time. Tyco has already broken up once in the post-Dennis Kozlowski era. They’ve announced that they are again breaking up into three and will be complete by the end of 2012. I haven’t finished my analysis yet, but Wally Weitz mentioned in his third quarter letter last year that he believed Tyco was worth $65. When he wrote that, shares were around $40. They’re above $53 now. I’ve seen other analysis as high as $80, but it pays to be more conservative. Even after the run-up to today’s prices, the stock is more than 20% undervalued. I wouldn’t be surprised if we have a better buying opportunity later this year as well.

Tyco is a lot bigger than pre-breakup ITT was. Tyco’s market cap is nearly $25 billion. That said, there are a lot of similarities in regards to the investing environment. Conglomerates are out of favor and smaller, more nimble companies have an advantage. It’s easy to raise cash in today’s environment and cash cow divisions aren’t needed to finance growth. There’s a good chance that sentiment will change in the future, especially if credit markets tighten up.

In ITT’s case, one of the spin-offs may be an acquisition target. Tyco has already received interest in one of their divisions as well. While I’d like to see Tyco’s stock price go down a bit before entering, I expect the results to be similar to ITT. Even buying at today’s prices should provide a safe investment not entirely correlated to the overall markets.

I just hope that Tyco comes up with better spin-off names than ITT did.

Disclosure: Long ITT, XYL, XLS

About the author:

Steven Kiel
Steven Kiel is the president and chief investment officer for Arquitos Capital Management, a Virginia-based investment management firm. He is a graduate of George Mason School of Law and a captain in the Army Reserves. He manages two spoke funds, The Freedom Fund, a value-oriented portfolio, and The Hayek Fund, a portfolio dedicated to free market principles. He can be contacted at steven.kiel@arquitos.com or through the firm's website at www.arquitos.com.

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Rating: 3.8/5 (16 votes)

Comments

rdj1234
Rdj1234 - 2 years ago
Hi Steven,

I hate the names too, and I think it is reflected in their post split prices. I have added a question to my spinoff checklist about whether the name makes sense or sucks like Xylem and Exelis. I am thinking about not buying any spinoffs in the future before the new name(s) are announced.
slkiel
Slkiel - 2 years ago
Haha- Well, I don't know if I'd go that far. The spin-offs from ITT aren't depressed because of their names. It seems to be primarily because of spin-off sales pressure. I have to do more research, but it appears at least two of three post-spinoff companies are very attractively priced right now.

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