Investing in fragments of a company can sometimes pay off handsomely
Mario J. Gabelli
From the Print Edition:
The Sopranos, Mar/Apr 01
(continued from page 1)
I'll provide two examples of our recent spin-off investments -- one of which is now largely history and another (a spin-off/liquidation) that is still very much alive. In March 2000, media company Ziff Davis (ZD) announced a recapitalization and the spin-off of its events (trade show) business. For each share of ZD, shareholders received 0.57 shares of ZD Net (an already publicly held tracking stock of the parent's Internet business); a $2.50 cash dividend; and 0.5 shares of Key3Media, which upon completion of the parent company's reorganization would be an independent publicly traded company, with additional shares being brought to market via an initial public offering (IPO).
By buying one share of ZD for $11.50, shorting shares of richly valued ZD Net and covering the short as soon as the reorganization was completed and pocketing the $2.50 per share cash dividend, we were effectively purchasing one share of Key3Media for $2.32. This was the equivalent of paying just 6 times trailing free cash flow for a very good, albeit not terribly sexy, business whose competitors (Penton Media and Primedia) were trading at 14 to 15 times free cash flow in the market. Sure enough, the Key3Media IPO shares came to market at $6 per share and the stock traded at $12 per share within a month, delivering a 417 percent return on our original investment in the parent company stock. Behold the power of the spin-off.
Ready for a spin-off you can take advantage of? You may want to consider Harbor Global Co. (OTC, HRBG), a recent spin-off from the merger of Pioneer Group and UniCredito Italiano. Harbor Global is managed by the former president and senior vice president of Pioneer Global Investments, a division of Pioneer Group.
This spin-off is also a liquidation, in that management's mandate is to liquidate all of Harbor Global's assets within five years. Liquidations are the sale of all of a public company's assets, with the net proceeds being paid directly to shareholders. Liquidations generally occur when companies have assets worth more to buyers of businesses than they are ever likely to be to public market investors.
As compensation, in addition to salaries, Harbor Global's management will pocket 10 percent of the value of all asset sales. These assets consist of approximately $35 million in cash, about $25 million (book value) of Russian investments and real estate, around $5.6 million (book value) of Polish venture capital investments, $12.5 million in timber inventory and equipment, $7.5 million (book value) in assorted tag-end assets and $4.5 million in net cash coming from the sale of Pioneer Group's gold-producing properties. All this adds up to $90.1 million in assets. Backing out $7.8 million in management compensation (including the 10 percent commission on asset sales) and $12 million in operating costs over the next five years, we estimate total net assets are $70.3 million. Divided by Harbor Global's 5,397,918 shares, this comes to approximately $13 of net assets per share. As I write, Harbor Global stock is trading at about $4.50 per share -- about a 40 percent discount to the cash and cash receivables currently on the books. This is an old-fashioned Graham & Dodd "net/net" -- a security selling below the value of the cash on the books.
Why so cheap? First, assets like Russian real estate and Polish venture capital investments aren't easy to evaluate. We have taken what we believe to be a conservative approach, valuing these assets at book. They may be worth considerably more. Second, with a market capitalization (total shares multiplied by share price) of just $21.6 million, no one on Wall Street is paying any attention to this stock. Finally, HRBG is a "bulletin board" stock. It isn't listed on NASDAQ and isn't actively traded. Harbor Global stock may never be "discovered," and consequently, may languish at or around its current $4.50 price for the next five years. [Editor's note: Harbor Global stock was selling at $5 a share as this issue went to press.] However, if all goes according to plan, when the liquidation is completed, shareholders should be receiving checks for $13 per share or more. That translates into a 288 percent return or better over five years.
Mario J. Gabelli is the founder and chairman of Gabelli Funds Inc., a Rye, New York-based financial services company. He appears regularly on CNN and CNBC.