|FUND HOLDING PROFILES: SPIN-OFF TRANSACTIONS
Spin-off transactions are a type of corporate action that owner-operators frequently use to unlock shareholder value. This quarter, we review two examples: Danaher Corp. and its recent spin-off, Fortive Corp., as well as AMC Networks.
Danaher Corp. & Fortive Corp. (Tickers: DHR, FTV)
Owner-Operator: Steven Rales and Mitchell Rales
On July 5, 2016, Danaher Corp. (“Danaher”) completed the spin-off of Fortive Corp. (“Fortive”). Danaher comprises the Environmental, Life Sciences & Diagnostics, and Dental segments, while Fortive consists primarily of the Industrial Technologies and Test & Measurement segments. Founders Steven and Mitchell Rales have a long history of successful, diversified acquisitions over more than 30 years since Danaher was reincorporated in 1984. (Danaher was originally organized in 1969 as a Massachusetts real estate investment trust (REIT); in 1984, the company was reincorporated as a Delaware corporation.)
The brothers have developed an operating strategy they call the Danaher Business System (DBS), based on the Japanese philosophy of “kaizen,” or continuous improvement. DBS is their process for identifying and reducing inefficiencies across all disciplines in the business, as well as a strategic tool for growing market share and driving new product development. The spin-off should allow Danaher to continue its strategy of generating more consistent revenue growth and higher margins by shifting its portfolio toward the Life Sciences & Diagnostics and Environmental businesses. By comparison, Fortive is likely to exhibit more volatile revenue than the parent company due to the cyclical nature of industrial demand. Longer term, however, Fortive’s low leverage, strong free cash flow, and consequent ability to increase leverage when necessary is likely to allow for the redeployment of capital through acquisitions. Given the Rales brothers’ track record of acquiring and integrating companies successfully, and the 14% annualized return generated by Danaher from 2001 to 2014 (compared to a 2% annualized return for the S&P 500), there is reason to believe that there is continued appreciation potential for these businesses going forward.
AMC Networks Inc. (Ticker: AMCX)
Owner-Operator: Charles Dolan
AMC Networks, Inc. (“AMC”) was spun off from Cablevision Systems in 2011, as part of a broader strategy by the Dolan family to separate the cable distribution assets, cable networks, and professional sports franchises into independent entities (Madison Square Garden Co. and MSG Networks Inc. are also Fund holdings). AMC operates in two segments: U.S. Networks and International Networks. In the U.S., the primary assets are cable channels, including AMC, BBC American, and IFC. AMC has produced some of the most widely-viewed and acclaimed original content over the past several years, including Mad Men, Breaking Bad, and The Walking Dead, which is still in production. In 2014, AMC acquired Chellomedia from Liberty Global plc (also a Fund holding), which comprises a number of international cable networks, reaching 390 million households in 138 countries. Despite this acquisition, AMC relies on its U.S. networks for the majority of its revenue and earnings: in 2015, U.S. networks accounted for $2.1 billion of revenues and $811 million of adjusted operating income (a 38% margin), compared to $453 million of revenues and $30 million of adjusted operating income (a 6.6% margin) for the International segment. The chief concern among investors is that the proliferation of media distribution outlets, which now include streaming services such as Hulu, Netflix, and Amazon, among others, will erode demand for the traditional platforms. This trend is believed to have the potential to disrupt both the distribution and advertising revenue streams for cable and satellite providers. However, AMC is a content provider, not simply a distributor. Therefore, it has the potential to monetize its original content over various distribution channels and has shown growth in revenues, operating income, and margin from 2010 to 2015.
AMC’s shares currently trade at approximately 9x earnings (as of Q3 2016), a discount relative to comparable companies and to AMC’s historical P/E multiple, which has been in the 16x-27x range over the last five years. Therefore, should the valuation multiple return to historical levels, which might well occur if the company is able to restore its historical growth rate (which would depend on the popularity of its programming), AMC’s shares have the potential to appreciate significantly. Additionally, if the company is able to expand the operating margin for its International segment, the potential earnings growth is significant; coupled with the multiple expansion that would likely accompany such an accomplishment, we believe there is potential for the share price to increase on the order of 100% from its December 30 price of approximately $52.