Since I read the book, You Can Be a Stock Market Genius, written by Joel Greenblatt, which suggests that spin-offs often present great investment opportunities (you can read the reasons here), I have been kept eye on new spin-offs to try the strategy in real life. After about a year of search, I finally came across an attractive opportunity: Honeywell (HON: NYSE)’s spin-off of its Transportation Systems (Garrett Motions Inc., will be listed as GTX: NYSE).
o Company Overview
Garrett Motions Inc. (“Garrett”) is a company that is about to spin-off from Honeywell (HON: NYSE) on October 1, 2018. Garrett develops, manufactures and sells turbochargers, electronic boostings and automotive software. The company’s business exposures are mainly as follows:
o The Spin-Off
In October 2017, Honeywell announced that it would spin-off its transportation systems business (Garrett) as the result of portfolio review. After almost a year, in September 2018, Honeywell announced that it would distribute the shares of Garrett to existing Honeywell’s shareholders on October 1, 2018. Honeywell’s shareholders will receive 1 Garrett share for every 10 Honeywell shares. The shares will be traded on NYSE with the ticker GTX.
Garrett has over 1,400 patents issued and pending today, providing the competitive edge and leadership in the industry.
o Valuation Analysis
Based on the information provided by Honeywell and my own assumptions, I decided to come with a valuation before the Garrett shares are listed on October 1, 2018.
Although the Garrett will be loaded with substantial amount of debt (long-term debt: $1.6 billion) and other liabilities (asbestos related: $1.6 billion, the projected payment is already incorporated in the “other expenses” in the P/L sheet), I believe the company will generate enough cash flow to compensate it.
The beauty of spin-off is that it gives management more accountability. The CEO of the company will be awarded $4.3Mil worth of Garrett’s restricted stocks, half of which can be vested in 3 years and the rest in 4 years. Such substantial amount of stock compensation should align CEO’s motivation with the shareholder’s best interest. I believe he will try everything he can to meet the 4% annual revenue growth through FY2022 and generate free cash flow.
Since the valuation varies greatly based on WACC and terminal growth assumption, I created a table with a wide range of combination of the assumptions. Although the valuation changes based on the assumptions, my main target is terminal growth of 0% to be conservative and WACC of 14% based on the estimate above.
Based on my valuation, the Garrett’s shares (GTX: NYSE) could be a buy if the shares end up being traded below $14. Although Garrett will be loaded with a substantial amount of debt and purchasing its shares will be somewhat risky, I believe the company will generate sufficient cash flow to repay the debt and reward the shareholders well in the long-term. As spin-off stocks tend to face a sell-off in short-term, I would recommend buying the shares only if you are willing to hold them for over 2 years to see how it plays out.
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I currently do not own any Honeywell stocks (HON: NYSE). I may purchase Garrett Motions Inc. (GYX: NYSE) in near future, depending on the pricing actions and availability of my own capital.