As Teck takeover drama shows, spinoffs offer hidden value for investors

Teck Resources Ltd. had plans to split itself into two companies which fell apart at the last minute. What’s next is either a new plan it hopes is more acceptable to shareholders or a hostile takeover bid from another mining company.

Either way shareholders stand to gain.  

Teck (TSX:TECK.B) wanted to create one company called Teck Metals Corp. that would operate Teck’s copper and zinc mines, and another called Elk Valley Resources Ltd. that would hold its metallurgical coal assets. Management believed it was a good way to unlock value with the two going concerns having more valuable than a single combined entity. So, it spurned a hostile $22.5 billion takeover offer by Swiss mining giant Glencore Plc.

Some large shareholders thought differently. Initially, in exchange for the coal assets, Elk Valley was to make quarterly royalty payments to Teck Metals as well as preferred share redemptions.

The royalty was payable until $7 billion had been made or Dec. 31, 2028, whichever came later. The preferred shares had an aggregate $4.4-billion redemption amount and a 6.5% cumulative dividend.

Teck later revised the terms, reducing the minimum term of the royalty from approximately 5.5 years to 3 years. 

For now, Teck is revising its plan and it can expect a sweetened offer from Glencore and perhaps other players. The latter happened last week when a Canadian mining industry veteran made an offer to buy Teck’s coal business for $8 billion in a bid to thwart Glencore.

The takeover interest has pushed Teck’s shares 25% higher in the past month.

History suggests Teck management was right in thinking that dividing the company into two was a good idea. Studies have shown that spinoffs are good for investors. While not all spinoffs outperform, many do.

Unlike initial public offerings where the companies are new and untried, spin-off businesses are usually well developed with a track record, as is the case with Teck. The parent companies are often the biggest shareholders – also Teck’s plan – and so have an incentive for the spinoffs to succeed. The new companies have experienced management who can be nimbler once they are out from under the bigger umbrella.

Some high-profile spinoffs in the last decade include eBay’s spin-off of Paypal, Expedia’s of TripAdvisor, and drug manufacturer Abbott Labs of AbbVie. Pfizer Inc. has several under its belt including Zoetis Inc., which was once its animal pharma unit. These have all done well.

This year, General Electric Co. (NYSE: GE) listed shares of GE Healthcare Technologies Inc. (NDQ: GEHC) as the first part of its plan to split into three pieces. GE is keeping 80% of GE Healthcare with the rest given to GE shareholders in a tax-free distribution. GE Healthcare has revenues of US$18 billion and makes medical equipment including X-ray, mammography, and ultrasound machines.

The shares are 20% higher than their IPO price. They were recommended in last week’s issue by contributing editor Glenn Rogers.

Johnson & Johnson (NYSE:JNJ) is spinning off its consumer products division later this year and will also keep 80% of the renamed unit, which will be called Kenvue.  Kenvue has US$15 billion in revenues and markets such over-the-counter brands as Band-Aid, Listerine, and Tylenol. J&J wants to separate these slower growth product lines from its drug development efforts.

Along with the opportunity comes risks, so a case-by-case evaluation is important. You should ask why the spin-off is occurring. Is it to unlock value or a fire sale to raise cash for failing operations? Can the new company attract the talent it needs, and does it have sufficient financial resources? Closer scrutiny by investors means more share price volatility. Mistakes that might go unnoticed in a conglomerate become magnified.

Telus International Inc. (TSX: TIXT) was spun off in 2019 from parent Telus Corp. TIXT provides IT and customer service to such companies as Uber and Fitbit, moderating online content and providing customer service via chat robots. Its shares surged after the IPO to $48 but at the current price of $28 are 40% below that mark.

IBM Corp.’s spinoff of Kyndryl Holdings Inc. (NYSE: KD) in 2021 has been far worse. Kyndryl also offers IT services and from a launch week high of US $40.75 in October 2021 it is trading at $14.30 at time of writing, a decline of 69%. 

For investors who want to play the spin-off theme, there is one exchange traded fund (ETF) to look at. The former Guggenheim Spinoff ETF is now the Invesco S&P Spinoff ETF (NYSE Arca: CSD).  It has US$53 million in assets and invests 90% of its holdings in the S&P US Spin-Off Index. The index is composed of companies that have been spun off within the past four years.

The ETF’s top holding is GE Healthcare followed by Constellation Software, and Otis Worldwide, the elevator company. The fund is up 8% year-to-date and 27% over the past three years.

Finally, one more thought about Teck. If Glencore is the winner, Teck shareholders may yet get their spin-off. That’s because it proposes to fold Teck into its operations and then split Glencore in half. One company would hold the coal operations (both steelmaking and thermal) which the other would own the metals mines of both companies.

If this should come about, Teck investors have the potential for a long-term gain. But rumbles from Ottawa suggest there will be some political hurdles to jump if talks get serious.

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