I have a great tech opportunity I want to share with you today.
You can almost think of it as “free money.”
And that isn’t some “come-on.’ The strategy that I’m about to describe is very real. It’s a slam-dunk winner – backed up by years of statistics – and, most important of all, is one way to really juice up your portfolio gains.
When the scenario plays out as I’m about to describe, you buy shares in one great technology company – but end up with investments in two separate firms.
And that second stock is “free.”
Investment pros refer to these as “special situations” – and with good reason. Opportunities like this don’t come along very often – which is why they are, in fact, “special.”
But individual investors tend to miss them – and the market-thrashing profits they tend to generate.
I don’t want you to miss out – which is why I’m writing this.
You see, one of these “two-for-one” profit plays has just hit my radar screen.
And today I’m going to tell you everything you need to know about it …
The Most Special of “Special Situations”
On Wall Street – and here in Silicon Valley – the term “Special Situation” is a catch-all phrase that includes such unique profit opportunities as IPOs, turnaround plays, buyout targets … and even stock “spin-offs.”
Strictly speaking, these investments don’t always follow the rules I have laid out for you in the past as part of my five-part system for building wealth through tech investing.
But that doesn’t mean we should ignore them.
Far from it, in fact. Special situations are “occasional” profit opportunities. But given the gains they can generate, I’m all for capitalizing on them whenever we can.
And there’s a spin-off opportunity that we need to start looking at right now.
Let me start by explaining how spin-off investing works.
Let’s say a big-cap tech firm believes it can operate much more efficiently as two independent companies. That means the senior execs believe there is extra value “hidden” in both the parent company and the unit they want to take public as a stand-alone firm.
In a case like this, engineering a spin-off to separate the two firms will enable the parent company to restructure its operations and become leaner and more focused – a process that will free up additional value for the existing shareholders. This maneuver also untethers the newly independent unit (now known as the “spin-off company”) from the bureaucracy that often comes with being part of a huge enterprise.
What typically happens in a case like this is that the company then creates and issues new shares of stock for the spin-off firm – and then presents those shares to its current stockholders. That second (“spin-off”) firm is now a public company, and you now own shares in both firms.
And you didn’t have to pay a single dime for the new company’s stock.
(In most cases, you also don’t incur any income-tax liability. With most spin-offs – before the actual transaction takes place – the parent firm typically confers with the IRS and structures the spin-off in such a way to keep from creating any tax liabilities. These transactions are formally known as “tax-free spin-offs.”)
For the companies involved, the completed spin-off transaction is the goal … is the end of the road.
For investors like us, however, the spin-off is just the start.
And the story gets even better from here …
In spin-off situations, you see, research shows that both stocks – the parent firm and its newly minted offspring – tend to outperform the broader stock market … and by a big margin. And within a few short years, many spin-off firms are taken over, often at substantial premiums to where they were trading at the time.
And all of this puts big money in your pocket.
In a moment, I will walk you through the real-world mechanics of how this process worked with one of my favorite spin-offs. Then I’ll tell you about one that’s set to occur at a company I have followed for years that already is a great tech stock in its own right.
But first, I want to back up the assertions I’ve made with some concrete numbers.
Over the years, several institutional investors and major universities have studied the impact of spin-off-related deals. Turns out, shareholders often score big. Very big.
A study by Lehman Bros. found that spin-offs typically outperform the market in their first two years by as much as 40%.
Two professors at Penn State University looked at 30 years of market data covering 174 spin-offs. They found that in the first three years of operations, these new independent companies showed price appreciations of 76%, beating the Standard & Poor’s 500 by 31%.
Ironically, the new firms often get off to a slow start. In their first year of operations, the new firms had an average return of 18%.
By that measure, a recent drug industry spin-off that is one of my favorites is going gangbusters.
Since they began trading at the beginning of this year, shares of AbbVie Inc. (NYSE: ABBV) are up about 25%. That’s almost a 100% premium to the gains generated by the overall stock market so far this year.
AbbVie used to be a part of drug giant Abbott Laboratories Inc. (NYSE: ABT). With a market cap of $69 billion, this is a well-diversified firm. It has products for nutrition, vision, animal health, diabetes care and diagnostics.
It has some great brands in its portfolio. Take the case of Humira. It’s the world’s leading drug for treating rheumatoid arthritis. Lupron ranks as the top hormone therapy for advanced prostate cancer. Synthroid is the No. 1 prescribed drug for thyroid disease.
So, if you were an Abbott shareholder of record last Dec. 12, you got access to this great lineup at no cost. When the split occurred, shareholders automatically got one share of AbbVie for each share of Abbot they owned.
That brings us to the potential spin-off play that I want you to put on your radar screen.
The Stock I’m Watching
Senior executives at data-storage leader EMC Corp. (NYSE: EMC) hope to have the same kind of success with a high-profile spin-off they undertook last April.
Known simply as Pivotal, the new firm is a play on the red-hot trend of cloud computing. We’ve talked great deal about “The Cloud,” the tech-sector term for data management, network-delivered software and other hosted network services.
I’ve looked at the business model for Pivotal – as well as the venture’s forecasts – and I see a lot of upside.
Last year, Pivotal had sales of $300 million. But EMC’s top leaders believe the business can more than triple to $1 billion in five years. How many tech firms can you name that can boast that kind of near-term, top-line growth?
Not many … And those that do are privately held, and are making venture capitalists and other institutional investors rich – meaning retail investors won’t even be able to get close.
Pivotal would be an exception.
The one caveat here is that we’re very early and the mechanics of the spin-off remain murky. EMC hasn’t announced a timetable for the divestiture. Nor has the company detailed how its existing shareholders get stock in Pivotal.
But if anyone knows the ins and outs of these kinds of deals, it’s EMC. In roughly the past decade, the company has integrated more than 70 tech firms in an acquisition spree totaling some $17 billion, slightly more than it spent on R&D in the period.
That’s just one of the reasons I think you should at least put this opportunity on your radar screen. More to the point, EMC itself has a lot of underlying strength.
EMC ranks as a global leader in data storage products that are integral to cloud technology. The firm also sells infrastructure services that include storage and data backup.
And talk about a cash machine…
EMC generates free cash flow of nearly $4.3 billion a year. Indeed, the company recently announced its first quarterly dividend, initially pegged at 10 cents a share. It also has increased its share buyback program by 500% to $6 billion.
With a market cap of $51 billion, it still has a ton of growth ahead.
At the same time, the stock is dirt cheap.
EMC has a “PEG ratio” (Price/Earnings to Growth Rate) of 0.99. A PEG ratio of 1.0 or less shows excellent prospects for growth. The stock trades at $24 a share with a forward P/E of 12.
I project an 18% annual earnings growth rate. That means profits could double in about four years.
That means that EMC – even without a spin-off – is the kind of company I tend to search out for you. For investors seeking to turn the average U.S. net worth of $25,000 into $250,000 or more, it will take opportunities like this.
But when you factor in the chance of getting two firms for the price of one, spin-off stocks may just help you get where you need to be … but twice as fast.
[Editor’s Note: I always enjoy reading and responding to your comments, questions and suggestions. So, post a comment below. I look forward to hearing from you!]