Why I passed on Honeywell's spin-off GTX

Since Joel Greenblatt popular book came out, investors have been turning over every spin-off in search of profits. Lately the activity has turned into a fever to invest in every spinoff, replete with (totally expected) launch of ETFs that will allow one to do just that. Studies that show spin-offs outperform the indices have been used to push these ETFs. Yet, those studies have not looked at what happens when everyone chases spin-offs. I suspect the future results from blindly buying spin-off may not be as good as past results, though they can be decent. This is all simply a long way of saying that investors must study each spinoff thoroughly to determine whether it’s likely to succeed (or even survive) on its own merits.

Investors in Garrett (GTX) the coming spinoff from Honeywell (HON) might benefit from doing the same. Suppliers to ICE autos have recently traded at low multiples due to fears of EVs, automation, peak auto cycle, etc. I am not an expert in this industry so I am unable to comment as to its future. There are many views on the issue (EV’s will not happen, they will happen slowly, automation will happen next year, or it will never happen, etc.) and I don’t know which one is correct. But Buffett, did once say that you don’t have to know exactly how much a man weighs to know if he is fat. In that vein of thought, one thing stood out to me from the GTX Form 10 and their investor day presentation.

The leverage, as presented in the investor day presentation (as well as the form 10), is not appropriate for use by equity investors and understates valuation.

The Form 10 Adjusted EBITDA adds back the legacy asbestos liability payment to Honeywell (related to Bendix). Presumably this document is directed to equity holders. On the other hand, in the credit agreement Adjusted EBITDA, this payment is not added back. Correspondingly, the credit agreement numerator does not include the present value of that liability. This indicates debt holders think of the asbestos cash outflows as not available for principal and interest payments (i.e. coverage has to be provided by after-asbestos cash flows). Thus, leverage is calculated off the lower EBITDA and the lower numerator. While this may be okay for the creditors, it’s certainly misplaced in the equity roadshow (investor day presentation).

To the extent Adjusted EBIDTA provided in the Form 10 adds back the asbestos payments, equity holders ought to recalculate the leverage ratio including the present value of such payments ($1.4 billion) in the numerator. All of these payments are ahead of equity holders. In fact, the asbestos liability, with a maximum annual payment of $175mm on a PV of $1364mm, is perhaps the most expensive of GTX’s ‘debt’. The recalculated leverage would be 4.8x v/s 3.25x presented on investor day.

Many of GTX's peers trade at a total EV/EBITDA multiples close to GTX’s leverage level alone (including the asbestos liability as noted above). This means Honeywell is getting paid full value of the business (through the dividend now and the continuing asbestos payments) in cash, leaving behind a highly leveraged business. With reference to the Buffett quote above, this man does not look fat! While that alone is not a sufficient reason against investing in GTX, it certainly was a quick way for me to move on to something else (given lack of industry specific knowledge). It appears the spin-off is designed more to benefit Honeywell by providing earnings boost to the parent by pick-pocketing the child. This history of these types of spin-offs has not been good.

Why make a post about something where I passed on investing? First, one of this blog’s purposes is to serve as a store of my thought processes which I can go back to later to see if I was right or wrong and to learn what could have been done differently. Second, this blog has very few other readers (to my knowledge) so I tend not to write with a particular audience in mind who might like to hear about this or that investment idea. I simply write my thoughts which does some include investment ideas but also includes other items I find interesting.

Disclosure/Disclaimer:

Under no circumstances should this communication be construed as investment advice or a recommendation to buy or sell any security, whether expressed or implied. Factual statements are believed to be truthful and reliable, but are not warranted against errors or omissions. Please do your own due diligence prior to investing.

Tom Rutledge's (CHTR) Widely Reported Equity Award Quantified

In the last two years, any discussion of Charter (CHTR) has not been without reference to the equity incentive package issued to the senior management team of the company in 2016. Greg Maffei has spoken about it to anybody who will listen (which is a lot of people because Maffei has a good track record as an investor). Seeking Alpha/VIC/COBF/etc. posts have also referenced it. But I had yet to see it quantified. Of course, there’s the headline figure of $99 million for Tom Rutledge (CEO) from the 2016 proxy statement. But serious investors know that the Summary Compensation Table in the proxy statements tells us almost nothing about the reality of compensation plans.

To really understand things, I’ve tried to make sense of that particularly large equity package granted to the management team by quantifying the pay-outs to the CEO in the event of the stock price reaching various thresholds. The results are in the following table:

Note:

I have calculated the payout at each threshold assuming Rutledge exercised all of his options at that threshold. So, for example, the 364.97 threshold assumes that options vested at 289.76 are also held and exercised (or exercised and stock held) at 364.97 per share.

It could, just as easily, be argued that the decision to hold from 289.76 to 364.97 is Rutledge’s own investment decision unrelated to any equity incentive envisioned by the BOD. However, it could also be argued that, if he believed in these targets, there is no reason he wouldn’t hold as many options as he could as long as he could. In that case, to see the maximum upside to Rutledge, we must assume that he does hold these options.

In reality, he likely does not have the type of additional liquid funds required to exercise the options, hold the underlying stock, and to pay taxes thereon. So readers can make their own changes to the calculation as needed. There are too many permutations and combinations for me to address them all here. The conclusion remains that this award package should serve to incentivize Rutledge rather well. Perhaps, more than well.

There are also further small equity awards/grants, but I have only attempted to quantify the large award from 2016 which is the largest portion of Rutledge's compensation 2016 onwards.

Disclosure/Disclaimer:

I own shares of CHTR (through LBRDK). Under no circumstances should this communication be construed as investment advice or a recommendation to buy or sell any security, whether expressed or implied. Factual statements are believed to be truthful and reliable, but are not warranted against errors or omissions. Please do your own due diligence prior to investing.