Corporate spinoffs offer the potential for substantial returns in a relatively short period, often without any regard to market direction. Whether the spinoff is directed by an activist investor -- as in the case of Bill Ackman and Fortune Brands -- or is a management-led spinoff -- such as the recent split-up of ITT (ITT) -- spinoffs provide fertile hunting ground for the opportunistic investor. Knowing what to look for and how to think about the company pre- and post-spinoff is the key element in exploiting this special area of investing.
Real Money readers may want to look closer at Carrols Restaurant Group (TAST), a small-cap that's probably not on the radar of many folks. Carrols is a $220 million company that owns and operates about 550 restaurants -- 303 Burger King restaurants and 247 Mexican restaurants under the Pollo Tropical and Taco Cabana names.
Earlier this year, the company announced its intent to split the company into two separate businesses. This transaction will occur by way of spinning off the Mexican brands into a separate publicly traded company to be named Fiesta Restaurant Group. The spinoff is expected to be completed early in the first quarter of 2012.
Management's rationale for the spinoff is an intelligent one: separate the fast-growing Mexican brands from the more stable, slow-growing Burger King chains. The value proposition from the spinoff is also a simple one. Carrols currently commands an enterprise value of $464 million, or about 6x 2011 EBITDA of $75 million. Same-store sales at Burger King have been declining since 2008, while growing nearly 10% for the Fiesta restaurants. In 2011, the Fiesta restaurants will account for nearly $65 million of the $75 million in EBITDA that Carrols will earn in 2011.
In anticipation of the spinoff, Carrols recapitalized the balance sheet so that after the spinoff, Fiesta will have about $200 million in debt, while the new Carrols, which will control only the Burger King restaurants, will have $65 million in debt.
For comparison, Wendy's (WEN), which continues to struggle operationally, currently trades at 8x EV/EBITDA, as does Jack in the Box (JACK), which owns the popular Qdoba Mexican chain. On the other end of spectrum you have Chipotle Mexican Grill (CMG) trading at 25x EV/EBITDA.
With sales and EBITDA growing by 10% at Fiesta, one can conservatively apply a multiple of 8x to 10x EV/EBITDA. In that same spirit, a 7x EV/EBITDA multiple for the Burger King operations is very acceptable. Assuming 2011 EBITDA of $60 million for the Fiesta business, the enterprise value would be $480 million to $600 million. At a $480 million EV, the market cap of Fiesta is $280 million. For the Burger King business, 2011 EBITDA of $15 million translates into an enterprise value of $105 million, or market cap of $40 million when you strip out the $60 million in debt.
The separate market caps of $40 million and $280 million equal $320 million, compared with Carrols' current overall market cap of $215 million, representing a near 50% upside that could occur within three to four months, or an annualized return of 150%-200%.
Of course it's likely that these companies will not be valued this way immediately after the spinoff. After all, the Burger King business will be a micro-cap company that may get little attention. Even Fiesta will be a small-cap that may fly under the radar. However, over time, the great growth story from the Mexican concepts will be the company's own catalysts. Fiesta alone is worth more than Carrols; the separation from Burger King will give growth investors an opportunity to own the growth story.
Overall, this spinoff offers a favorably skewed outcome. At worst, the two separate companies trade for today's current valuation; at best, you have an opportunity to pick up a possible 50% or more upside in as little as three months.
