T. Boone Pickens loses in federal court

I’ve been watching the career of oilman T. Boone Pickens since I picked up coverage of his Amarillo, Texas-based Mesa Petroleum as a rookie analyst in 1979.

Always a showman, Mr. Pickens was, in my view, at best a middling oilman, but he was a brilliant user of financial engineering.  For example, when Mesa had bought a large swath of Gulf Coast drilling rights that turned out not to contain much oil and gas–only enough to recover costs–Pickens borrowed an idea from nineteenth-century steel companies and spun the dud properties off to shareholders in a royalty trust.

Placing them in the hands of income-oriented investors gave them a value they would never have otherwise had.  The action spruced up the financial metrics of the slimmed-down Mesa, to boot.  And Pickens successfully cast the move as the caring response of a powerful oil company to shareholder needs–which, in a sense, it was.

His latest foray into fund-raising for athletics at his alma mater, Oklahoma State University, however, is a little weird.  According to the Wall Street JournalPickens and OSU decided to insure the lives of 27 elderly alumni for $10 million each, in a program named “Gift of a Lifetime.”  OSU would pay the premiums and be the beneficiary.  The idea was apparently that if the participants died faster than the insurance company actuaries figured, OSU athletics could gain up to a quarter-billion dollars.

A fly in the ointment   …those old Cowboys refused to die.  (Actually, if the WSJ figures are correct, the entire group would have had to pass away within two years for the fundraising effort to have a $250 million “profit.”)

After two years and $33 million in premiums paid, the program ran out of money and allowed the policies to lapse.  Then Pickens and OSU sued the insurer, Lincoln National Life, claiming fraud and demanding its premiums back.

The whole odd story came to light when a Federal Appeals court last week upheld the verdict of a lower court in favor of Lincoln.

Strange   … and how the mighty have fallen.

spinoffs: sometimes toxic, sometimes hidden gold

The March 12th edition of the New York Times’ excellent Dealbook section has an article written by Buckeye professor Steven Davidoff, titled “In Spinoffs, a Chance to Jettison Liabilities.”  It’s well worth reading.

spinoffs

In it, Mr. Davidoff documents how in a spinoff ( which is when publicly listed companies separate out a chunk of themselves into a separate legal entity, whose shares they then distribute to existing shareholders) the parent companies sometimes have ulterior motives.  (…shocking!)

being left behind on an ice floe

Many times, such “spinoffs” are businesses the parent wants to sell but can’t find buyers for.  They often are loaded up with a disproportionately large amount of the company’s debt.  Sometimes the spinoff is even forced to take out new loans and turn the proceeds over to the parent before it’s launched.  Davidoff gives lots of examples.

One of my favorites is the case of Monsanto, which spun off its industrial chemicals and fiber operations as Solutia, to get rid of liabilities relating to its production of PCBs.  It later spun off its agricultural businesses as the “new” Monsanto, retaining its pharmaceutical businesses in the parent, which was renamed Pharmacia.  Spinoff Monsanto was forced to agree to compensate Pharmacia for any losses it might suffer from Solutia-related litigation.  Sort of like a belt and suspenders.

three points

–None of this spinoff-unfriendly activity takes place completely in secret.  Somewhere in the SEC filings all of the potential bad stuff is disclosed.  Don’t expect it to be to be highlighted in LARGE print and a bold typeface.

There is a quick and dirty way to help focus your attention, though.  See where the current CEO is going end up.  There’ll never be potentially toxic liabilities there.  Look at the other parts of the deal.

–Not all spinoffs are disasters waiting to happen.  There’s a legitimate case to be made against conglomerates.  If a company has, say, two unrelated businesses, one which generates tons of cash flow but has few growth prospects, and a second that has huge growth opportunities, it may make sense to separate the two.  Income investors will bid up the price of the first, growth investors the second.  The sum of the two parts can be worth much more than the original conglomerate.

Sometimes, too, a small growth business can be lost in a much larger entity and starved of capital.  Spinoff will allow it to flower.

Two things to look for:  in my experience, it’s a good sign if the spinoff is relatively small and doesn’t “fit” with the rest of  the firm (think:  Sara Lee and Coach).  Also, it’s a plus if the parent retains an interest in the spinoff.

–There’s a perverse, human nature aspect to the spinoff game.

A captain, dying to get his own ship–even if it is rapidly taking on water–may be unduly optimistic in talking about his new command.

On the other hand, if you’re a shrewd businessman, once you learn your division is going to be spun off–usually at least a year, maybe two, in advance–you know there’s no sense in shining up the business any more until it’s its own public entity.  Improving your business pre-spinoff only makes your post-spinoff job harder!!  Best just to go on vacation for a while.  The result:  a “good” spinoff can be shockingly good in the first few years.