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Welcome to Episode 29 of Special Situation Investing
Today’s episode will be brief and will cover the spin-off that wasn’t and the bankruptcy that crushed it. We begin with Office Depot’s botched spin-off and end on a high note with Garrett Motions continued success. So without further delay let’s get into it.
Way back in January, in episode 5, we covered Office Depot’s pending spin-off of its retail division along with their planned sale of CompuComm. Based on the information we had at the time it looked like a potential double from a low forties stock price. Office depot had already received offers up to $2 billion for the retail division which alone would have brought in as much cash as the companies total market cap and would have left the remaining B2B division well capitalized to pivot the company in a new direction. In the ensuing months the company courted other offers for their retail division and spent some of there cash reserves to separate the two divisions and prepare for the spin-off. All of this leads us up to last weeks announcement from Office Depot that they’ve completed the “realignment of their operating business entities to better serve customers” which they did by canceling the spin-off that they’d spent the better part of a year selling to investors.
This is the first time I’ve seen such a fully developed spin-off get canceled altogether and quite predictably the stock gapped down on the news Monday morning trading as low as the high twenties for a period of time. Office Depot left open the possibility of a future spin-off in their most recent announcement but now it remains for the individual investor to determine whether or not to hold the stock in hopes that the company follows through or sell and move on to better opportunity. I for one haven’t decided what to do with my shares. I guess I’ll wait for the shock of the news to wear off before I make my next move.
With that painful update out of the way let’s move on to better news. Garrett Motion once again announced that not only are they on track but they’re ahead of schedule in normalizing their capital structure. Garrett announced this week that they plan to fully redeem their series B stock in full on 28 June. As a reminder the series B stock was their 800 million liability to Honeywell that came out of last years bankruptcy proceedings. Rather than stick to the planned payback schedule which would have allowed for minimum payments into the 2030s the company absolutely crushed their repayment plan. To illustrate just how aggressive the re-payment was consider the fact that the company started trading post bankruptcy in October of 2021 and that next week only eight months later they will have re-payed an 800 mm debt to former parent Honeywell. This means that a 500mm market cap company payed off 160% of its market cap over an eight month period, which is incredible. During my last update on this company I predicted that they might pay the debt off within a year but to hear that they’d accomplished the feat in just eight months blew me away.
Now, with the Honeywell debt re-payed what’s next for Garrett. First off they will probably look to convert the series A preferred stock into common. This would allow the company to stop the series A dividend from accumulating unpaid and draining their capital. If your remember from our previous episode on Garrett Motion the series A preferred pays an 11% dividend that accumulates even if it’s unpaid. Garrett estimated in their recent SEC filing that the unpaid dividend currently owed to series A shareholders amounts to about $171 mm. There are roughly 220 mm shares of series A outstanding at this time which indicates a pending dividend of about .77 cents per share. GTXAP shares trade in the low $8 dollar range at this time.
Because every quarter with the series A shares outstanding costs Garrett in the form of dividend payouts I contend that the companies next move will be to pay the back dividend on the stock and convert it to common shares. The next dividend pay date is 1 July with 1 Oct the next pay date after that. Again, given the fact that the company is producing such strong free cash flows along with the fact that each dividend payment costs the company some of those cash flows I wouldn’t be surprised if they elected to payout the dividend in July or October and then move to convert the series A preferred. Once the conversion is complete the company should begin trading closer to its peers in the turbo charge industry.
We’ve covered this before but Garrett’s closest comp is BrogWarner with 5 billion in debt, 1.3 billion in operating income, and a 8.5 billion market cap. Garret Motion has about 1 billion in debt, 500 mm in operating income, and a 500 mm market cap. Understand that the market cap is closer to 2.3 billion when you add the 260 mm in preferred shares that trade in addition to the common shares. In any case Garrett is trading at close to 4x operating income while Brog is trading at 7x operating income and with a higher debt load. If Garrett Motion is revalued in line with BrogWarner then I’d expect about a double in the share price from here along with the dividend payout for series A preferred shareholders.
Well that does it for today. I hope that you got something out of the bad news as well as the good and that you learned something about stock valuation in the process. We will be back again next week with another episode or update.