What to Do When Your Dividend Stock Spins Off a Business

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For those of you currently holding shares of Abbott Laboratories (NYSE:ABT), Kraft Foods (NASDAQ:KFT) and United Online (NASDAQ:UNTD), you’ve got a decision to make in the foreseeable future — particularly if you’re holding those stocks to collect dividends.

With all three names prepping for a spinoff, the picture might feel a little murky as to what will happen to the payout once the spinoff is complete. Don’t sweat it, though, as history gives us a little clarity about where the dividend’s going before, during and after the process.

Not That Big of a Deal

Although not quite as common as an acquisition, we’ve seen dividend-stock spinoffs before — recent ones — with little to no headache or stress.

Take ConocoPhillips (NYSE:COP), for instance. Prior to April 30 of this year, Phillips 66 (NYSE:PSX) was under the ConocoPhillips umbrella. Though Phillips is a refinery and pipeline (midstream) operation while Conoco is an exploration and production player, the relationship was functional. In fact, in many of the obvious regards, the relationship was complementary. More important to income-hunters, the typical dividend yield of more than 3% when the two outfits were working in tandem wasn’t too shabby, either.

This is one of those cases, though, where the sum of the parts is greater than the whole.

The company’s management felt each division would be better served by operating independently — especially the exploration and production side (Conoco), an industry generally valued at higher multiples than refiners. So, the split was made, and the dividend payout was affected. Now, explorer ConocoPhillips yields a stronger 4.7%, and the refiner/pipeline name Phillips 66 yields a weaker 1.9%. Both companies pay about 20% of their cash flow as dividends, but Conoco is clearly the stronger earner.

Defense contractor Exelis (NYSE:XLS) and water-management firm Xylem (NYSE:XYL) also are recent spinoffs, put into play by former parent company ITT Corporation (NYSE:ITT).

The energy and industrial infrastructure maker’s CEO, Steve Loranger, decided that “each new company will be more nimble and able to build stronger, more intimate customer relationships to accelerate mutual success.”

More important, the move broke the company up into pieces that clearly fit into one style category or another. Exelis is yielding 4%, but with a slightly dwindling top and bottom line. ITT is only paying out a dividend of 1.8% of the current share price, but revenues recently grew by 11%. Xylem only pays 1.7%, but with an 18% increase in last year’s top line, it could almost be considered a growth stock … where dividends don’t matter at all.

By breaking the company up into its distinctively different divisions, investors were able to pick and choose which enterprise made the most sense to them. And, given how different those three business are, it’s not tough to believe they’re each better off by operating separately from the parent.

Likely Outcomes

So what might the ITT and ConocoPhillips spinoffs tell us about the pending spinoffs for Abbott, Kraft and United Online?

First, they suggest that spinoffs do indeed unlock different kinds of value for different kinds of investors. Second, however, they imply that the new enterprises tend to look and act a lot like their peers. As an example, defense contractor Exelis pays a dividend comparable to group peer General Dynamics (NYSE:GD), while refiner Phillips 66 yields as weakly other refiners.

With that as a backdrop, we can make some basic assumptions about what’s in store for the three big spinoffs coming later this year:

Abbott Laboratories: This big health care company is slated to split into two pieces. One of them will focus on the more challenging but more lucrative pharmaceutical business, and has been named “Abbvie.” The other company will retain the Abbott name, and focus on squeezing the most it can out of the (fairly) reliable medical devices, generic drugs and diagnostic equipment markets. If either division is going to remain dividend-friendly, it’s Abbott.

Kraft Foods: It’s a little bit ironic that Kraft is scheduled to spin part of itself off, in that Kraft was the spin-ee just five years ago when parent company Altria (NYSE:MO) saw a break as the best way to unlock the respective values of the food business and the tobacco business. Now the food division is poised to further split itself into an international snacks division — called Mondelez — and the more familiar packaged foods division.

The growth side of the business will be Mondelez, which likely will not pay a great dividend, but should grow like crazy as emerging markets start to open up. The grocery side, being a cash cow, is expected to pay an even better dividend than the stock’s current yield of 2.8%.

United Online: Feeling it holds down the enterprise’s overall value, United Online has opted to split its revenue-bearing websites apart from florist support service FTD.

This one is the trickiest of the three spinoffs to get a bead on. FTD accounts for about two-thirds of the company’s revenue and earnings, but it’s the other businesses like NetZero and Classmates.com that provide the reliable recurring revenue commonly seen with strong dividend payers. Odds are FTD will be better equipped to keep paying that strong 8% yield, but that doesn’t mean the company is going to use the income in that way. It might try to use the cash flow coming from the web-based businesses to put cash in investors’ pockets, and simply try to grow FTD like crazy by not paying a dividend from its income at all. We’ll all have to wait and see how those chips fall, or even if they fall.

Bottom Line

As far as “what to do now” goes, you don’t have to do anything if you want your current holdings in Kraft, United Online or Abbott to become positions in two distinctively different companies — the spinoff is the default action, and your broker does the re-registration for you. In fact, the only way to avoid the spinoff is to sell your holdings before each spinoff’s date of record.

There is some mental homework to do in the meantime, though. Now that you know what’s likely in the cards for these stocks and their spinoffs, you have to decide which ones (if any) make the most sense for you, your income goals and your risk tolerance.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2012/08/what-to-do-with-these-dividend-stock-spinoffs-abt-kft-untd/.

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