Recent spin-offs coming along nicely

Many studies show that one of the best ways for a company to unlock hidden value is to spin off a subsidiary as a separate company. Shares of the new company sometimes fall in the first few months, as many investors tend to sell their new stock. But over time, both the parent and the spin-off usually outperform comparable stocks.

In the past two years, several of our recommendations have completed spin-offs. All of these new companies have done well. That’s not surprising, since they came from well-managed parent companies with long histories of rising profits.

Here are five recent spin-offs. We like all of them, but only three are buys right now.

GAMESTOP CORP. (New York symbols GME $56 and GME.B $56; Aggressive Growth Portfolio, Consumer sector; Shares outstanding: 75.8 million; Market cap: $4.2 billion; WSSF Rating: Extra risk) sells new and used video game players and software through over 4,600 stores in the United States and 14 other countries.

GameStop was a wholly owned subsidiary of Barnes & Noble Inc. up until February 2002. That’s when Barnes & Noble sold its GameStop class A common shares (one vote per share) to the public at $18 each.

In November 2004, Barnes & Noble handed out its GameStop class B shares (10 votes per share) to its investors as a special dividend. GameStop now wants to convert the class B shares into class A shares, which would improve liquidity. The conversion requires stockholder approval.

In its third fiscal quarter ended October 28, 2006, GameStop earned $0.17 a share (total $13.6 million). The latest earnings included a $3.4 million pre-tax charge on the early retirement of debt, and $5.2 million for employee stock options. In the year-earlier quarter, it lost $0.04 a share ($2.5 million), which included $7.5 million in charges related to its merger with rival Electronics Boutique.

Thanks to the acquisition, sales rose 87.2%, to $1.0 billion from $534.2 million. On a same-store basis, sales rose 8.8%.

GameStop’s business is seasonal, and it earns most of its profit in the two months before the Christmas holiday shopping season.

Thanks to strong demand for new video game systems by Sony and Nintendo, GameStop’s sales in the nine weeks ended December 30, 2006 rose 30.8%, to $1.7 billion from $1.3 billion a year earlier. Same-store sales grew 23.9%.

The new players should also prompt customers to trade in their older games. That’s good news for GameStop, since used games account for around 25% of its sales, but supply nearly 45% of its profits.

The stock has tripled since it first went public, and now trades at 27.3 times the $2.05 a share it should earn in fiscal 2007. That’s expensive in light of growing competition from Wal-Mart and other big retail chains.

GameStop is a hold for aggressive investors.

AMERIPRISE FINANCIAL INC. $59 (New York symbol AMP; Conservative Growth Portfolio, Finance sector; Shares outstanding: 242.0 million; Market cap: $14.3 billion; WSSF Rating: Average) provides financial planning services and products to individuals and institutions. In October 2005, former parent American Express Inc. handed out one Ameriprise share for every five Amex shares held.

As an independent company, Ameriprise launched a national advertising campaign to establish its brand. This seems to be paying off.

In the three months ended September 30, 2006, earnings before unusual items rose 28.8%, to $0.94 a share from $0.73 a year earlier. Revenue rose 5.3%, to $2.0 billion from $1.9 billion.

Ameriprise is shifting its focus away from average investors to wealthier individuals, who tend to generate higher fees. The company is also focusing on strengthening the relationship between its advisors and clients. This new approach should help it hang on to more clients, and give it more predictable revenues.

The company’s insurance businesses are also growing strongly. While demand for its mutual funds is still weak, redemption rates are shrinking. Ameriprise aims to sell more of its funds through banks and other firms, which should improve sales.

The stock has gained about 55% since the spin-off. It now trades at 16.1 times its 2007 profit forecast of $3.66 a share.

However, the financial services industry is highly competitive, and a poor earnings report could lead to a sharp setback. The $0.44 dividend yields 0.7%.

Ameriprise is a hold.

TIM HORTONS INC. $31 (New York symbol THI; Aggressive Growth Portfolio, Consumer sector; Shares outstanding: 191.8 million; Market cap: $5.9 billion; WSSF Rating: Extra risk) operates over 2,600 stores in Canada that sell coffee, donuts and a variety of other foods. The company also operates roughly 300 outlets in the United States, mostly near the Canadian border. Franchisees operate about 97% of its outlets.

The company was a wholly owned subsidiary of Wendy’s International Inc. until March 2006, when Wendy’s sold 17.25% of its Tim Hortons’ shares to the public at $23.16 each.

In September 2006, Wendy’s handed out its remaining 82.75% stake to its own shareholders as a tax-deferred special dividend.

In the three months ended September 30, 2006, the company earned $0.27 a share, down 34.2% from $0.41 a year earlier (Tim Hortons reports its results in Canadian dollars; $1 Cdn. = $0.85 U.S.).

The company blamed the drop on higher taxes and the start-up costs of a new distribution facility. Revenue rose 7.1%, to $413.6 million from $386.1 million.

A big part of Tim Hortons success is its ability to introduce innovative new products. A good example is its iced cappuccino drink, which helped increase summertime sales.

Other products such as submarine-style sandwiches and hot breakfast sandwiches have helped Tim Hortons overtake McDonald’s as Canada’s largest fast-food chain in terms of sales.

Despite strong competition from more-established companies like Dunkin’ Donuts and Starbucks, Tim Hortons aims to open 200 outlets in the U.S. over the next three years.

The stock shot up to $33 on its first day of trading, but fell to $24 in August 2006. It now trades at 26.2 times the $1.39 Cdn. it will probably earn in 2007. The $0.28 Cdn. dividend yields 0.8%.

Tim Hortons is a buy.

WINDSTREAM CORP. $15 (New York symbol WIN; Income Portfolio, Utilities sector; Shares outstanding: 476.8 million; Market cap: $7.2 billion; WSSF Rating: Average) provides traditional telephone services to over 3 million customers, mainly in rural areas across 16 states. It also offers Internet access and business communication services.

The company took its present form in July 2006, when Alltel Corp. merged its telephone operations with Valor Communications Group Inc.

Alltel investors received a tax-deferred dividend of 1.0339267 shares of Windstream for each Alltel share held. The spin-off let Alltel focus on its wireless operations.

Windstream’s main appeal is its $1.00 dividend, which yields 6.7%. Although the phone business is growing slowly, as more people switch to Internet-based services, Windstream’s annual cash flow of about $2.00 a share is enough to cover the dividend.

The company plans to limit capital spending in 2007 to about $0.70 a share, mostly to upgrade its high-speed Internet services. It also hopes to hang on to customers with a new digital TV service.

Windstream’s long-term debt of $5.5 billion is a high 9.1 times its equity of $602.9 million. Many spinoffs start out with low book equity, but lots of goodwill developed internally, which doesn’t appear on the books. This makes their debt-to-equity look worse than it is.

The company now plans to sell its directories operation, and use $250 million of the $525 million proceeds to pay down debt. It will use the remaining $275 million to buy back stock. Windstream’s shares now trade at just 14.3 times the $1.05 a share it will probably earn in 2007.

Windstream is a buy.

IDEARC INC. $31 (New York symbol IAR; Income Portfolio, Consumer sector; Shares outstanding: 146.0 million; Market cap: $4.5 billion; WSSF Rating: Average) publishes over 1,200 white pages and yellow pages directories in 35 states.

The company is the former directories division of Verizon Communications Inc. In November 2006, Verizon spun off Idearc to its stockholders as a tax-deferred dividend of one Idearc share for every 20 Verizon shares held. Idearc has a 30-year deal to supply Verizon with directories, which cuts its risk.

Revenue from directories has weakened in the past few years, as more people use the Internet to locate individuals and businesses. Rising paper and transportation costs have also squeezed profits. But Idearc owns SuperPages.com, a leading online directory.

SuperPages accounts for less than 10% of its revenue, but Idearc’s strong reputation is helping lure print customers to its online operations. Alliances with Google, MSN, and eBay also enhance SuperPages’ long-term prospects.

Another area of growth for Idearc is Spanish-language directories. It publishes over 50 Spanish-English directories, and operates a Spanish-language version of SuperPages.

The stock has moved up steadily from $25 since the spin-off, and now trades at 10.7 times the $2.90 a share it will probably earn in 2007. The company aims to pay an annual dividend of $1.37 a share (4.4% yield).

Idearc is a buy.