On November 1, 2011, White Plains, New York-based ITT Corp (NYSE:ITT) executed a three-way split that created two new publicly-traded companies. ITT’s water-services division was spun off and re-branded as Xylem Inc (NYSE:XYL) . Meanwhile, its “defense and information solutions” division was spun off and re-branded as ITT Excelis . This defense-relations firm later dropped the “ITT” from its name. Since the split, the performance of the original company has slightly exceeded that of the broader market. By contrast, the two spin-offs have produced volatile and ultimately mediocre results.
Xylem produces basic machinery and infrastructure for water utilities and distributors in North America, East Asia, Europe, South America and the Middle East. The company’s utility-services division produces large-scale infrastructure items like waste-water treatment tanks, holding tanks, transmission pipes, filtration and disinfection devices, quality-testing equipment, and various types of control mechanisms like valves, pumps and joints. Xylem’s “applied” division primarily focuses on household-level infrastructure like pumps, heaters, piping and dispensers. It also produces irrigation equipment and certain other industrial products. Xylem employs about 12,500 people and earned $276 million on revenues of $3.8 billion in 2012.
ITT Corporation is a diversified materials company that manufactures and distributes various types of industrial and infrastructure-related equipment. After the spin-off, it owns four principal divisions. The company makes a wide range of pumps, drills, valves, fracturing devices, centrifugal pumps and petrochemical storage tanks for the energy-extraction and petrochemical industries. It also builds drills, wells, blasters and specialized vehicles for various ore miners. Finally, ITT engages in the production and sale of various fabrication devices as well as large-scale components for factory-floor machinery and vehicles. The company employs nearly 9,000 people and lost $458 million on $2.2 billion in gross revenues in 2012. It is important to note that this financial performance reflects the lingering effects of the recent split.
Headquartered in McLean, Virginia, Excelis is a diversified defense contractor that manufactures mainframes, communications devices and other technology solutions for various branches of the U.S. military. The company also produces cutting-edge reconnaissance devices and long-distance surveillance equipment that enables military personnel to monitor real-time “hot zone” events from remote locations. Excelis maintains encrypted communications networks, designs satellites and sells airborne surveillance devices. It also assists with space launches and provides ongoing support for various radar and sonar systems. Excelis employs over 20,000 people and earned $308 million on revenues of $5.6 billion in 2012.
How the Deal Was Structured
Under the terms of the dual spin-offs, ITT’s stock underwent a two-to-one reverse split. The company’s October 17, 2012 shareholders of record received one share of Excelis and one share of Xylem for every ITT share that they owned before the reverse split’s effective date. Xylem began trading at $25 per share. Excelis debuted at $12 per share. Meanwhile, ITT’s stock price declined sharply on its first post-split trading day and closed below $19 per share.
Post-Deal Performance
These three companies have performed unevenly in the wake of the spin-off. ITT shareholders have done fairly well: From its post-split low of $18.80 per share, the company has climbed to close near $26.50 as of mid-February of 2013. This represents a market-beating premium of about 41 percent.
Meanwhile, Xylem’s shares have swung wildly between a high of $28.73 per share and a low of $23 per share. It now sits near $27.50. Relative to its post-split debut price of $25 per share, this represents a premium of 10 percent. For comparison, the S&P 500 rose by more than 20 percent during the same period of time.
Excelis’s performance has been somewhat disappointing. From its debut price of $12 per share, the company’s stock has ranged between a high of $12.86 per share and a low of $8.34 per share. As of mid-February, it sits near $11. This represents a discount of slightly more than 9 percent in actual terms and nearly 30 percent relative to the broader market’s performance.
Long-Term Outlook and Likely Outcomes
It is important to note that Excelis’s long-term share price movements are likely to be affected by looming budget cuts to various U.S. defense programs. In fact, anticipation of these cuts has been a principal cause for its relative weakness since the spin-off. Along with other defense contractors like Northrop Grumman (NOC) and Raytheon (RTN), Excelis relies on the U.S. government to fund the bulk of its activities. While the company’s survival is not yet in question, it is clear that an extended period of military budget cuts would take a substantial chunk out of its bottom line.
Meanwhile, ITT looks poised to re-position itself in the wake of the split. Since the financial crisis, the company has struggled to keep up with its more nimble competitors. With the dual spin-offs now safely in the past, ITT’s investors have already rewarded its management team with a 40 percent stock-price boost. With a decent amount of cash and no debt on its books, this company looks like a prime investment target.
Of these three companies, ITT looks like the strongest short-term bet. However, Xylem offers an interesting long-term play on the future of the global water-delivery industry. As the planet’s population increases, sources of fresh water will become scarcer and dirtier. As a purveyor of large-scale storage and filtration systems, Xylem is well-positioned to take advantage of this trend. If this thesis is correct, Xylem’s shares look very cheap at these levels. Long-term investors would do well to take note.
The article Bumpy Ride After the Spinoff originally appeared on Fool.com and is written by Mike Thiessen.
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