Unlocking shareholder value is one thing, but holy valuation! Rockwell International Corp.’s spinoff of Conexant Systems is looking almost embarrassing for the former parent company.
Since shedding its Newport Beach-based semiconductor systems business 13 months ago, Rockwell’s market cap has moved up about $1.3 billion, or 17%, roughly in line with the percentage increases in the S & P; 500 and the Dow Jones Industrial Average. As of late last week, Rockwell’s market capitalization was about $8.9 billion.
But Conexant, whose market cap was only a fraction of Rockwell’s at the time of the split, has seen its stock price rocket more than 1,500%, creating a company with a market cap of $24.9 billion, or nearly three times that of its former parent.
Don’t tell your accountant, but sometimes 1+1 doesn’t equal 2.
Despite the seemingly endless wave of corporate mega-mergers and acquisitions, some companies are growing big by thinking small, or at least smaller pieces. More companies are setting high-growth units free in an attempt to cash in on a tech-infatuated market, including General Motors, which is issuing a tracking stock for its Hughes Electronics division, and Bell Canada, which recently spun off cellular-phone unit, Nortel Communications.
Homegrown Spinoffs
But two of the most dramatic examples are right here in OC. There’s Conexant, and then there’s QLogic Corp.
When OC computer equipment maker Emulex Corp. spun off QLogic in 1994, both companies were small-cap players. Today, Emulex is worth $4.6 billion, impressive until compared to QLogic, which is valued at around $7.4 billion.
Forget unlocking shareholder value. Try “unleashing.”
“The dynamics of the semiconductor business are very different than the dynamics of an electrical equipment company like the rest of Rockwell,” says Mike Barnes, Rockwell’s chief financial officer. “The natural shareholders base for each one is very different, so this was a natural move.”
Still, a Rockwell historian might note sentimentally that while Conexant is a rising star in the hot field of broadband communication, Rockwell, which used to make everything from space stations and B-1 bombers to car parts and printing presses, is today predominantly a manufacturer of machine controls headquartered in Milwaukee, Wis. Nice enough business, but not where the action is.
And the difference in how Wall Street values the companies’ respective businesses shows: Rockwell, while barely a third of Conexant’s market cap, has more than four times the trailing 12-month sales ($7 billion to $1.6 billion) and five times the net earnings ($605 million to $122 million).
Friendly Competition
While one might expect Conexant’s ascension to provoke a trace of jealousy among Rockwell old-liners, the two companies have as much as two-thirds of their shareholders in common, including many employees and management officials, even if Rockwell has no formal stake in the younger company.
“Our employees and management have a real big smile on their faces, because they’ve been made pretty wealthy,” Barnes says, pointing out that his own Conexant holdings number in the hundreds of thousands of shares. “There’s nobody pulling for Conexant more than the employees and management of Rockwell.”
Part of the phenomenon, admit officials at both companies, stems from Wall Street’s ever-changing investment predilections. In the 1980s, conglomerates of completely unrelated businesses were in vogue, under the theory that good performance in one would hedge against not-so-stellar performance in another. And more recently, some have favored “synergistic” match-ups of barely related but complimentary businesses, as evidenced by AOL’s recent purchase of Time-Warner.
Pure Plays
And in the same vein, so-called “pure-play” inclinations of some investors have led many companies to spin off or sell their black-sheep divisions and subsidiaries.
Still, the speed at which Conexant was able to dwarf Rockwell surprised even the most optimistic executives in each company. Part of that, no doubt, is due to the sky-high valuations enjoyed by technology companies these days, particularly those in the Internet sector.
But despite radical differences in valuations given to Rockwell’s electronics and factory automation sector and to the broadband communications chip market Conexant dominates, the boom is far from inevitable. Conexant’s stock hovered in the $8 to $10 range (split adjusted) for nearly three months after it began trading.
“It’s easy to conclude that somehow things changed the day we were spun off,” said Balakrishnan Iyer, Conexant’s chief financial officer. “But the reality is that many of the initiatives that are driving our growth have had their genesis in strategies or investments that were being undertaken as far back as two or three years ago. And at the end of the day, performance counts.”
Now that it is firmly established as a company in its own right, Conexant in at least one way is behaving like the one-time corporate conglomerate from which it was spawned: It’s buying up other companies.
Making Aquisitions
To expand its product reach, Conexant has acquired Microcosm Communications, Maker Communications and a division of Oak Technology.
And neither Emulex nor QLogic has hesitated to forge ahead, either. Officials at both Costa Mesa companies consider the 1994 split ancient history.
QLogic’s CFO Thomas Anderson says his company has maintained a tight focus on its original business, even as its former parent has expanded into new lines of business, including ones that position the pair as competitors. Both companies make fibre-channel host bus adapters, which speed up connections in networks and internal components.
But rather than diluting the power of either one, Anderson says, having two strong companies in the field helps legitimize the market.
Splitting off a company is no guarantee of instant riches, a reality QLogic experienced its first few years as an independent company. But despite added administration and other costs, spun-out companies have some distinct advantages over their startup counterparts.
“If you’re spinning a company off, you’re not going to spin off some company that doesn’t have any revenue and is just going to flounder,” he says. “It’s going to be a company that has a customer list and enough resources to fend for itself.” n
