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Traders' views - Spread betting

Alcoa Inc is a buy before the company breaks up

By , 07 Oct 2016

They say “breaking up is hard to do” but in financial market break-ups spinoffs can be very profitable and give companies a new lease of life.

A spinoff is the creation of an independent company or in some cases more than one company through the sale or distribution of new shares of an existing listed company to shareholders holding the parent company at a certain date.

A company may choose to spin out a business which could have hidden value or it may be a less attractive business which they wish to distance from the parent company and protect the main business.

I chose Alcoa as a top tip for BullBearings in December 2015.

Alcoa was trading at $9 when I first featured it - it’s now trading at $10.20 so up around 10% plus a small dividend which is not bad but the real gains have not happened yet.

A quick recap: Alcoa Inc (NYSE:AA) produces and manages primary and fabricated aluminium, and alumina worldwide. The engineered segment offers titanium, alloy, aluminium castings, fasteners, wheels, architectural extrusions, forgings and hard alloy extrusions. Its products are used in transportation on air, land and sea; packaging; building and construction; oil and gas; defence; consumer electronics; brazing; power generation; and industrial applications.

Alcoa has been a terrible investment in recent years but 2016 has been a bit brighter and the company has approved the spin-off of the new company Arconic which will take affect from the 1st November.

Let me outline what is about to happen and how to profit.

The best way to describe this split is that the legacy Alcoa mining and upstream business is being spun out as a tax-free distribution to shareholders on the share register 20th October 2016.

The "new Alcoa" company -- that is, the company being spun out -- will be named Alcoa Corporation, while the existing company -- currently named Alcoa Inc. -- will be renamed Arconic and will trade under the symbol ARNC.

The company is also planning a reverse share split – so this means you will get fewer shares but the price will be higher – the plan is a 3 for 1 consolidation. If you owned 300 shares of Alcoa before the split, you'll own 100 after, and you'd get 33 shares of the "new" Alcoa when it was separated from the company on November 1.

80.1% of the business is being spun out so Alcoa will keep 19.9% of Arconic.

To profit you need to be on the share register before the 20th October.  If you have a financial spread bet then the bet will be adjusted accordingly. 

You will then have two companies: a slower growth metals business which in the traditional Alcoa business (AA) and a new higher margin more dynamic business Arconic (ARNC) which focuses on aerospace parts.

Over the past 18 months, Arconic has signed at least $10 billion in new contracts with important aerospace customers, including Boeing, Airbus, Embraer and GE. The company also has auto parts and other higher value components. 

There is a factsheet here that explains the business in full: http://www.alcoa.com/global/en/about_alcoa/corp_gov/PDFs/about-arconic.pdf

The traditional aluminium business which has been a very hard business to make money in is starting to show signs of stabilisation. China has been flooding the market for some years but that seems to have at least slowed down. 

Alcoa has a large debt load -- about $9 billion in long-term debt and $5.4 billion in pension and post-retirement benefits. Most of this will go on the books of Arconic.  Some of the debt will be paid off post-split from about $900 million that post-split Alcoa will pay to Arconic. 

Where are the shares heading?

I see a 40% upside in the share price, this will take around 12 months to filter through, Arconic has the higher growth prospects but don’t write of the old Alcoa business and I intend to hold both parts.

Warning: Remember, particularly if you are new to trading in the stock market and in forex, that the prices of shares and other investments can fall fast and you may not get back the money you originally invested. The material here is for general information only and is not intended to be relied upon for individual investment decisions. Take independent advice before making such decisions. Also, the BullBearings free stock exchange simulation portfolios are a good way to practice trading techniques.

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