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Tax Avoidance is the Name of the Game...It's Raining REITs and MLPs

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July 29, 2014 – Comments (5) | RELATED TICKERS: WIN , IP , KS

The name of the game in today's market is lowering taxes.  Earnings growth really isn't there for many companies in today's recovering yet still sluggish economy.  They only way for many of them to achieve sufficient growth to keep their stock prices rising is to either buy back stock to lower their number of outstanding shares and make their earnings look larger or to avoid taxes.  Tax avoidance actually is a double bonus for stocks, not only does it make companies' earnings higher but it usually increases the multiple that investors are willing to pay for those earnings.

Tax inversion is one way that companies have been attempting to lower their tax bills.  That essentially involves purchasing a foreign company and officially relocating your headquarters from the United States to a country that has a lower tax rate, such as Ireland.  This has been a big theme in the pharma sector.  Even  Walgreens (WAG) is rumored to be considering such a move.  To me, inversion seems sort of scummy, but I suppose we should have had corporate tax reform a long time ago and a lot less of this would be happening.  I personally wouldn't renounce my U.S. citizenship to pay a lower tax rate.  Pharma can get away with this, but I would think that a more consumer-facing company like a retailer might face significant blowback from consumers that could impact its business.  Who knows though, Budweiser has always advertised itself as being an American brand and it was bought out by a Brazilian company without any impact to its business that I have been able to see.

Another slightly less controversial way that companies try to lower their tax bills is to spinoff part of their assets into more tax-efficient vehicles, such as REITs, MLPs and YieldCos.   There probably isn't much of a difference between avoiding taxes like this and inversion, but it seems less unpatriotic than leaving the U.S. completely.  I have been playing this investment theme with a number of companies with quite a bit of success, from Oil Services International's (OIS) spinoff of Civeo Corporation (CVEO) to SunEdison's (SUNE) creation of a YieldCo.  I wrote about YieldCos here a month or so ago, Yield Co. creation can be a very profitable special situation .

Two new industries have gotten in on the REIT and MLP conversion game recently.  It started off late last week when word broke that a hedge fund called Perry Capital is trying to convince several paper companies to convert their plants into MLPs.  The paper industry has gone through a period of significant consolidation which many believe should enable companies to improve pricing.  Many investors believe that this makes them a good investment on their own, the ability to convert their plants into MLPs would add juice to that.

Perry Capital thinks that KapStone (KS) shares have as much as 98% upside (pre-pop) if it was to convert its mills into MLPs. Other companies that it contends would have significant upside, 50% to 60%, include International Paper (IP) and Rock-Tenn Company (RKT).

Perry Capital’s Plan To Double The Value Of The US Paper Industry

Spinning of mills into MLPs would generate cash, improve tax efficiency, and bring in yield hungry investors

http://www.valuewalk.com/2014/07/perry-capitals-paper-industry/

I personally absolutely love the idea from an investment perspective, but I wonder if it is going to really happen.  Perry proposed the idea and owns stakes in IP, RKT and KS, but I don't know if it has actually engaged in any discussions with the companies yet and it remains to be seen if the IRS will allow it.  Given the fact that the plan places a cap on the amount of recycled materials that can be used in the manufacturing of paper of 25%, it actually looks like it discourages recycling.  It would be a pretty dumb move for the government to incentivise companies not to recycle, but who knows?  

This morning yet another industry has gotten in on the act, telecom.  Windstream (WIN) announced that the IRS is letting it spinoff certain wireline assets into a REIT.

Windstream to Spin Off Assets Into Publicly Traded REIT

WIN is the big "Winner", get it pretty punny huh, this morning with its stock up a whopping 25% on the news.  Other companies in the sector, even titans like Verizon (VZ) and AT&T (T) are up 3% to 4% on the news.  This could have huge implications for every company in the sector.  Why wouldn't they all do this?

I'm going to scour both the paper and telecom sectors today to see if I can pick up shares of a few companies that stand to benefit from this trend.  Ideally one would purchase stock in these companies before they officially announce that they are making such a move.  Doing so should enable one to get better prices. It has been one heck of a ride for WIN shareholders.  The company's stock has nearly doubled since February.  I didn't hear a peep about the potential for this conversion and I keep my ear very close to the ground for this sort of thing.  One has to wonder if there was any insider trading going on there.  I suspect that there was.

The next logical extension of this theme is cable companies.  What's the difference between cable companies and telecom?  Not much.  They both have wires in the ground.  Thinking that I was super smart and was going to beat everyone to the punch, I just looked up a quote on Cablevision (CVC) only to see that its stock is up 4.5% already.  Drats.  Time Warner (TWC) is already up over 3%. Comcast (CMCSA) is up 2.5%.

I suspect that the economic benefit to these companies and the ultimate benefit to shareholders, especially in the form of multiple expansion, exceeds these increases.  I'd love to hear others' thoughts on the subject.

Thanks for reading and commenting.  Have a great day.

Jason

5 Comments – Post Your Own

#1) On July 29, 2014 at 4:28 PM, TMFDeej (99.32) wrote:

The most hilarious part of the spike in Windstream's stock today is that the combined dividend of the new REIT and WIN's remaining operations will actually be 20% less than the company's current dividend. A REIT conversion is the only way a company could announce that it's slashing its huge dividend by 30% and see its shares skyrocket. Fascinating. It just goes to show what absurd multiples investors are paying for REITs, MLPs and YieldCos right now. The moral of the story is to try to hop onto as many of these conversions as early as possible and flip them for a profit before the music stops and you're left without a chair.

Windstream Soars 21% On REIT Spin-Off Plan

http://blogs.barrons.com/incomeinvesting/2014/07/29/windstream-soars-21-on-reit-spin-off-plan/

Jason

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#2) On July 30, 2014 at 10:14 PM, gman444 (28.71) wrote:

Cut your dividend, lower your taxes, and see your stock price spike. Interesting indeed.  I think you are really onto something here, as I think the hard assests these companies own are going to become increasingly more expensive to build, and the products they provide are basic and essential---they are consumer necessities in a necessity driven world.  And with everybody searching so frantically for yield, this may catch a wave.

But I really wanted to say thanks for drawing my attention to CORR--after some research I bought a small position for my mother's retirement portfolio, and it is doing very well.  I don't spend as much time on CAPS as I used to, but am rethinking that.  Thanks again Deej.

Gman 

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#3) On July 31, 2014 at 12:34 PM, TMFDeej (99.32) wrote:

You're very welcome, Gman.  Thanks for stopping back to let me know that you've done well with it.  I love it when we individual investors can help each other out.  CORR has indeed done very well.  I am personally more fond of that one than some of my other investments because I more or less found it from scratch rather than from someone else's article.  Not that there's anything wrong with that, I'll take ideas from anywhere.

I've found another reall, really interesting one that I plan on posting about after I buy in myself.

Make sure to come back from time to time, it's getting lonely here in CAPS :).

See you around.

Jason

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#4) On July 31, 2014 at 12:35 PM, TMFDeej (99.32) wrote:

Man earnings season is fascinating. I absolutely love this stuff. Combine this with the fact that today is the MLB trade deadline (I am also fascinated with the construction of professional sports teams) and I'm in heaven.

A company that saw its stock surge after the Perry Capital REIT conversion report the other day, KapStone Paper and Packaging Corporation (KS), is giving back much of what it gained after missing earnings today. It's down nearly 6% and counting.

I need to look into whether the company would actually consider making the REIT conversion move. If it would actually go through with it, this could be a very interesting stock.

KapStone Reports Record Second Quarter Results (apparently not a big enough record for Mr. Market)

http://finance.yahoo.com/news/kapstone-reports-record-second-quarter-201500092.html

Jason

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#5) On July 31, 2014 at 7:04 PM, gman444 (28.71) wrote:

Yes, somehow the ones you find on your own are the most satisfying--of course, it is hard to object to making money in the market whereever the idea came from.  On the other hand, the ones you find and then don't buy, only to see them take off, are very painful.  Such is the way of the market.

Will look forward to reading about your next idea--your last couple posts put me onto a whole new line of investigation--very interesting.  Am taking a close look at BEP, again for my mother's retirement portolio, and will be considering a small position after it takes the drop it looks like it wants to take.

Happy hunting,

 Gman 

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