Special Situation Investing

Tuesday, November 14, 2006

Mueller Water Products Inc. (MWA) - Spinoff

Mueller Water Products (MWA) will be spun off from Walter Industries (WLT) in mid-December of this year. MWA is, as you may have guessed, in the water infrastructure business. Walter Industries will be left with coal, homebuilding and financing divisions.

The situation is a little more complicated than just the spinoff, and has a bit of history. WLT originally acquired MWA in Oct, 2005. Then, WLT IPO'd ~25% of it's MWA shares in June, 2006 at $16 / share. The remaining 75% of the stake will be dished out in the spinoff to WLT shareholders that I referred to previously. It is a just bit more complicated in that there are also some preferred shares which can be converted to WLT shares and receive the spinoff shares. Also, the new shares that will be issued in the spinoff have greater voting power. These new shares will control 96% of the voting power while making up 75% of the equity interest. Shares are currently going for $13 and change. So from a special situations vantage point, at first glance it looks like you have a confusing situation and may have some institutional selling and down pressure on the stock.

I found a quote on the number of shares that will be distributed to WLT shareholders. I believe the range is due to the preferred shares.

Walter Industries holds all of Mueller's nearly 85.9 million Series B shares outstanding, but plans to spin them off to shareholders by the end of year, a company spokesman said Tuesday. For every share of Walter Industries, shareholders will receive between 1.6 and 2 shares of Mueller, he added.

Unfortunately I am not sure convinced that the institutional selling is unwarranted. There are some legitimate issues with the deal. For 1, MWA is heavily tied to the housing market as much of it's business revolves around new construction. I haven't actually crunched the numbers but have seen estimates of ~50% of revenue from new construction. Obviously this should be a bit of a concern as a housing slump seems inevitable. It is more a question of how severe it will be. The company is also tied to government spending to upgrade water infrastructure. As you may imagine, this can lead to very lumpy and unpredictable results. Finally, the existing MWA shares have little voting power. I am not sure how much weighting to give the votes in terms of price but certainly I would rather having voting than non-voting shares.

From a financials perspective things are also mixed. The company has about negative $500 million tangible assets so you don't have much support there. Recent profits have been next to nothing but should improve as the company gets over restructuring and pays it's debt down. Excluding restructuring and other 1-time items the company has operating income of about $275 million against a market cap of $1.56 billion. That in itself would be a sweet ratio to jump in at but the fact is there is additional restructuring and a lot of debt repayment ($1.1 Billion long-term debt outstanding) remaining.

Where I am at with this one is basically nowhere. I have done enough research into it (I feel) that it doesn't look CHEAP at this point. Not that it's expensive, will under-perform or anything like that but it's not outright cheap. I just don't buy stocks unless I think the risk/reward ratio is tilted in my favour or I have some special insight into the situation. Neither condition occurs here.

Another blogger, ControlledGreed, is bullish on MWA. You can view his rationale here. He also has another article with some insightful comments on the situation here.


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