"In this next step of our strategic plan we configure ourselves for the future. Our two new companies will be designed so that their businesses can be more differentiated and more competitive in their own space. More importantly, that addressable space will expand for each as we eliminate the burden of organizational conflicts of interest (OCI)," said Jumper.
The spin-off has been completed last month. The purpose of this article is to analyze both the parent company (Leidos Holdings) and the spin-off company (SAIC) after the spin-off. In performing my analysis, I used Joel Greenblatt's framework specified in his book "You Can Be a Stock Market Genius."
SAIC
Reasons for Spin-Off
According to the 10-12B filing from SAIC, there are four major reasons for the spin-off:
1. Reduce Regulatory Constraints in the Pursuit of Business Opportunities.
Under the Federal Acquisition Regulations (FAR), when a company has
provided SETA (System Engineering and Technical Assistance)
services for a particular U.S. Government program, it may be prohibited
from selling products to the U.S. Government under the same program due
to an organizational conflict of interest. The spin-off will allow us to
expand the addressable market
for our offerings that were previously constrained by OCI (organizational conflicts of interest) regulations.
For example, a contractor that performs on a contract with a U.S.
Government customer to provide system requirements for a military
weapons system cannot also compete on a
contract with the government customer to deliver the weapons system to
meet those requirements. Similarly, the contractor that performs on a
contract with a U.S. Government customer to deliver a weapons system may
not also perform on a contract with
the U.S. Government customer to conduct the test and evaluation on the
weapons system to verify its performance and satisfaction of the system
requirements. Both of these examples pose an actual or potential OCI not
allowable under the FAR.
2.Strategic Focus of Management’s Efforts.
Our business represents a discrete portion of Parent’s overall
business. It has historically had
different financial and operational requirements than Parent’s other
businesses. The separation will allow us to better focus management’s
attention on New SAIC’s business.
3.Investment Focus. While operating as a part of Parent, the internal investments of the company were directed according to Parent’s strategic
interests as a whole. The separation allows us to focus our investments on projects that generate returns for our business.
4.Improved Management Incentive Tools. As an independent company, we will be able to better structure and incentivize our current and future employees
through direct participation in the performance of the company through new equity compensation plans.
It seems like SAIC's main motivation is similar to what L-3 did with its spinoff: separating the slow growth, and headwinds-facing parts of its business and removing internal conflicts, which could possibly bring in new business.
2. Insider Ownership and Compensation Structure:
Long-Term Incentive Awards
Historically
The amounts of these awards granted under Parent’s 2006 Equity Incentive
Plan are determined based on market data and vary based upon an executive officer’s position and responsibilities.
Stock Options.
Approximately 25% of the targeted total value of equity awards granted
to New SAIC named executive officers in fiscal 2013 was
comprised of stock options. These options vest 20% of the shares at the
end of each of the first three years and 40% of the shares at the end of
the fourth year and expire at the end of the seventh year. The
objective of these awards is to link
rewards to the creation of stockholder value over a longer term and aid
in employee retention with a vesting schedule weighted toward the end of
the option term. Parent believes that stock options motivate Parent
executives to build stockholder
value because they may realize value only if Parent’s stock appreciates
over the option term.
Restricted Stock Units. Approximately
25% of the targeted total value of equity awards granted to New SAIC
named executive officers in fiscal
2013 was in the form of restricted stock units (RSUs). These RSUs vest
20% of the shares at the end of each of the first three years and 40% of
the shares at the end of the fourth year. RSUs are intended to provide a
strong incentive for employee
retention and promote the building of stockholder value.
Performance Share
Awards.
Approximately 50% of the targeted total value of equity awards granted
to New SAIC named executive officers in fiscal 2013 was in the form of
performance share awards that may result in
shares being issued depending on the company’s achievement of specific
financial performance goals for each fiscal year over the three-year
performance period covering fiscal 2013 through fiscal 2015. In the
first quarter of fiscal 2013, the
Parent Committee set the performance goals for fiscal 2013 and approved
the threshold, target and maximum performance share award amount for the
entire three-year period, one-third of which is allocated to each of
the respective three year
performance periods and is set forth in the “Grants of Plan-Based
Awards” table.
The
following table sets forth the target
number of shares and corresponding target value for performance shares
awarded in fiscal 2013 for the three-year performance period covering
fiscal 2013 through fiscal 2015, with the target number of shares based
on the closing sales price of
Parent’s common stock on the NYSE on the trading day before the grant
date. The target grant date values were between 50% and 120% of base
salary.
| Target Shares | Target Value | |||||||
|
Anthony J. Moraco
|
45,421 | $ | 600,000 | |||||
|
John R. Hartley
|
15,141 | $ | 200,000 | |||||
|
Thomas G. Baybrook
|
26,496 | $ | 350,000 | |||||
|
Brian F. Keenan
|
22,711 | $ | 300,000 | |||||
|
Nazzic S. Keene
|
31,546 | $ | 400,000 | |||||
The employee incentive plan sounds standard, with options, RSUs and other performance-based equity compensation making up the majority of compensation. Both options and RSUs have a 3-5 years vesting period so long term value creation is encouraged. Executives also have to give back their compensations if financial statements are restated.
3. Comparable Company Analysis:
Comparable Companies: EGL (L3 spin-off) and NOC.
I. Using Operating Earnings
NOC: 52 weeks trading between $13 billion to $21.4 billion, 2012 operating Income $3.13 billion. Price/Operating income ranges from 4.2-7.
EGL: 52 week trading between $300 million and $600 million, 2012 operating Income (excluding goodwill impairment charge) $97 million. Price/Operating Income ranges from 3-6.
Average of NOC and EGL - Price/Operating Income of 5x. Apply that to SAIC's $281 million operating income, we will get a market cap of about $1.4 billion, or $28.6 per share.
Leidos Holdings
Comparable Companies:
LEIDOS, INC.
UNAUDITED PRO FORMA
CONDENSED CONSOLIDATED STATEMENT OF INCOME
| Year Ended January 31, 2013 | ||||||||||||||||
| Pro Forma Adjustments | ||||||||||||||||
|
(in millions)
|
Historical Leidos, Inc. |
New SAIC [A] |
Other | Pro Forma | ||||||||||||
|
Revenues
|
$ | 11,165 | $ | (4,690 | ) | $ | — | $ | 6,475 | |||||||
|
Costs and expenses:
|
— | |||||||||||||||
|
Cost of revenues
|
9,814 | (4,237 | ) | — | 5,577 | |||||||||||
|
Selling, general and administrative expenses
|
572 | (68 | ) | — | 504 | |||||||||||
|
Separation transaction and restructuring expenses
|
38 | (28 | ) | (10 | ) [B] | — | ||||||||||
| |
|
|
|
|
|
|
|
|||||||||
|
Operating income
|
741 | (357 | ) | 10 | 394 | |||||||||||
|
Non-operating income (expense):
|
||||||||||||||||
|
Interest income
|
10 | — | — | 10 | ||||||||||||
|
Interest expense
|
(93 | ) | — | — | (93 | ) | ||||||||||
|
Other income, net
|
8 | — | — | 8 | ||||||||||||
| |
|
|
|
|
|
|
|
|||||||||
|
Income from continuing operations before income taxes
|
666 | (357 | ) | 10 | 319 | |||||||||||
|
Provision for income taxes
|
(137 | ) | 126 | (4 | ) [B] | (15 | ) | |||||||||
| |
|
|
|
|
|
|
|
|||||||||
|
Income from continuing operations
|
$ | 529 | $ | (231 | ) | $ | 6 | $ | 304 | |||||||
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