Is Alcoa's Plan to Split an Opportunity for Investors?

By Markets Fool.com


Alcoa will become Arconic and spin out a "new" Alcoa later this year. Image source: Alcoa.

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Alcoa Inc(NYSE: AA) is moving forward with plans to split the company up before the end of the year.

And in a lot of ways, the guiding reasons behind the plans make sense: Today's Alcoa is largely already two very different businesses.According to recent SEC filings, as well as a series of presentations given by company management earlier this summer, the planned separation will result in the legacy commodities business segments being spun off -- though they'll retain the Alcoa name and stock symbol -- while the remaining highly engineered products and services business will be renamed Arconic, trade under a new ticker, and retain close to 20% ownership of the spun-out Alcoa business.

But what does this mean for investors? Is this an opportunity to invest in the business before it splits? Let's take a closer look.

The rationale behind the split

Management says Alcoa is largely already two different businesses:

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  • Bauxite, alumina, and aluminum production.
  • Value-add highly engineered products and services.

The mining and production business is a typical commodity-driven enterprise, where it's all about being a low-cost producer, and riding out the up- and down-turns of industrial demand and macroeconomic cycles. The value-add business, on the other hand, isn't sensitive to commodity pricing in the same way as the raw or basic materials Alcoa produces, and has different macroeconomic sensitivities. The value this business brings to its customers is in product design and engineering for high-demand and high-performance applications such as in the automotive and aerospace industries.

This can create competing interests within one company for limited resources, potentially limiting the company's ability to best leverage its assets as a whole. Furthermore, management thinks that two separate companies will be better able to operate within the most effective capital structure for its needs, as well as having a more clear investment thesis, versus the currently integrated company.

So by separating, the resulting businesses should be able to more efficiently allocate capital, and structure operations based on the unique markets they operate in, and the growth opportunities in front of them.

Nuts and bolts of the spinoff

Once the split is complete, shareholders of record will own two different companies: Arconic, which will trade under the symbol ARNC, and Alcoa, which will trade under AA. However, it's important to understand that Arconic will actually be the parent company, while Alcoa will be the new, spun-off business. According to the SEC filing, shareholders will receive 80.1% of the spun-out Alcoa business, while Arconic will retain "no more than 19.9%" of Alcoa.

The distribution of shares in the "new" Alcoa is expected to be tax-free, but it's important to understand how it affects your tax basis. The SEC filing says the tax basis for your Alcoa (pre-split) investment will be allocated between the two separate stocks on the date of the distribution. This is important for investors who plan to sell either company post-split: make sure you understand the tax implications from any sale, based on your situation.

It's also noteworthy how debt will be handled. Arconic will retain all existing debt, though Alcoa will raise $1 billion in debt and give the proceeds to Arconic, which will in turn use those proceeds to reduce debt. Alcoa will also obtain up to $1.5 billion in secured debt that it will be able to use for liquidity financing.

Opportunity or not? Think longer-term

By and large, the answer depends on how the market chooses to value the separate businesses post-separation. There's certainly the potential that separating Alcoa and Arconic will untap more value. But trying to turn that potential value into short-term gains between now and the separation of the companies is far from guaranteed to work out.

The rationale behind the split makes sense, at least on paper. But it's really going to boil down to execution, and that will take time -- likely at least a year or two -- before it's apparent or not. So before you invest in Alcoa today based on profiting from higher share prices post-split, it's probably a good idea to be prepared to ride out your investment for the long-term.

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Jason Hall has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.