Since buying from forced sellers is one of my favorite investment strategies, I always like to look at spin-offs. At the end of today, September 30, ADP, the enormous payroll processor, is spinning off its highly profitable and growing car dealer services company, CDK Global. Each holder of ADP on September will be receiving 3 shares of of CDK for each share of ADP.

Since ADP is in the S&P 500 and CDK will not be (its joining the smaller S&P Midcap index), every S&P500 index fund that owns ADP will need to sell their CDK shares quickly to stay aligned with the proper index composition.  Because the amount of money invested in midcap funds is dwarfed by the S&P 500 funds,  there will be many more forced sellers of CDK from the SP500 funds than forced buyers from the midcap funds. The result is a potential opportunity for a mispriced stock.

How good is the opportunity? Well, its good enough that I decided to read the CDK roadshow materials and run some simple calculations.  Unfortunately, its not a value play, at least at current when issued pricing of around $30.50 share.

Growth investors who believe that CDK’s smaller digital car sales marketing division (373M revenue) will continue to increase at 20% year for years to come and overtake its slower growing but larger back office car dealer services (1500M) division should look at CDK more closely.  But I’m a value guy, so I think I’ll take a pass.

Here is my 10 minute analysis. Call me if the stock drops to $20.

Given the recent events surrounding Awilco, the management sale of a small stake below then current market prices, the Scottish independence scare changing North Sea capex plans, and the decline in energy prices, I wanted to revisit the impact on daily rig rates on Awilco’s dividend.

Currently, Awilco owns two rigs under contract in the North Sea at an average day rates of $386,500 through 2015. At these rates, it is able to cover all maintenance and capex and still pay an impressive $4.60/year dividend, for a 25% yield at its current $18.25 stock price.

If nothing changed, we could simply multiply the current $1.15 quarterly dividend by the 18 year remaining life of Awilco’s two rigs, discount the dividends at 10%, skip the dividend once every three years to reflect downtime for maintenance, plug the numbers into Excel and get a future dividend stream worth $35.  At today’s price of $18.25, that looks like a pretty attractive proposition. Of course, drilling is a cyclical business and assuming the rig rates stay constant is about the only thing I can guarantee won’t happen.

So what happens when rig rates change?   Given that most rig operating costs are fixed, changes in rig rates show a leveraged impact on profitability. To help me with this, I constructed a simple model to estimate the impact of a change in daily rates on the dividend.

Key Assumptions:

1. We know that Awilco is committed to distributing all cash above its reserve for major expenditures.
2. We know its rig rates.
3. We know how much it has paid in dividends.

Color code: The values in purple are my estimates, the values in orange include a month when a rig is in dry dock (Dec 2015- Jan 2016 and March 2016 – April 2016), and  the values in black are either actual or calculated values.

The contracted Awilco Daily Rig Rate = the sum of both rigs contracted rate divided by two. Zero is used for rigs in dry dock undergoing maintenance.

Quarterly Revenue = Average Rig Rate * 90 days * 2 Rigs * 97% up-time

“All costs” is the catchall bucket for what it costs Awilco to pay all expenses and capex.

Lastly, there is a gap of about 45 days between when the quarter ends and the company pays the dividend.

Impact of a cut in Rig Rates on the dividend

How do these rates translate into dividend yields and stock prices?

I use high rates to reflect that some of the dividend is really a return of capital since the rigs will be scraped in 18 years.

Using this model, the $19.12 price (120NOK) at which the Wilhelmsen’s sold a 10% stake would imply they expect a 25% or so drop in rig rates in 2016 if they are seeking a 14% yield.  Or it may just imply how hard it is to sell a large stake in an illiquid company that they had to take a discount even if they expect rates to stay the same.

For more information on rates, the Awilco site has a recent “Pareto Oil & Offshore Conference September 2014” slide with North Sea rate history.

In closing, I know this model is very simplistic, and I know it is “wrong”, but I found it  a useful way to think about rates and I hope you have as well.

Disclosure: I still own AWILCO, but I am no longer interested in being overweight this stock until the bottom of the next cycle when its inherent leverage will be more likely to work in my favor.