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Mac,

I'm still trying to figure all this out myself, but maybe we can work through this together.

In one regard, I think you are absolutely correct. The parent company can take advantage of the spinoff to boost their own position. The spinoff adds value to the parent company and benefits the shareholders of the parent company b/c they can saddle their spinoff with some of their debt or, in the case of Hanesbrands and Sara Lee, infuse themselves with some capital that they (Sara Lee) will never have to pay for. At the same time, I think it is a vote of confidence in the spinoff by both the management of the parent company and of the spinoff. As Greenblatt says, it's in no one's interest for the spinoff or the parent to fail (that's why sometimes the parent gives the spinoff some cheap capital instead of vice versa), but that doesn't mean that they always succeed. In the First Data (FDC)-Western Union (WU) spinoff, WU took on the majority of the debt, the assumption being they are more likely to be able to handle it.

As near as I can tell, investing in a leveraged company is somewhat similar to trading on margin, but more similar to buying a call, as Greenblatt explains in his section on stub stocks and LEAPS. Here's why I think it is only somewhat similar to trading on margin. When you borrow money to buy stocks, you are responsible for repaying your loan and if your stock tanked, you'd be out both your cash outlay for the stock and still be responsible for your loan, but when you buy a leveraged stock or a call option, the most you can lose is what you paid for the stock or the option. The company is ultimately responsible for repaying their own debt or your option would expire worthless, no harm, no foul.

The rest of the story has to deal with the tax benefits (interest is deductible) of a leveraged structure and the way leverage can magnify earnings. The market should discount the stock b/c of its debt burden, so you can benefit from a rising P/E (better interest coverage = less risk) in addition to a leveraged increase in earnings.

Hopefully that helps, and hopefully I'm not too far off the mark in my explanation. I would always recommend getting a second opinion on anything I say, as I am still very much an amateur and still have a lot to learn. Let me know if you want me to delve into any part of this explanation more deeply or try to explain it more clearly since I tend to ramble.

Jim
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