On July 31, 2012, Valero Energy Corp. (NYSE: VLO) announced its Board had approved efforts to pursue the separation of its retail segment through a sale or tax-efficient spin-off of the operations. Management expects a transaction could be completed in the next six months. Valero has daily throughput capacity of more than 3 million barrels per day combined at its 16 refineries located on the U.S. West Coast, Midwest and Gulf Coast. The stock has traded at a discount to daily processing capacity to other large U.S. refiners, although Valero also has lower gross margins per barrel due to the location of its plants (see attached exhibit). Investors might expect a pure-play refiner could trade at a premium to a vertically integrated distributor due to the complexity of the latter. Retail gasoline spreads do not necessarily move in tandem with refiner spreads, providing more difficulty for investors to determine future profitability. While many refiners operate wholesale fuel distribution, most have previously exited the retail market, which can be driven by convenience store food margins and traffic inside stores, as opposed to spreads on gasoline. High capital expenditures for refineries also may limit station spending for interior redesigns or new marketing campaigns.

A peer group of U.S. retail gas station operators trade about 0.26x last year’s sales and 7.2x 2011 EBITDA (see attached exhibit). If one applied those multiples to Valero’s retail segment sales of $11.7 billion and EBITDA of $496 million, the business could be considered worth about $3 to $3.5 billion. Applying a 3.8x multiple to Valero’s 2011 refining segment EBITDA of about $4.9 billion generates a fair value of about $18.6 billion. One could also expect modestly higher SG&A for each business if the retail arm is separated through a tax-free spin-off.

The refineries, wholesale marketing and ethanol businesses would remain with the parent following a separation. The retail segment includes about 1,000 stores in the U.S. (80% owned and 20% leased) as well as 381 owned or leased stores in eastern Canada. Over the last decade retail margins have been far more stable than refining margins due to less volatile retail gas spreads and benefit from higher margin convenience-store sales. As such, retail operators tend to receive higher multiples than the more capital intensive, volatile refiners.

On July 19, 2012, PPG Industries Inc. (NYSE: PPG) announced plans to separate its commodity chemicals business in a spin-off or split-off and immediately merge it with chemicals and building products manufacturer Georgia Gulf Corp. (NYSE: GGC). The separation is expected to be tax-free and will require an affirmative IRS ruling, Georgia Gulf shareholder approval, a declaration of effectiveness by the SEC, and any additional regulatory approval. The merger will be structured as a Reverse Morris Trust transaction, which would maintain the tax-free status of the separation. Following the transaction, PPG shareholders would control approximately 50.5% of the newly merged company, while Paul Carrico of Georgia Gulf will be the CEO. The deal is valued at $2.1 billion based on the current share price of GGC, a $900 million cash distribution paid to PPG, and $182 million in assumed debt and minority interests. The merger is expected to occur in late 2012 or early 2013. The transaction appears to be following a trend in the industry. Earlier this year, Cytec Industries hired a financial advisor to explore the sale of its coating resins business to focus on less commoditized products.

After the separation, PPG will focus on building out its higher-growth coatings and specialty materials businesses. The commodity chemicals business was PPG’s only segment to experience a year-over-year revenue decline in 1H 2012, however this was offset by lower feedstock (natural gas) prices. If 1H 2012 results were annualized, the remaining business could be expected to generate revenue of $6.9 billion in revenue and $972 million in segment profit. PPG does not appear to be trading at a discount to the peer group (see attached exhibit). But removing the more cyclical, slower growth business could be rewarded by investors. The benefit from lower natural gas prices may not be sustainable, in which case, segment margins could be negatively affected moving forward.

The merger will afford GGC increased scale in what could be argued is a more commoditized and cyclical business. Georgia Gulf will have revenues of approximately $5 billion making it the third largest chlor-alkali producer and second largest vinyl chloride monomer producer in North America.

‘Regular way’ trading commenced on June 29, 2012, for shares of Hillshire Brands Co. (NYSE: HSH) and D.E Master Blenders 1753 (AEX: DE). DE was separated from Sara Lee Corp in tax-free spin-off; shares were distributed on a 1:1 basis. In conjunction with the transaction, a $3 per share special dividend was paid to shareholders of record, and Sara Lee Corp. changed its name to Hillshire Brands. Immediately following the transaction, HSH conducted a 1-for-5 reverse stock split. Shares of DE trade on the NYSE Euronext in Amsterdam.

HSH appears attractively valued in early regular-way trading based on The Spin-Off Report fair value estimate of $34 per share. The former Sara Lee Corporation had reportedly received several takeover offers directly prior to the spin-off announcement in late 2010. However, the offers were rejected and deemed too low. Strategic and financial suitors were widely reported as interested in certain pieces of the business. With ancillary operations now sold or separated, the North American meat-focused business may once again become interesting to suitors. A note of caution: shares may still see further pressure over the next several days. Standard & Poor’s is replacing Hillshire in the S&P 500 with Monster Beverage (NASDAQ: MNST). The change may lead to forced selling by index-tracking funds.

The average takeover multiple in the food and beverage industry over the last decade is about 8.9x, according to Fitch Ratings. A fair value for HSH of $34 per share can be reached by applying that multiple to a projected F2012 EBITDA of $554 million. DE appears reasonably priced in early trading, based on The Spin-Off Report’s fair value estimate of €8 per share. Please see the Sara Lee Corp. Spin-Off Report (4/20/2012), and FLASH notes (6/1/2012, 6/6/2012) for further information and additional fair value calculations.

On June 28, 2012, NACCO Industries Inc. (NYSE: NC) announced plans for a tax-free spin-off of its materials handling business. Management intends to list the entity, to be named Hyster-Yale Materials Handling, on the NYSE following the separation under the symbol ‘HY’. Hyster-Yale is expected to have two classes of stock, with NC shareholders receiving one share of HY Class A common stock and one share of HY Class B stock for each share of NC Class A or B owned at the time of the transaction. The separation is tentatively scheduled to be completed in 3Q 2012. The spin-off still requires an affirmative IRS ruling on the tax-free status of the transaction and SEC approval of all filings.

NC’s current operations include materials handling (forklifts and aftermarket equipment), kitchenware, and coal production. The eclectic group of businesses that will remain following the HY spin-off may suggest further transactions are likely as the synergies between coal mining and small kitchenware, such as blenders, appear to be non-existent. Of note, NACCO is the tenth largest U.S. coal producer with operations in Texas, Mississippi and North Dakota.

In 2011, Hyster-Yale generated $2.5 billion in sales, representing 76% of NACCO’s total revenue, and $141 million in EBITDA, or 63% of total company EBITDA. One could use a normalized annual EBITDA estimate over the past ten years of $90 million (excluding outliers) in an attempt to derive a value for HY. Using a peer group EV/EBITDA multiple from diversified heavy equipment manufacturers of 7.9x results in a $711 million enterprise value for HY. NC’s current enterprise value is only $922 million. Investors should keep in mind that HY generates the majority of NC’s operating profit.

NC has twice before attempted to spin-off its kitchenware operations, which includes several well-known brand names, such as Hamilton Beach, and Proctor Silex. In 2006, Hamilton Beach was to be separated and then merged with Applica Inc. in a Reverse Morris Trust transaction. When that deal did not consummate, NC again attempted to spin-off the division in 2007, but called the deal off and cited market volatility as the reason.

On June 28, 2012, News Corp. (NYSE: NWSA) confirmed plans for a tax-free spin-off its scandal-plagued publishing unit. The stock was up nearly 9% on June 26 when management acknowledged the Board was considering such a move. Rupert Murdoch would serve as Chairman of both entities as well as CEO of the entertainment company, while a CEO of the publishing unit has not been named. The transaction is projected to be completed in the next 12 months. The company expects to distribute one share of the publishing entity for every share held of NWSA. Both companies will have a dual share structure, including both ‘A’ and ‘B’ shares. A special shareholder meeting is likely to be convened in 1H 2013 to give final approval. The transaction will also require an affirmative IRS ruling related to the tax-free nature of the spin-off, as well as a declaration of effectiveness by the SEC of filings, and any additional regulatory approval.

With News Corp. facing mounting scrutiny over alleged phone hacking by reporters at its UK-based newspapers and mired in scandal, the separation of the more profitable entertainment unit could make sense. Through the first three quarters of F2012 (ended March 31), the company’s publishing segment generated operating income of $458 million, down more than 22% from the year-earlier period, due in part to the closing of The News of the World as well as lower advertising rates at other publications. NWSA also took $167 million in charges related to the ongoing investigation of the growing scandal. Other parts of the company continue to expand. Cable programming, which includes Fox News and the FX Network, increased operating income 17% year over year to $2.5 billion in the first three quarters of F2012. Notably, The Spin-Off Report Radar Screen initially highlighted the potential for a publishing unit spin-off in the April 2012 edition. Since that date, NWSA is up 13% compared to a 5% decline for the S&P 500 over the same period.

The publishing segment accounted for 11% of operating income (excluding charges) and about 25% of revenue in the first three quarters of F2012. Segment EBITDA totaled $777 million in that period. If one annualized 1H 2012 EBITDA and applied a 4.6x multiple (in line with a group of large newspaper publishers) to annualized EBITDA, an enterprise value for the segment of around $4.8 billion could be reached. However, a discount to the group could be required near term, given the uncertainty regarding the outcome of the ongoing investigation. Alternatively, The Washington Post Company (NYSE: WPO) and Gannett Co. (NYSE: GCI) trade about 0.7x sales. NWS’ publishing arm generated sales of $6.2 billion in the first three quarters of F2012. Applying the comparables’ multiple to annualized sales would generate a market capitalization of about $5.8 billion for a standalone publishing arm.

The higher margin, faster growth entertainment unit is likely to be awarded a higher multiple as a standalone business. Operating margin for the publishing arm was less than 10% in F2011 compared to total company operating margin of nearly 15%. Publishing revenue has been essentially flat since F2008. Other entertainment companies such as Viacom (NYSE: VIA) and Walt Disney Co. (NYSE: DIS) trade at an average 1.9x-2.0x sales compared to about 1.6x for News Corp. Non-publishing revenue for News Corp. in the first three quarters of 2012 totaled $19.1 billion. If one applied a 2x multiple to News Corp.’s annualized non-publishing sales, a market capitalization of about $51 billion could be attained. One might also consider a more focused entertainment company can focus on new ways to expand the business unencumbered by further investment in the stagnant-growth publishing arm.

Adding the market capitalizations calculated for publishing and non-publishing segments results in a sum-of-the-parts fair value of $56.8 billion, or about $23.50 per share.

On June 26, 2012, L-3 Communications Holdings Inc. (NYSE: LLL) announced that its Board of Directors had given final approval to spin-off part of its Government Services unit to shareholders of record as of July 16, 2012, in a tax-free distribution The spin-off entity, Engility Holdings Inc., will trade under the ticker symbol ‘EGL’ on the NYSE beginning on July 18, 2012. The ‘when issued’ market is expected to commence on or about July 9, 2012. Shareholders of L-3 will receive one share of EGL for every six shares of LLL. The transaction still requires the SEC to declare the filing effective.

As noted in our initial L-3 Communications Spin-Off Report (March 16, 2012), the fair value calculations for both entities would be adjusted based on the finalized distribution ratio, capital structure, dividend policy and changes in company/industry fundamentals. The dividend being paid by EGL to L-3 was lowered to $335 million from an initially proposed $500 million plus. As a result, this raised The Spin-Off Report’s estimate for the parent’s 2012 interest expense and lowered the estimate for EGL’s interest expense. L-3 also said it would use part of the proceeds from the dividend to buy back stock, which lowered the 2012 year-end projected share count. Finally, P/E multiples for defense industry comparables have also narrowed resulting in a slightly lower fair value estimate for the parent than originally proposed.

Despite the above-mentioned changes to the fair value estimates, the general thesis presented in the earlier report remains intact. One might expect L-3 will be rewarded a higher multiple post-separation due to its improved growth and margin profiles without the weaker piece. When applying a large defense contractor multiple to a revised L-3 EPS estimate (ex.-EGL), it would appear shareholders would be receiving shares of EGL essentially for free (see attached exhibits). Based on L-3’s current management guidance for 2012 revenue and segment operating margin post-separation, one could reach an EPS estimate of roughly $7.83 per share (assuming the company operated without EGL for the full year). Based on this analysis, L-3 could be valued at $73 per share, modestly above yesterday’s closing price.

For Engility, the low and declining margins and significant drop in revenue in 2011 and projected for 2012 offer little support for potential purchasers of the stock. There are no clear comparables in the group that display such significant declines in operating profit over a two-year period. One has to look back almost twenty years to find defense contractors in a similar position as Engility. In the early 1990s, the Cold War had concluded, new terrorist threats were almost a decade away from significantly developing, and a new Democratic White House had taken leadership following twelve years of Republican control. Defense spending was seen as under great threat. From late 1992 into early 1994, GD and NOC traded between 5x and 6x forward and trailing EPS. As this is the situation that best approximates the position of Engility post spin, it seems reasonable to expect a similar multiple immediately following the transaction. In addition, ITT Corp. (NYSE: ITT) spun off its defense assets in October 2011 as Exelis Inc. (NYSE: XLS). Management of Exelis offered 2012 EPS guidance of $1.80 to $1.86 in early March 2012. The stock is trading slightly less than 6x guidance. Alternatively, one might attempt to consider placing a multiple closer to other government service providers such as SAIC Inc. (NYSE: SAI), which trade closer to 8x 2012 EPS. We include this multiple in the attached exhibit, but do not support utilizing this figure for a fair value estimate. The exhibit utilizes management revenue and operating guidance for EGL as a standalone. One might assume greater pressure on margins as a result of higher SG&A as a percentage of revenue for a much smaller company.

One might expect EGL to trade in the mid to high $20 per share range post-spin. Given the great uncertainty of future revenue streams, The Spin-Off Report sets a fair value estimate of $22 per share, about 5.5x 2012E EPS. One might consider purchasing the stock if it trades below this level. The valuations may be updated as further information becomes available prior to or shortly after the transaction. For further information, please see The L-3 Communications Spin-Off Report, dated March 16, 2012.

On June, 5, 2012, Sara Lee Corporation (NYSE: SLE) held an analyst day to discuss the company’s plans following the spin-off of the international coffee and tea business, D.E Master Blenders 1753. The Sara Lee name will be replaced by Hillshire Brands Company and the ticker symbol will be changed to ‘HFH’ immediately following the transaction. As previously disclosed D.E Master Blenders 1753 will trade under the symbol ‘DE’ and move its listing to NYSE Euronext in Amsterdam. The distribution of DE is scheduled to occur on June 28, 2012, after the market close. ‘When-issued’ trading is expected to commence on June 12.

Hillshire Brands laid out its mid-term goals, which included efforts to increase operating margin to 10% in F2015, a 200-basis point increase from the current 8% through 3Q F2012. The company operates on a June fiscal year. Management expects to drive margin expansion through 4-5% revenue growth, mainly from volume expansion. The hot dog and deli meat provider will attempt to grow market share through increased advertising and marketing spending. The company plans to set its annual dividend based on a 30-35% payout ratio. A fair value estimate for HFH based on the proposed dividend payout and current dividend yield (2.3%) results in a fair value estimate of $32 per share (see attachment).

Net debt will be approximately $822 million post-separation, below The Spin-Off Report’s previous estimate of $871 million. Based on the revised net debt level, a fair value estimate of $35 could be derived (see attachment). Using an average of these two methods the fair value estimate for HFH post spin remains unchanged at $34.

There is no change to the fair value estimates for DE of €8, or $10, per share. Please see the Sara Lee Corporation Spin-Off Report, dated April 20, 2012, and FLASH dated June 1, 2012, for further details.

On May 31, 2012, Sara Lee Corporation (NYSE: SLE) announced that the company’s board of directors approved the spin-off of its international coffee and tea business, CoffeeCo. Following the spin-off, CoffeeCo will immediately merge with D.E Master Blenders 1753, an Amsterdam holding company. D.E Master Blenders 1753 shares will trade on the NYSE Euronext in Amsterdam under the symbol DE. In conjunction with the spin-off SLE shareholders as of the record date June 14, 2012, will receive a $3.00 per share special dividend. The transactions are expected to occur after the close on June 28, 2012, with ‘regular way’ trading of SLE and DE commencing on June 29, 2012. Shares of SLE will begin trading ‘ex-distribution’ and shares of DE will begin trading on a ‘when-issued’ basis on June 12, 2012. SLE shareholders as of the record date will receive one share of D.E Master Blenders 1753 for every one share of SLE owned. The SEC must still declare the registration statement effective. The company has received a favorable ruling from the IRS regarding the tax-free status of the CoffeeCo spin-off.

Following the transactions SLE will conduct a 1-for-5 reverse stock split. As noted in our initial Sara Lee Spin-Off Report (April 20, 2012), the fair value calculation would be adjusted based on the finalized distribution ratio, capital structure, dividend policy and changes in company/industry fundamentals. The adjustments to the initial calculation to account for the post-spin reverse stock split are shown in the attached FLASH. The post-spin fair value estimate of SLE is revised to $34 per share. The fair value estimates for pre-spin SLE of $20 and post-spin DE of €8, or $10, remain unchanged.

Please see the Sara Lee Corporation Spin-Off Report, dated April 20, 2012, for further details.

On January 28, 2011, Sara Lee Corp. (NYSE: SLE) announced that its Board of Directors had approved a tax-free spin-off to separate its business into two publicly traded companies. The parent company will consist of its North American retail and food service operations, which manufacture, market, and sell a variety of meat-based and dessert products, and will retain the Sara Lee corporate name. The spin company will consist of the International Beverages business, which sells a variety of coffee- and tea-based products throughout mostly Europe, Australia, and South America. The spin company will be named D.E Master Blenders 1753 and will be listed on the NYSE Euronext in Amsterdam. In conjunction with the spin-off, the company intends to declare a $3 per share special dividend, funded largely through the already completed sale of its North American bakery business. The company’s Form F-1 has been declared effective by the SEC, and the IRS has given SLE a favorable ruling on the tax-free status of the transaction. The transaction requires no further approval. Share distribution and capital structures have yet to be finalized. The transaction is expected to be completed in 1H 2012.

The transaction appears to be the last step in a business transformation that has taken more than five years. The sale of non-core businesses and the separation into two pure-play companies may attract a more focused shareholder base for each entity. However, the international listing of D.E Master Blenders 1753 may inject volatility into that stock’s initial trading.

The remaining SLE businesses have had difficulty in recent years driving sales and margin expansion, as increased prices to offset higher commodity costs were met with reduced demand. Management plans relaunches of products, increased advertising, and a more rational pricing strategy to help kick start sales. Given previous interest from both strategic and financial suitors, post-spin-off SLE may be an attractive target, especially in light of what could be considered an underlevered balance sheet. Incorporating the potential of a takeout, a fair value estimate of $7 per share can be derived.

D.E Master Blenders 1753, on the other hand, appears to be decently positioned in what is an attractive global growth industry. Secular trends showing an increasing consumer preference for single-serve coffee options present opportunities for management to grow revenue above historical industry levels and to widen margins. Coffee companies in general have benefited from these trends, with investors awarding outsized valuation multiples. Following the spin-off transaction, if shares of D.E Master Blenders 1753 were valued in line with peers, a fair value estimate of $10 per share could be derived.

It should be noted that given the listing of D.E Master Blenders 1753 in Amsterdam, there is a potential for forced selling by investors who cannot, or choose not to, own foreign listed securities. Initial trading at a significant discount to the $10 per share fair value estimate may represent an attractive buying opportunity.

Using a sum-of-the-parts valuation, a fair value estimate of $20 for pre-spin shares of Sara Lee can be derived, consisting of $7 for post-spin SLE, $10 for D.E Master Blenders 1753, and including the $3 per share special dividend to be declared in conjunction with the spin-off. Given an absence of likely upside from current levels, shares of SLE are not recommended for purchase ahead of the transaction.

On April 13, 2012, MeadWestvaco (NYSE: MWV) announced that it intends to complete the spin-off of its consumer and office products (C&OP) business on May 1, 2012. Upon completion of the spin-off, C&OP will immediately merge with ACCO Brands Corporation (NYSE: ABD) in a Reverse Morris Trust transaction, whereby MWV shareholders of record on April 24, 2012, will receive 0.33 shares of ABD for every share of MWV owned. Following the merger, MWV shareholders will own 50.5% of the new ACCO. In addition, MWV announced that it had received a favorable private letter ruling from the Internal Revenue Service in regard to the tax free status of the spin-off transaction. In conjunction with the merger of the C&OP business with ACCO Brands, the ticker symbol will change to ‘ACCO’ (from ABD) on the NYSE.

ACCO shareholders still must approve the merger with Mead’s C&OP business at a special meeting on April 23, 2012. If the merger is approved, shares of MWV and ACCO are expected to begin trading on a ‘when-issued’ basis on April 24, 2012. As noted in the initial MeadWestvaco Spin-Off Report and subsequent FLASH (March 12, 2012), following the spin-off of the C&OP business, initial trading of MWV is expected at $27 per share. Given global growth prospects for the packaging industry, near-term upside is likely limited. However investors with a longer-term time horizon may arrive at a $39 per share fair value estimate. Shares of ACCO Brands Corporation are expected to trade at an initial value of $11 per share following ACCO’s merger with the C&OP business, near the current price of the pre-merger stock. Please see the MeadWestvaco FLASH, dated March 12, 2012, for further details.