On January 7, 2013, Newcastle Investment Corporation (NYSE: NCT) announced plans to spin off its residential assets into a separately traded real estate investment trust (REIT), New Residential Investment Corporation, leaving behind investments in commercial properties. The spin-off was revealed in conjunction with the announced investment of up to $340 million in excess Mortgage Servicing Rights (MSRs) from Nationstar Mortgage Holdings Inc. (NYSE: NSM). Funding from the acquisition will come from a proposed 40 million share offering of NCT.

The separation would appear to be an effort to unlock value in NCT, which has traded at an average dividend yield of about 12% over the last 12 months. At Friday’s market close, the stock had a 9.8% yield, based on an $0.88 annual dividend. A peer group of investment REITs trade at about 1.0x book and a dividend yield of about 9%, according to Bloomberg. New Residential filed its Form 10 this morning. The 1:1 distribution is targeted for 1Q 2013. The spin-off entity is applying for a listing on the NYSE under the ticker ‘NRZ.’ The spin-off still requires an effective declaration of the New Residential Form 10 by the SEC, acceptance of New Residential’s listing by the NYSE and final approval by the Board of Directors.

According to a Newcastle presentation, New Residential will have book value of about $840 million and a targeted IRR of 14%, producing cash available for distribution of about $0.54 per share. A group of similar residential mortgage REITs has a dividend yield of about 7.5%, and 1.4x price to book. Assuming a 7.5% yield, NRZ would trade about $7.20 per share. Based on a 213 million share count, the market value would be around $1.5 billion. If it trades around 1.4x book value, the market capitalization would be about $1.2 billion.

The post-spin NCT, which would hold the commercial assets, will have a book value of about $770 million and estimated cash available for distributions of about $0.50 per share. Based on a 12% dividend yield, the stock would be priced at about $4.15 per share with a market value of about $890 million, using a 213 million share count. If it trades around book, the market value would be about $770 million. The stock closed on Friday at a price per share of $8.99, equating to a market capitalization of $1.9 billion, based on a 213 million share count. The stock is up about 4% in early trading.

On July 31, 2013, oilfield services provider Oil States International Inc. (NYSE: OIS) announced its Board of Directors approved plans to spin off its accommodations segment into a separate publicly-traded company through a tax-free distribution of shares to OIS shareholders to be completed by summer 2014. The distribution ratio, capital structure and management of the spin-off entity have not been disclosed or determined. The entity will initially be spun off as a C-Corp. Management will also consider conversion of the spin-off entity into a real estate investment trust (REIT), which could be conducted in 2015. A feasibility study must be conducted first. 

Several media reports have indicated that certain shareholders have been advocating for a spin-off and REIT conversion of the accommodations segment. Notably, in June 2013, the Internal Revenue Service began a review to determine the definition of a REIT for tax purposes given the recent efforts of other companies to complete conversion.  REITs do not pay federal income tax, but they are required to return 90% of taxable income to shareholders as dividends. For an entity to qualify for REIT status, at least 75% of its investments must be in real estate assets or cash, and it must derive 75% of its gross income from real-estate–related sources. Given the tax advantages, and thusly the ability to pay out greater distributions to shareholders, REITs typically trade at higher multiples. The spin-off still requires an affirmative IRS declaration regarding the tax-free nature of the distribution, an effectiveness declaration from the SEC following a Form 10 filing, and final Board approval. A conference call to discuss 2Q 2013 earnings and the spin-off proposal is scheduled for 11 a.m. ET. 

Following the separation, Oil States will operate in three segments: Offshore Products, Well Site Services and Tubular Services (see attachment). The spin-off would appear to be an effort to generate a higher valuation for the faster-growth, higher margin accommodations business. The spin-off could further benefit from REIT conversion. Notably tubular services is a commoditized, low margin business (although typically a positive cash flow generator) involving the distribution of oil country tubular goods (OCTG) used in well casing. The well site services business is focused on US land drilling and well completion. It will be impacted by shifts in US rig count, and as a result, can be very cyclical. Although the company’s coiled tubing and wireline units can be utilized to correct production issues at previously completed wells, providing some buffer during rig activity downturns.  The offshore products segment manufactures connectors and other equipment for offshore rigs, platforms, and pipeline. Products are sold worldwide, including the North Sea, West Africa and Southeast Asia. Cycles will be driven by offshore drilling and production activity. 

The proposed spin-off entity generates more stable revenue given the location of structures in long-term development areas including the Canadian oil sands, and Australian mining communities. The structures tend to be portable, modular configurations designed and constructed by OIS. The operations generate stable ongoing revenue streams given long-term contracts for housing, catering and onsite services.  These contracts would tend to lend themselves well to a REIT structure, in which investors may demand relatively secure dividends. The ability to expand operations in the Canadian oil sands and other remote locations offers growth potential. There are no pure-play direct comparables to this business, but perhaps the closest peers would be Canada’s Black Diamond Group Ltd. (BDI CN) and the UK’s Compass Group plc (CPG LN). BDI is perhaps closer given its accommodations business in the oil sands. Compass Group provides food and support services worldwide. Compass generates far lower EBITDA margins, but stronger cash flow, given limited capital expenditures. BDI is trading at about 9.8x trailing 12-months EBITDA, while CPG trades around 11.5x trailing and 11x forward. Applying a 10.5x multiple to $500 million in accommodations segment EBITDA results in an enterprise value as a standalone business of about $5.3 billion. Perhaps the closest comparable companies with REIT structures would be prison operators The GEO Group Inc. (NYSE: GEO), and Corrections Corp. of America (NYSE: CXW), which converted in early 2013. They trade about 12.5x trailing EBITDA. One could argue a prison operator should receive a higher multiple than oilfield accommodations providers, as it should generate more secure revenue streams given relatively stable and growing populations. However, as an exercise, applying a 12.5x multiple to $500 million in EBITDA generates an enterprise value of $6.3 billion. 

The parent can be compared to other US land service providers and offshore product suppliers. The well site services segment can be compared to other land drillers and service providers, such as Pioneer Energy Services (NYSE: PES), which provides drilling and completion services, Parker Drilling Company (NYSE: PKD), which has remote international and shallow offshore drilling services, as well as rental tools operations, and Patterson-UTI Energy (NASDAQ: PTEN), which offers land drilling and pressure pumping services. These stocks are trading 4x-5x EBITDA. Applying an average 4.5x multiple to 2-year average segment EBITDA of $220 million results in a segment enterprise value of $990 million. Offshore products can be compared to businesses such as Cameron International Corp. (NYSE: CAM), FMC Technologies Inc. (NYSE: FTI) and Aker Solutions ASA (AKER NO), which trade around 10x EBITDA. Applying that multiple to $105 million in EBITDA (segment EBITDA minus corporate expense) generates an enterprise value of $1.05 billion. Tubular good assets at year-end 2012 totaled $65 million. The combined parent enterprise value post spin through this rough, preliminary exercise totals about $2.1 billion. Adding the $5.3 billion in enterprise value for the spin-off entity as a C-Corp totals $7.4 billion. Subtracting net debt of $940 million would put the fair value at about $117 per share. If the spin-off is successfully converted into a REIT, a sum-of-the-parts enterprise value could total $8.4 billion, offering substantially more upside. The stock closed last night at an enterprise value of $6.2 billion. The stock is trading pre-market at around $104 per share. 

On July 25, 2013, ONEOK Inc. (NYSE: OKE) announced its Board of Directors approved plans to spin off its natural gas utilities into a separate publicly-traded company to be called ONE Gas Inc. through a tax-free distribution of shares to OKE shareholders. The distribution is expected to be completed in 1Q 2014. ONE Gas will be listed on the NYSE under the ticker “OGS”. The distribution ratio has not been determined. The spin-off entity distributes natural gas to more than two million customers through the utilities Oklahoma Natural Gas Company, Kansas Gas Service and Texas Gas Service. The parent will maintain its 43.3% interest, including general partner (GP) interest, in midstream master limited partnership (MLP) ONEOK Partners LP (NYSE: OKS). ONE Gas is expected to make a cash distribution to the parent of around $1.2 billion at the time of separation, leaving OKE with net debt of about $1.2 billion (excluding the consolidated net debt of about $4.7 billion of OKS). The transaction still requires final Board approval, an affirmative ruling on the tax-free nature of the transaction and regulatory approval. More details will be offered during a conference call scheduled for 10 a.m. on Friday, July 26.

The CEO and Chairman of OKE, John Gibson, will retire following the separation, while remaining non-executive Chairman of both entities. OKE President Terrry Spencer will become CEO following the transaction, while Pierce Norton, executive vice president, will become CEO of ONE Gas. The separation appears to be an effort to simplify the corporate structure and increase distributions to the parent’s shareholders, as it will no longer fund the utilities’ capital expenditures. OKS’s growth strategy includes acquisitions and new construction programs. OKS has been investing in pipelines and natural gas liquids (NGLs) processing in the Bakken Shale. It also has transportation and processing assets in West Texas and Mid-Continent. The gas utilities serve customers in Kansas, Oklahoma and Texas. Both entities are expected to pay a dividend. 

The utility segment generated average operating income of $210 million over the previous three years. Assuming it will pay 5.2% interest on its $1.2 billion in debt and taxed at a 35% rate, EPS should be around $0.47 (see attachment). Natural gas utilities (including Northwest Natural Gas Corp. [NWN], WGL Holdings Inc. [WGL], and South Jersey Industries Inc. [SJI]) trade about 19x EPS, payout about 60% of earnings to shareholders, and yield about 3.5%. Applying those metrics, the spin-off entity could be valued at $8-$9 per share, assuming a 1:1 distribution ratio. 

OKS paid the parent $130 million in distributions in 1Q 2013, including general partner incentive rights. Assuming those distributions are paid directly to OKE shareholder post-spin, based on an effective tax rate of 15%-35%, 5.2% interest on OKE’s non-consolidated debt of $1.2 billion and share count of 206 million, the annual distribution could be $1.44 to $1.89 per share. Assuming a 4% yield, in line with other pure-play MLP general partners, OKE could be valued between $36 and $47 per share. A sum-of-the-parts valuation of $44-$56 per share could be reached through this rough, preliminary exercise. Upside to this valuation could come from higher distributions from the MLP. The spin-off entity could benefit from increased utility rates. OKE is currently trading at approximately $50 per share.

On July 10, 2013, Tribune Co. (OTC: TRBAA) announced plans to separate its publishing operations from its broadcasting unit. The media conglomerate, which exited bankruptcy protection late last year, announced a deal earlier this month to purchase 19 broadcasting stations for $2.73 billion. The separation follows last month’s spin-off by News Corp. (NASDAQ: NWSA) of its newspapers and publishing arm, which kept the News Corp. name, and left behind its other media operations as Twenty-First Century Fox  (NASDAQ: FOXA). Similarly Time Warner Inc. (NYSE: TWX) is spinning off its magazine division as media empires begin disbanding to separate the more profitable, growth-oriented broadcast units from publishing segments, which have diminishing profitability. 

The spin-off, to be called Tribune Publishing Company, will include the Los Angeles Times, Chicago Tribune, Harford Courant. Orlando Sentinel, The Baltimore Sun, The Morning Call and Daily Press, while the parent, Tribune Company, will be home to 42 local television stations, as well as WGN America, and equity interests in The TV Food Network, CareerBuilder, and assorted real estate assets. The transaction requires customary regulatory approvals, positive opinion from counsel regarding the tax-free status of the separation and additional due diligence. Pending final Board approval, the separation could take one year to complete. In 2012, the publishing arm generated revenue of $2 billion, operating profit of $89 million (down from $90 million in 2011 and $156 million in 2010) and EBITDA of $207 million. Revenue had been relatively flat during the bankruptcy period, while margins continued to slide. 

The broadcasting unit generated revenue of $1.14 billion in 2012 (up 3.5% from 2011 and 2010), operating profit of $366 million, up 10% from 2011, and EBITDA of $415 million. Revenue grew modestly during bankruptcy, but margins improved. The segment should be bolstered by the recently-announced television station acquisitions, particularly if synergies can be generated. Income on equity investments totaled $197 million in 2012. 

In June 2013, Gannett Co. (NYSE: GCI) announced a deal to acquire fellow broadcaster Belo Corp. (NYSE: BLC) for about $2.0 billion (including the assumption of $715 million in debt), or about 7.8x trailing EBITDA of $259 million. Applying a 7.8x multiple to Tribune broadcasting segment 2012 EBITDA of $415 million (plus $197 million from equity investments) generates an enterprise value of about $4.8 billion.  Alternatively, one may apply the peer group average EV/trailing EBITDA multiple of 10x to reach a value of $6.1 billion. Newspaper companies including NWSA are trading around 7x trailing EBITDA. Applying that multiple to Tribune 2012 EBITDA of $207 would value the spin-off entity at about $1.4 billion. The sum-of-the-parts enterprise value totals $6.2 to $7.5 billion in this initial exercise. Tribune has net debt of about $450 million. Although there is a significant tax issue outstanding with the IRS, which we are not including in this figure. Tribune’s current market capitalization is $5.3 billion

On August 7, 2013, Murphy Oil Corp. (NYSE: MUR) announced shares of Murphy USA Inc. would be distributed after the market close on August 30, 2013, with regular way trading scheduled to begin on the NYSE on September 3 under the ticker ‘MUSA.’ Shares will be distributed on a 1:4 basis to MUR holders as of August 21, 2013. Trading on a ‘when-issued’ basis is expected to commence on or about August 19. The transaction still requires an effectiveness declaration by the SEC. 

As noted in the initial Murphy Oil Spin-Off Report (June 13, 2013), the fair value calculations would be adjusted based on the finalized distribution ratio, capital structure, dividend policy and changes in company/industry fundamentals. The adjustments for MUSA are based on the 1:4 distribution ratio and higher net debt level than initially modeled ($607 million compared to the initial $453 million). The adjusted fair value for the parent is based on a lower share count due to the ongoing repurchase program, higher debt level, and expanding valuation multiples for the peer group due to rising crude oil prices. The parent (including the UK refining and marketing business, which is likely to be sold) is valued at $60 per share (previously $59). The spin-off entity, which includes the two ethanol plants and midstream assets, is valued at $14 per share (or $54 when including the 1:4 distribution ratio). See attached exhibits.

On August 19, 2013, shares of Murphy USA Inc. (NYSE: MUSA) begin when-issued trading as the kiosk operator’s separation from Murphy Corp. (NYSE: MUR) nears completion. Shares will be distributed on a 1:4 basis to MUR holders as of August 21, 2013. Regular way trading commences on September 3, 2013. 

The Spin-Off Report‘s fair value estimate for MUSA of $54 per share takes into account anticipated location expansion through 2015, a sale of its ethanol plants and two terminals, and relatively flat fuel spreads of around $0.12 per gallon (annual average in 2010 and 2012). However, given that no final decision has been reached on the ethanol plants and location expansion will not be completed until late 2015, one might expect initial trading of the stock to be in the range of $40-$45 per share. Trading below this level would present an appealing entry point given prime kiosk locations in the parking lots of Wal-Mart Stores Inc. (NYSE: WMT). Despite the disappointing 2Q 2013 results announced by WMT in August 2013, it would appear unlikely this would have a significant impact on MUSA fuel volumes given the entity’s strategy of lower-priced supply. 

Assuming average annual EBITDA per location of $253,000 (average in 2010 and 2012), location growth to about 1,320 by late 2014, and utilizing a peer group multiple of 8.7x, one may reach a value for the retail segment of $2.9 billion (see attached exhibits). The fair value also assumes net proceeds of $200 million from sales of the ethanol plants and $44 million for the terminals. Based on net debt of $607 million and 47 million shares (1:4 distribution), a fair value of $54 per share is reached. Even if one chooses to discount store growth and applies the multiple to current location count (1,179), a fair value of $48 per share is reached. Essentially $6 per share is credited for growth. 

However, investors may lean more heavily on management guidance when seeking an initial fair value for the spin entity. Based on mid-range guidance for 2013 of $310 million in EBITDA, and applying the peer group 8.7x multiple, subtracting $607 million in net debt, and assuming a 47 million share count, a fair value of about $45 per share is reached. Some investors may seek a discount to the peer group given MUSA’s heavy reliance on more volatile-margin fuel sales as opposed to more stable higher-margin merchandise. These concerns should be more than offset given the heavy volumes and prime locations of MUSA kiosks, the advantages of the terminal network to distribute lower-priced fuel, and the ability to add 200 stores in three years at low cost ($2.1 million per location). 

On February 15, 2013, AbbVie Inc. (NYSE: ABBV) announced that the company’s board of directors had approved a $1.5 billion share repurchase program and declared a quarterly dividend of $0.40 per share. The share repurchase program is expected to be completed over the next several years.

As discussed in the initial Abbott Laboratories Spin-Off Report, dated September 20, 2012, AbbVie generates significant free cash flow from its portfolio of high margin pharmaceutical products. The company is highly reliant on sales of HUMIRA, which continues to see solid sales gains, including a 20.7% increase in 2012 versus 2011.

The fair value estimate for ABBV has been revised to $42 (from $39) to reflect management’s 2013 EPS guidance (see attachment). The fair value estimate is now based on a peer dividend yield and the midpoint of management’s 2013 EPS guidance of $3.03 to $3.13. The peer group includes Eli Lilly & Co. (NYSE: LLY), Johnson & Johnson (NYSE: JNJ), Merck & Co. Inc. (NYSE: MRK) and Pfizer Inc. (NYSE: PFE). Previously the fair value estimate was based on the dividend payout and projected EBITDA. Longer-term upside to the fair value estimate could be realized through either an increased dividend per share payment or rapid completion of the share repurchase program.

Please see the Abbott Laboratories Inc. Spin-Off Report, dated September 20, 2012, and FLASH, dated November 29, 2012, for further details.

Shares of 21st Century Fox and New News Corp. Expected to Begin Regular-Way Trading on July 1; Fair Values Adjusted
On May 24, 2013, News Corp. (NYSE: NWSA, NWS) announced that its Board of Directors had approved the spin-off of NWSA’s publishing business. The distribution of shares on a 1:4 basis of new News Corp. is expected to occur after the close on June 28, 2013, with regular-way trading scheduled to commence on July 1, 2013. Following the separation, the parent company will be known as 21st Century Fox and will trade on the NASDAQ under the symbols ‘FOXA’ and ‘FOX’. The transaction still requires a private letter ruling from the IRS and an effectiveness declaration from the SEC. New News Corp. has established a $500 million share repurchase program, which may prevent significant initial selling pressure following the distribution.
 
As noted in the initial News Corp. Spin-Off Report (January 30, 2013), the fair value calculation would be adjusted based on the finalized distribution ratio, capital structure, dividend policy and changes in company/industry fundamentals. The fair value estimate for post-spin NWSA has been revised to $17.20, from $4.28 per share, to account for the 1:4 distribution ratio (see attachment). The fair value estimate is based on an average of normalized free cash flow and price to book.
 
The fair value estimate for 21st Century Fox has been revised to $23 per share (from $22) to reflect the updated peer group multiple. It should be noted that NWSA shares risen 29% year to date, versus a 15% increase for the S&P 500. NWSA shares now trade at 12x 2013 estimated EBITDA, a 20% premium to 21st Century Fox’s peer group. The fair value is based on the peer group free cash flow yield and projected EBITDA. Initial trading in FOXA may approximate $30 if the current NWSA multiple remains intact. However reversion to the peer group multiple may present downside risk to share price following the spin-off.
 
Please see the News Corp. Spin-Off Report, dated January 30, 2013, and FLASH, dated March 11, 2013, for further details.

Shares of Starz (NASDAQ: STRZA) have reached The Spin-Off Report fair value estimate of $21.49. Holders may utilize this estimate in deciding whether to maintain their position in the stock. Investors will recall that Liberty Media Corporation (NASDAQ: LMCA) spun off all assets other than the Starz cable channel business on January 11, 2013. The spin entity took the Liberty Media moniker while the parent company adopted Starz as a corporate name.

Since the close of the first day of regular way trading, shares of STRZA have increased 38.7% versus an increase of 6.3% in the S&P 500. Additionally the peer group used to evaluate STRZA, including Discovery Communications Inc. (NASDAQ: DISCA), Scripps Networks Interactive Inc. (NYSE: SNI), and AMC Networks (NYSE: AMCX), has increased on average just 14.1%. While STRZA shares have reached the fair value estimate, some investors may wish to maintain a position given the potential for the company to be an acquisition target. STRZA management has publicly commented that the company would provide synergistic benefits to larger media organizations. However, upside from a takeout may be limited given STRZA already trades at 8.4x EV to trailing EBITDA and yields less than 8% on a free cash flow basis.

Please see the Liberty Media Corporation Spin-Off Report, dated October 24, 2012, and FLASH, dated December 27, 2012, for additional details.

On March 8, 2013, News Corp. (NYSE: NWSA) filed an amended Form 10 with the SEC providing details relating to the planned capital structure of the spin-off of the company’s publishing business. As detailed in the initial News Corp. Spin-Off Report, dated January 30, 2013, fair value estimates would be adjusted based on revised capital structures. It is now expected that Fox Group Inc. will make a cash contribution of approximately $1.8 billion to New News Corp. in conjunction with the separation. The spin-off is expected to be completed in 1H 2013; however, a date has not been set. New News Corp. still requires a private letter ruling from the IRS, and an effective declaration of the company’s Form 10 filing by the SEC.

New News Corp. will hold $2.6 billion in cash on its balance sheet, and no long-term debt when it begins operations as a stand-alone entity. The prior fair value estimates assumed New News Corp. to have approximately $1 billion in net cash. The revised capital structure results in an adjusted fair value estimate for New News Corp. of $4.28 per share (previously $3.44). The fair value estimate increase is a direct result of a wide variance between the prior assumption of book value at New News Corp. and the pro-forma projections released. In addition, since the initial publication, News Corp. released an updated balance sheet in conjunction with 2Q F2013 results, which showed an approximate $4.2 billion decrease in net cash due to acquisitions. The fair value estimate is based on an average of two methods: normalized free cash flow yield, and price to book ratio.

Given the cash contribution to New News Corp., an updated balance sheet, and the fact that comparable multiples have expanded since the initial publication, the underlying assumptions have been modified in the Fox Group valuation. However, the fair value estimate of $22 per share remains intact.

NWSA shares currently trade above the revised sum-of-the-parts fair value estimate of $26, as such, the shares are not recommended for purchase prior to the transaction. Please see the News Corp. Spin-Off Report, dated January 30, 2013, for further details.