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.

On April 4, 2013, Valero Energy Corp. (NYSE: VLO) announced 80% of shares of CST Brands Inc. would be distributed on May 1, 2013. The stock is scheduled to begin regular way trading on the NYSE the following day under the ticker ‘CST.’ Shares will be distributed on a 1:9 basis to VLO holders as of April 19, 2013. Trading on a ‘when-issued’ basis is expected to commence on April 17. The transaction still requires an effectiveness declaration by the SEC.
 
As noted in the initial Valero Energy Spin-Off Report (January 17, 2013), the fair value calculation would be adjusted based on the finalized distribution ratio, capital structure, dividend policy and changes in company/industry fundamentals. Using the average of the three valuation methodologies from the initial report, the fair value for CST Brands has been raised to $29.45 per share (from $27.18) based on the revised distribution ratio, capital structure as well as the updated peer group multiple and 2013 growth projections (see exhibit in attachment). While consensus growth estimates for the peer group in 2013 have been revised lower since initial publication, EV/EBITDA multiples have expanded.
 
Post-spin Valero would be recommended for purchase below $35 per share, based on recent refinery acquisition multiples, book value for the ethanol operations, the peer group multiple for the midstream assets, which are likely to be carved out in the near future, and the value of the remaining 20% stake in CST following the spin-off. Please see the Valero Energy Spin-Off Report, dated January 17, 2013, for further details.
 
The spin-off entity consists of 1,876 gas stations and convenience stores in the US and Canada. More than half the US stations are in Texas, with the remainder in California and additional western and southwestern states. The Canadian operations are primarily in the province of Quebec, with additional stations in Ontario, the Maritimes, and Newfoundland. The US retail stores are joint filling stations and convenience stores, some of which also offer car washes, video and game rentals, as well as ATM access. Of the 1,027 US locations, 828 are owned and 199 are operated under long-term lease. In Canada, there are 256 filling stations with joint convenience stores that are owned or operated under long term lease, 514 retail sites where CST holds title to the motor fuel, but the convenience stores are operated by third parties and 79 cardlocks, owned and operated in remote areas by CST, where pumps are unlocked by membership card and there are no adjoining convenience stores.
 
The possible catalyst for CST Brands would appear to be the potential to invest inside its stores. Previously cash flows generated from the retail business were likely utilized for heavy cap-ex required by refineries. A management focused on improving profitability in this standalone business would seem to have opportunities to expand margins. In fact, merchandise margins have trailed the peer group over the last four years. Increased investment in stores could lead to faster growth for CST than its peers in coming years.

“Shares of 21st Century Fox and News Corp. to Begin ‘When-Issued’ Trading; Fair Values Adjusted
On June 19, 2013, News Corp. (NASDAQ: NWSA, NWS) and 21st Century Fox are scheduled to begin trading on a ‘when-issued’ basis. New News Corp. will trade under the symbols ‘NWSAV’ and ‘NWSW,’ while 21st Century Fox will trade under the symbols ‘FOXAV’ and ‘FOXW’ on the NASDAQ. Shares of New News Corp. will be distributed at the close of business on June 28, 2013, to shareholders of record as of June 21, 2013, on a one-for-four basis. Following the distribution, the parent company will adopt the moniker 21st Century Fox with the spin-entity keeping the News Corp. name. ‘Regular-way’ trading will begin on July 1, 2013. Following the separation, the parent company will trade on the NASDAQ under the symbols ‘FOXA’ and ‘FOX’.
 
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 for New News Corp. is revised to $15 per share (from $17) by applying a peer group multiple to normalized free cash flow and forecasted F2014 EBITDA (see attachment). The projection for F2014 EBITDA (ending June 30) utilizes revenue trends and EBITDA margins through 3Q F2013. The peer group includes The Washington Post Company (NYSE: WPO), Gannett Co. Inc. (NYSE: GCI), and The New York Times Co. (NYSE: NYT).
 
New News Corp may be under pressure in early trading as investors exit the struggling publishing business in favor of the faster growing 21st Century Fox. A price 10% below this fair value (under $14 per share) may represent an attractive entry point. It should be noted that New News Corp. will have in place a $500 million share repurchase program that may help mitigate initial selling pressure.
 
The fair value estimate for 21st Century Fox is revised to $25 per share (from $23) based on forecasted F2014 EBITDA (see attachment). The projection is based on revenue and margin trends through 3Q F2013, while the valuation multiple utilizes an average of the current 10.4x NWSA multiple and the peer group average multiple of 9.1x. The 21st Century Fox peer group consists of Viacom Inc. (NASDAQ: VIAB), CBS Corp. (NYSE: CBS), Time Warner Inc. (NYSE: TWX), The Walt Disney Company (NYSE: DIS), and Scripps Networks Interactive Inc. (NYSE: SNI). Initial trading may exceed this fair value estimate; however, the current multiple is at the high end of the peer group range and historic range. This may limit further appreciation. Please see the News Corp. Spin-Off Report, dated January 30, 2013, and FLASH notes, dated March 11, 2013, and May 24, 2013, for further details.” – The Spin-Off Report

On February 6, 2013, Elan Corporation plc (NYSE: ELN, DUBLIN: ELN) announced that the company has agreed to restructure its current collaboration with Biogen Idec Inc. (NASDAQ: BIIB). Elan will receive a $3.25 billion upfront payment from BIIB for its stake in Tysabri, but will continue to receive recurring royalty payments. ELN will receive a 12% royalty over the first 12 months. After the first year, the royalty will increase to 18% of as much as $2 billion in worldwide sales, and will rise to 25% when sales exceed $2 billion annually. The company will not pay any cash taxes on the $3.25 billion upfront payment. The deal is expected to close by mid-2013 and will end the current profit sharing agreement between the two companies

ELN management has indicated that the company intends to pursue acquisitions with proceeds from the transaction in an effort to diversify operations. The deal removes uncertainty regarding the Tysabri patent expirations that will begin in 2020. However, it will also leave the company without any profitable drugs. As noted in the initial Elan Corporation plc Spin-Off Report (December 12, 2012), ELN is currently reliant on Tysabri for 100% of operating profit.

Following the close of the deal, ELN’s pharmaceutical assets will include the royalty stream from Tysabri; ELND005, a small molecule which has just entered phase II of clinical testing for Alzheimer’s disease; as well as the continued interest in Janssen AI, in partnership with Johnson & Johnson (NYSE: JNJ) and Pfizer Inc. (NYSE: PFE), which has seen recent setbacks.

Give the partnership restructuring, the fair value estimate for ELN has been revised to $11 per share (from $10). The fair value estimate is now based exclusively on a discounted cash flow model incorporating the new tiered royalty structure plus the projected net cash position following the transaction (see attached exhibit). The previous fair value estimate was based on a prior DCF, comparable peer multiple and a dividend yield.

Please see the Elan Corporation plc Spin-Off Report, dated December 12, 2012, and FLASH, dated December 17, 2012, for further details.

On April 26, 2013, Newcastle Investment Corp. (NYSE: NCT) announced shares of New Residential Investment Corp. would be distributed on or about May 15, 2013, with regular way trading scheduled to begin on the NYSE the following day under the ticker ‘NRZ.’ Shares will be distributed on a 1:1 basis to NCT holders as of May 6, 2013. Trading on a ‘when-issued’ basis is expected to commence on May 2. The transaction still requires an effectiveness declaration by the SEC. 

As noted in the initial Newcastle Spin-Off Report (February 25, 2013), the fair value calculation would be adjusted based on the finalized distribution ratio, capital structure, dividend policy and changes in company/industry fundamentals. Since publication, NCT made a $250 million equity investment in a portfolio of consumer loans that will be placed with New Residential following the separation. In February 2013, NCT raised about $206 million through a 23 million share offering. The previous valuations assumed cash raised from the offering would be split evenly between the two entities. The revised fair value is based on the NRZ investment in the consumer loan portfolio. As a result, the NRZ fair value is raised to $7.23 per share (from $6.52), while NCT is revised to $4.46 per share (from $4.69). See the exhibits in the attachment for fair value calculations and the Newcastle Spin-Off Report, dated February 25, 2013, for further details. Valuations are based on book value and projected dividend yields.

On January 14, 2013, Seacor Holdings Inc. (NYSE: CKH) set the record and distribution dates for Era Group Inc. in a Form 10 filing with the SEC. Era Group is scheduled to begin trading ‘regular way’ on the NYSE under the ticker ‘ERA’ on February 1. Shares will be distributed on a 1:1 basis to CKH holders as of January 24. Trading on a ‘when-issued’ basis is expected to commence on January 22. The transaction still requires final Board approval, an IRS private-letter ruling pertaining to the tax-free status of the spin-off, an effectiveness declaration by the SEC and acceptance of the listing by the NYSE. 
 
As noted in the initial Seacor Holdings Spin-Off Report (December 5, 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 fair value for post-spin Seacor Holdings has been revised to $68 per share (from $73) reflecting the $5 per share cash dividend paid in December 2012, utilizing a portion of a debt offering also in December. The ERA Group fair value of $19 per share remains intact. Please see the Seacor Holdings Spin-Off Report, dated December 5, 2012, for further details.

On April 25, 2013, Theravance Inc. (NASDAQ: THRX) announced plans to separate into two independent, publicly traded companies through a spin-off of its early stage drug development business to shareholders. The spin entity may keep the name Theravance, while the parent is temporarily being referred to as Royalty Management Co. Theravance will be capitalized with $300 million at the time of the transaction, which is expected to fund operations for two to three years. The transaction is scheduled to be completed in late 2013 or early 2014. Rick E. Winningham, the current Chairman and CEO of THRX, will initially assume the CEO position at both companies. Management has not determined whether the transaction will qualify for tax-free status. The separation still requires an effectiveness declaration from the SEC, and any other standard regulatory approvals.
 
Royalty Management Co. will control late stage respiratory program partnerships with GlaxoSmithKline plc (NYSE:GSK). Royalty’s assets will be comprised of therapies likely to be commercialized in the near term. These programs include RELVAR, BREO ELLIPTA, ANORO ELLIPTA and VI monotherapy, many of which have already completed Stage III or are near completion of Stage III clinical trials. These products are expected to provide treatment for chronic obstructive pulmonary disease (COPD), potentially a $20 billion market, according to industry experts. The company will assume all of THRX’s NOLs, as well as milestone payments due to GSK at the time of commercialization, and all convertible notes, and is expected to return capital to shareholders through dividends, if and when the respiratory therapies are formally marketed. The parent is due to receive royalties that range from 5-15% of sales, varying per product. Royalty will be minimally staffed as R&D and commercialization expenses are being handled by its partner, GSK. Most Theravance employees will remain with the spin entity at its current headquarters in San Francisco, CA.
 
Theravance will focus on early stage, small molecule development for rare diseases. The transaction will separate the riskier and longer development timeline biotech drug discovery business from the more commercially viable operations that will remain with Royalty Management. The announcement follows a similar transaction completed by Elan plc (NYSE: ELN) in December 2012, where the early stage development programs were separated from the revenue generating partnership with Biogen Idec Inc. (NASDAQ: BIIB). ELN’s spin company, Prothena Corp. plc (NASDAQ: PRTA), has traded at levels moderately above the initial capitalization in its early months as a standalone business.

On May 23, 2013, industrial conglomerate Dover Corporation (NYSE: DOV) announced its Board had approved plans to separate into two independent, publicly traded companies through a 100% tax free spin-off to shareholders of a substantial portion of its communication technologies segment into a company to be known as Knowles Corporation. The spin entity will include microphones, speakers, receivers, transducers and assorted components used in communications infrastructure. Annual revenue for the business is estimated around $1.3 billion. Dover will maintain its energy, refrigeration, fluids, and printing & identification businesses, which generate annual revenue of about $7.5 billion. Knowles is expected to have an investment grade credit rating. Leading brands include Knowles, Sound Solutions, Dielectric, Novacap, Syfer and Vectron. Current segment head Jeffrey Niew will serve as CEO. Current Dover CEO Robert A. Livingston will retain that position. Dover is expected to focus on core acquisitions and potential share buybacks moving forward. The transaction is scheduled to be completed in early 2014. The separation still requires a private letter ruling from the IRS pertaining to the tax-free status of the transaction, an effectiveness declaration from the SEC, and final Board approval. Costs to complete the transaction are estimated at about $60-$70 million. Despite significant international manufacturing operations, the new entity will be headquartered in the US.
 
Dover currently reports operations in four segments: Communications Technologies, Energy, Engineered Solutions, and Printing & Identification. The Communications Technologies segment accounted for 19% of total revenue in 2012, in line with its contribution over the previous three years, and 16% of segment earnings down from 19% in 2010.
 
The segment benefited from the July 2011 acquisition of Austria-based Sound Solutions from NXP Semiconductor NV for $855 million, or about 2.6x sales. Sound Solutions builds speakers and receivers for the fast-growing smart phone market and other consumer electronics. However, the business has recently had production issues and faces the possibility of slower growth after a massive uptick in smart phone demand. Communications technology segment sales have grown at a tepid pace in the aerospace and defense market as strength in the commercial aircraft arena has been offset by ongoing weakness in European defense. The telecom sub-segment, which manufactures frequency control components for wired and wireless network, has posted revenue declines in recent years due to tight spending from the customer base. Segment EBITDA margin has declined from 25.8% in 2010 to 23.2% in 2012.
 
Weaker margins in the communications segment may be masking faster growth in Dover’s other businesses, most notably energy, which builds components for pump-jacks and other artificial lift technology, as well as instruments for down-hole measurement and valves and gauges in the downstream (pipeline and refining) market. Increased hydrocarbon development, particularly horizontal drilling and more technologically-complex exploration and production, likely benefit the upstream operations. Segment revenue increased 46% in 2011 and 14% in 2012, while EBITDA margin increased to 29.2% in 2012 from 28% in 2010. In April 2013, General Electric (NYSE: GE) announced it would acquire leading pump-jack manufacturer Lufkin Industries Inc. (NASDAQ: LUFK) for about 17x 2012 EBITDA, indicating the potential growth viewed for the artificial lift market. One might assume that the parent will receive a higher multiple post-spin given greater uncertainty and potentially slower-growth in the spin-off entity. One might expect Dover to focus on bolt-on acquisitions in the energy segment post-separation. However, it seems unlikely that the parent will receive a sizable cash distribution from the spin entity given management desire to maintain investment-grade status for the new business.
 
Energy segment peers trade about 7.7x EBITDA, Engineered Systems peers about 10.1x and Printing & Identification about 10.3x (see attached exhibit). The consensus estimate assumes $100 million EBITDA growth for DOV in 2013. For simplification purposes, we split the growth evenly among the Energy, and Engineered Systems segments. Applying these multiples to the adjusted 2013 projected EBITDA of parent segments ($646 for Energy, $734 for Engineered Systems, and $169 for Printing) generates an enterprise value of $14.1 billion for post-spin Dover.
 
Establishing a clear peer group for the spin-off entity is challenging. (The list in the attachment includes equipment suppliers for telecom networks as well as communications equipment. Applying the peer group 7.6x multiple to Communication Technologies EBITDA of $352 million results in an enterprise value of $2.7 billion for the future Knowles. The sum-of-the-parts valuation is about $16.8 billion. The current enterprise value for DOV is $16 billion.