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.

On December 26, 2012, Liberty Media Corporation (NASDAQ: LMCA, LMCB) announced that it will complete the spin-off of all assets excluding the Starz business after the market close on January 11, 2013, pending final Board approval. Following the transaction Liberty Media will change its name to Starz LLC and trade on the NASDAQ under the symbols ‘STRZA’ and ‘STRZB.’ The spin company will adopt the Liberty Media Corporation name and will continue to trade on the NASDAQ under the symbols ‘LMCA’ and ‘LMCB.’ Shareholders of record as of January 10 will be distributed one share of either STRZA or STRZB for each share of LMCA or LMCB, respectively.

As noted in the initial Liberty Media Corporation Spin-Off Report (October 24, 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 Liberty Media of $118 per share remains intact. The Starz LLC fair value has been revised to $21 per share (from $23) reflecting a lower valuation multiple, partly offset by a lower than previously projected net debt level (see attached exhibit). The EV/OIBDA multiple has been reduced based on higher risks associated with the Starz business model versus the peer group, particularly given the recent announcement that Starz will no longer broadcast Disney (NYSE: DIS) content beginning in 2016.

Please see the Liberty Media Corporation Spin-Off Report, dated October 24, 2012, for further details.

On June 17, 2013, Ashford Hospitality Trust Inc. (NYSE: AHT), a hotel-focused real estate investment trust (REIT), announced its Board had approved a plan to spin off 80% of its ownership in an eight property portfolio in the form of a taxable special dividend to shareholders. The spin company, to be named Ashford Hospitality Prime Inc., is expected to trade on the NYSE under the symbol ‘AHP.’ Ashford Trust will maintain 20% ownership. Ashford Prime includes the premier hotels in AHT’s portfolio, generating RevPAR (revenue per available room) of about $140 in 2012. The spin entity will also enter into option agreements with Ashford Hospitality to acquire two additional upscale properties. Ashford Prime will be externally advised by Ashford Hospitality Advisors LLC, which is a subsidiary of AHT. Following the separation, AHT’s portfolio will consist of 115 hotels with 2012 RevPAR of approximately $95. The spin-off is scheduled to be completed by late 3Q 2013, and still requires an effectiveness declaration by the SEC. The Form 10 was filed on June 17. In 2012, Ashford Prime’s portfolio of hotels generated revenue of $221 million, estimated hotel EBITDA of $73 million and had debt of $628 million with no maturities until 2017. Management expects that Ashford Prime will eventually operate with a leverage ratio below 5x; however, no time table was specified to achieve this target.
 
The transaction appears to be management’s attempt to unlock value, as premium hotel REITs (generating RevPAR in excess of $140) trade at significantly higher valuation multiples than the overall group (see attachment). Premium hotel REITs include Pebblebrook Hotel Trust (NYSE: PEB), Chesapeake Lodging Trust (NYSE: CHP), Strategic Hotels & Resorts Inc. (NYSE: BEE), and Lasalle Hotel Properties (NYSE: LHO). This group trades at an average EV to forward EBITDA of 14.8x, while AHT trades at 11.5x. The separation of Ashford Prime from the weaker RevPAR Ashford Hospitality hotels should result in a lower cost of capital, which would allow Ashford Prime to fund acquisitions that are not feasible under the current corporate structure.
 
Applying a 14.8x multiple to Ashford Prime’s estimated hotel EBITDA of $73 million, and accounting for debt of $628 million, would result in a market capitalization of $452 million (see attachment). AHT’s current market capitalization totals only $948 million. However, investors may exercise caution as initial leverage levels are well above management’s goal. Given management’s stated efforts to expand the portfolio, it may raise questions about future equity offerings. Additional overhangs on post-spin shares may result from concerns over the corporate structure, whereby the portfolio is externally managed by an AHT subsidiary. Non-premium hospitality REITs generating similar RevPAR to post-spin AHT currently trade at an average 12.2x forward EBITDA. AHT may initially trade at a lower multiple post spin given the separation of the upscale properties, despite the parent maintaining a 20% stake.

On March 6, 2013, Time Warner Inc. (NYSE: TWX) announced plans to spin off its publishing subsidiary, Time Inc., into a separately-traded independent company, leaving behind the company’s television networks and film-related businesses. The spin-off entity publishes 21 magazines in the US, including People, Sports Illustrated, InStyle, and Time, and over 70 magazines internationally. The tax-free distribution of shares to TWX shareholders is subject to an effective declaration of the company’s Form 10 filing by the SEC, receipt of a private letter ruling from the IRS, and final approval by the Board. The transaction is expected to be completed by the end of 2013. Following the separation, Time Inc. CEO Laura Lang will step down from her position. A search for her successor has begun. The announcement follows a February, 2013, Reuters report that TWX was in talks to sell most of its magazine division to Meredith Corp. (NYSE: MDP). TWX was highlighted in the March edition of The Spin-Off Report Radar Screen. According to various media reports, talks broke down in part over concerns about a potential culture clash between the two units. MDP is based in Iowa, Time Warner in New York City.

The spin-off will allow TWX to focus on the more profitable film and television businesses, while separating the lagging, low-margin publishing segment. The remaining businesses will include television programmer Turner Broadcasting System Inc., which operates networks such as TNT, TBS, CNN among others, and Home Box Office Inc., as well as filmed entertainment through Warner Brothers Entertainment. Time Inc.’s revenue declined 6.5% in 2012 while operating income decreased 25%. The segment generates only 11.6% of total TWX revenue and 6.6% of operating income.

The trends in Time Inc.’s business are not surprising given the secular decline in the publishing industry, which has seen dramatic decreases in subscriber counts and advertising rates. It could be argued that the publishing business may have been a drag on the company’s valuation as television and film peers trade at a higher multiple than the publishing group. As such, the separation could be seen as a way for TWX to lower its cost of capital. While the film and television segments generated no revenue growth in 2012, operating income expanded by 4.7%.

A basket of media companies involved in magazine and newspaper publishing, including MDP, Scholastic Corp. (NASDAQ: SCHL), The Washington Post Company (NYSE: WPO) and Gannett Co. Inc. (NYSE: GCI), currently trades at 5.5x trailing EBITDA. In 2012, TWX’s publishing segment generated about $511 million in EBITDA. If that peer group multiple were to be applied, and it were to be assumed that no debt is placed on the spin company, TWX’s publishing segment could be valued at $2.8 billion, or $3.01 per share. However, that peer group multiple may in fact prove high, as TWX’s magazine publishing segment provides far less diversification than is included in the larger structure of those peers. Post separation, the remaining film and television business could be compared to the likes of Scripps Networks Inc. (NYSE: SNI) AMC Networks Inc. (NASDAQ: AMCX), and Viacom Inc. (NASDAQ: VIA), which currently trade at an average of 10.7x 2012 EBITDA.

Applying that multiple to TWX’s remaining operations would result in an enterprise value of $69.5 billion. However, TWX’s business may be most comparable to VIA, which includes filmed entertainment as well as television network programming. If Viacom’s multiple is solely applied, an enterprise value of $60.4 billion is derived. Using an average of the two valuations, and the same assumption that no debt is placed with the spin company, a fair value estimate of $51 would be derived. The assumption of placing no debt with the spin company is likely to change as the capital structure is finalized. It can be noted that a combined market capitalization would increase with if more debt is placed with the spin company as the parent receives a higher multiple.

Investors will recall this is not TWX’s first experience with a spin-off transaction. In 2009, the company separated AOL Inc. (NYSE: AOL) via a spin-off. In the two years following that transaction shares of AOL decreased 37%, shares of TWX increased 2.3%. The S&P 500 increased 6.2% over the same time period. TWX also spun off its cable operations Time Warner Cable Inc. (NYSE: TWC), in a two-stage transaction. TWX distributed its remaining 84% stake in the cable operator to TWX shareholders in March 2009, although TWC had already been trading since February 2007 as a result of a transaction to acquire Adelphia Cable in exchange for 16% of TWC. In the two year from the final separation, TWC shares were up almost 200%, TWX rose almost 120%, while the S&P was up less than 70%.