CST Brands Inc. (NYSE: CST) began trading on a ‘when-issued’ basis on April 17, 2013. The distribution of 80% of shares by Valero Energy (NYSE: VLO) to shareholders is scheduled for May 1 with regular way trading commencing the following day. VLO reported 1Q 2013 EPS this morning. The retail segment, which comprises the CST spin-off, posted EBITDA growth of about 7% year over year to $72 million as stronger US fuel spreads more than offset weaker Canadian fuel volume. CST has recently traded around $30 per share in the when-issued market, which appears to take into account 5-7% EBITDA growth, while applying a peer group EV/EBITDA multiple (see attached exhibit). However, as noted in the initial Valero Energy Spin-Off Report (January 17, 2013), longer-term investors may consider CST’s ability to improve merchandise gross margins after separation from VLO, which could raise the valuation by about $5 per share.

One may contend that cash flow generated from the retail business was previously funneled into the capital intensive refining operations. CST has generated about $260 million in annual free cash flow (cash flow from operations minus maintenance cap-ex) over the past three years (see page 27 of the initial report). Following the spin-off, CST may be able to utilize more cash inside the stores, increasing prepared food offerings to raise US gross merchandise margins to the peer group average 34% (compared to 29% for CST in recent years, see page 10 of the initial report). In CST’s road show presentation, management highlighted increased prepared food offerings in new stores and internal store redesigns.

Based on a 34% margin, CST would add about $53 million annually to gross profit. Even assuming certain additional marketing and administrative costs, increasing EBITDA or free cash flow by $45 million would seem attainable. Applying the peer group EV/EBITDA multiple of 8.7x, and a 7% free cash flow yield, the valuation would rise $5 per share (see attached exhibit). Based on about a $35 per share fair value, assuming US merchandise gross margin improvement, the stock is recommended for purchase.

On May 3, 2013, Covidien plc (NYSE: COV) announced that shares of spin-off entity Mallinckrodt plc are expected to be distributed after the market close on June 28, 2013, with regular-way trading likely to commence on the NYSE under the symbol ‘MNK’ on July 1. The share distribution ratio, and record date have yet to be finalized. Management also offered operating guidance for both entities following the spin-off. The transaction still requires an effectiveness declaration by the SEC.
 
As noted in the initial Covidien Spin-Off Report (March 6, 2013), the fair value calculations would be adjusted based on the finalized distribution ratio, capital structure, dividend policy and changes in company/industry fundamentals. Mallinckrodt will have a net debt position of $753 million, below the prior estimate of $1.4 billion, which was based on comparable leverage ratios of peers. In addition the fair value now reflects guidance, which included revenue growth of 7% – 11% and EBITDA margin of 17% – 21%.
 
The fair value estimate for Mallinckrodt has been revised to $6.51 per share (from $6.71) by applying a peer group multiple of 9x to projected F2013 EBITDA of about $425 million. The prior estimate incorporated revenue growth of 4.9% and EBITDA margin of 21.1%. Longer-term investors may see upside to approximately $9.52 per share based on historic takeout multiples. Over the past eight years, on average, companies in the generic pharmaceutical industry were acquired at 12.0x trailing EBITDA and 2.75x trailing revenue, according to Bloomberg. It should be noted that there may be tax implications preventing a takeout of the spin company within two years of the transaction. The revised calculations are shown in the exhibit below.
 
The fair value estimate for COV has been revised to $57.45 per share (from $56.98) to reflect updated capital structure assumptions and management guidance, which includes revenue growth of 4%-5%, operating margin of 22%-22.5%, and an effective tax rate of 17%-17.5%.
 
Previously, the tax rate for New Covidien was unknown, largely due to uncertainties in the distribution of NOLs. As such, the prior fair value estimate was derived in part using EBITDA to avoid an incorrect tax rate assumption. Given management’s guidance surrounding corporate tax rate, New Covidien’s valuation is now reached by applying a peer group multiple to projected EPS and normalized free cash flow. The revised calculations are shown in the attached exhibit.
 
COV is not recommended for purchase prior to the spin-off transaction given limited upside to the $64 per share sum-of-the-parts valuation. Please see the Covidien plc Spin-Off Report, dated March 6, 2013, for further details.

On May 24, 2013, Covidien plc (NYSE: COV) announced that the company’s Board had given final approval for the distribution of shares after the close on June 28, 2013, of spin-off entity Mallinckrodt plc. Regular-way trading will commence on the NYSE under the symbol ‘MNK’ on July 1, 2013. Holders of COV, as of the close on June 19, 2013, will receive one share of MNK for every eight shares of COV. ‘When-issued’ trading is likely to begin around June 17, 2013. Covidien has already received a private-letter ruling from the IRS affirming the tax-free status of the distribution. The transaction still requires an effectiveness declaration by the SEC.
 
The spin company will be a leading manufacturer of generic drugs in the US, including acetaminophen. The pharmaceuticals business accounts for about $2 billion of COV’s $11.6 billion in annual sales. The parent (‘New Covidien’), a diversified medical products and supplies company, was spun off from Tyco International (NYSE: TYC) in 2007 and is based in Dublin, Ireland. The company sells a wide variety of vascular, respiratory, operating room monitoring, and nursing care products. About 80% of the parent’s revenue (post-separation) is generated from medical device sales.
 
As noted in the initial Covidien Spin-Off Report (March 6, 2013) and FLASH (May 3, 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 fair value of $57.45 per share for post-spin COV remains intact.
 
The fair value estimate for Mallinckrodt has been revised to $57.16 per share (from $6.51) to reflect the 1:8 distribution ratio and an increase in the peer group multiple. The fair value is derived by applying a peer group multiple of 9.7x (previously 9.0x) to projected F2013 EBITDA of about $425 million (see attachment).
 
Longer-term investors may see upside to approximately $76 per share based on historic takeout multiples. Over the past eight years, on average, companies in the generic pharmaceutical industry were acquired at 12.0x trailing EBITDA and 2.75x trailing revenue, according to Bloomberg.
 
The fair value for MNK utilizes the pro forma net debt as of December 31, 2012. The valuation could be adjusted based on revised Form 10s, which may show a change in the net debt position as of March 30.
 
Please see the Covidien plc Spin-Off Report, dated March 6, 2013, and FLASH, dated May 6, 2013, for further details.

On May 29, 2013, Sallie Mae (NASDAQ: SLM) announced its Board had approved a plan to spin off its education loan management business through a 100% tax free distribution to shareholders. The company also announced that COO John Remondi will replace Albert Lord as CEO effective immediately. Remondi is expected to lead the loan management business following the completion of the spin-off. The transaction requires final Board approval, a private letter ruling from the IRS, and an effectiveness declaration by the SEC. The transaction is expected to be completed within 12 months. Management is targeting a 1Q 2014 separation date. Following the transaction, Sallie Mae will retain its consumer banking operation, which originates and services private education loans, as well as offers student insurance and college savings programs. Executive Vice President Joseph DePaulo will become CEO of this business.
 
The education loan management portfolio, currently referred to as NewCo, will include about $118 billion in Federal Family Education Loan Program (FFELP) loans, $32 billion in private education loans, and $8 billion of other interest-earning assets, as well as the federal loan servicing platform. About 95% of current SLM assets and 100% of senior indebtedness will be included in this business. FFELP was eliminated in 2010 through the passage of the Health Care and Education Reconciliation Act. The government replaced private lenders in extending federally backed loans to students. As a result most of this portfolio is in run-off mode and may be hiding the greater growth prospects in the consumer bank. Since 2010, SLM has focused on private loans to students, holding about 47% share of this growing market. SLM private loan originations expanded from $2.3 billion in 2010 to $3.3 billion in 2012.
 
The consumer banking business will include nearly $10 billion in private education loans, deposits of $7.8 billion, as well as the private loan origination and servicing platforms. The consumer banking business will have an approximate book value of $1.6 billion with a targeted ROE of 16% – 20%. Assuming a 16% to 20% ROE on $1.6 billion in capital, annual net income would total $256 to $320 million. Other consumer banks with mid teen ROEs, including KeyCorp (NYSE:KEY), Eagle Bancorp Inc. (NASDAQ: EGBN), BankUnited Inc. (NYSE: BKU), and German American Bancorp (NASDAQ: GABC), trade in a range of 12x to 14x projected 2013 EPS. Applying that multiple range to projected net income yields a market value of $3.1 to $4.5 billion (see attached exhibit).
 
The education loan management business is expected to have total capital of $3.5 billion. Since 2010, SLM has traded between 1.8x and 2.0x book value. Applying this multiple range to the far larger entity, results in a market value of about $6.3 to $7 billion. This valuation assumes investors largely ignored growth prospects and higher returns generated from the consumer bank.
 
Continued growth in consumer banking originations would likely result in the higher-end of the multiple range and upside to the current stock price. Legislative changes to the federally-backed student loan program offer potential downside risk to NewCo. A sum-of-the-parts valuation provides a range of $9.4 to $11.5 billion.

On December 14, 2012, PPG Industries Inc. (NYSE: PPG) announced a deal to acquire AkzoNobel NV’s (AKZA:NA) North American architectural coatings business for $875 million cash and the assumption of $175 million in underfunded Canadian pensions, or about 0.7x annual sales of $1.5 billion. This follows plans to separate PPG’s commodity chemicals business and merge with Georgia Gulf Corp. (NYSE: GGC) in a Reverse Morris Trust transaction, which is likely to be conducted as a split-off in early 2013. The fair value estimate of PPG is unchanged at $126 per share (see PPG Industries Spin-Off Report, dated October 17, 2012, for initial calculations). The fair value estimates for GGC of $41 per share immediately following the transaction and $67 per share longer-term are also unchanged.

The acquisition includes 600 home paint stores throughout North America, as well as leading brands, such as Glidden home paints and Liquid Nails adhesive products. About 60% of AkzoNobel’s North American sales are in the United States, 30% in Canada and the remainder primarily in the Caribbean. The PPG fair value derivation is shown in the attached exhibits. The fair value estimate incorporates the likelihood of a split-off transaction related to the separation of the commodity chemicals business, EBITDA and normalized SCF growing $80 million based on the acquisition, and higher net debt due to the deal.

On December 14, 2012, Elan Corporation plc (NYSE: ELN, DUBLIN: ELN) announced that shares of spin-off entity Prothena Corporation plc will be distributed after the market close on December 20, 2012, with regular way trading commencing on the NASDAQ the following day. Elan shareholders of record at the close of business on December 14, 2012, will receive one share of ‘PRTA’ for every 41 shares of ELN. PRTA is expected to begin ‘when-issued’ trading on December 18, 2012.

As noted in the initial Elan Corporation plc Spin-Off Report (December 12, 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 estimate for post-spin ELN of $10 per share remains intact. The fair value estimate for PRTA has been revised to $4.61 per share (from $5.64) to reflect a higher than previously estimated share count. The PRTA fair value estimate is derived through an average of the projected year-end 2013 cash balance and a multiple of initial book value. The revised calculations are shown in the attached exhibit.

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

In an SEC filing on October 10, 2012, Comverse Technology Inc. (NASDAQ: CMVT) disclosed that shareholders had approved the spin-off of Comverse Inc. (NASDAQ: CNSI). Shares will be distributed on a 1:10 basis to holders of record as of October 22, 2012. A when-issued market is likely to commence around the record date. Shares will be distributed on October 31, 2012, after the market close with regular-way trading expected to commence on November 1, 2012. The transaction still requires an effectiveness declaration by the SEC, final Board approval and acceptance of the ticker symbol by the NASDAQ. CMVT will retain the holdings in Verint Systems Inc. (NASDAQ: VRNT), a provider of a suite of enterprise workforce optimization applications, which capture, distill, and analyze underused information sources such as voice and video. Those shares will be merged with VRNT in a transaction expected around January 2013. CMVT will also have about $30 million in cash to continue operations as a holding company until the merger closes. It will also hold $25 million in escrow to be paid to CNSI at the time of the merger.

VRNT is purchasing the 16.3 million shares owned by the holding company, plus the 11.2 million preferred shares, and additional shares valued at around $25 million for a total purchase price of around $779 million, based on the current VRNT stock price, or about $3.56 per CMVT share. When subtracting that value, plus the approximately $299 million in cash expected to be held by CNSI after the closure of the merger, CNSI has an adjusted enterprise value of only about $302 million. The stub is valued at $1.38 per share or 0.48x F2013E sales (see attached exhibit). Notably this calculation excludes the value of NOLs, which totaled about $1.5 billion as of January 2012.

The EV/sales ratio is well below the historic trailing 12 month EV/sales ratio for CMVT dating back to 2001, excluding the period of delisting from NASDAQ. Since mid 2010, the stock has traded about 1.1x trailing sales. It is also well below the current peer group EV/sales of about 1.0x (see attached exhibit). Potential growth products for CNSI in coming years include converged billing software and visual voicemail, which could benefit from growth in smart-phone usage and telecom service bundling.

One may reasonably choose to place a discount on CNSI given its lack of history as a standalone company, and ability to return to profitability. Applying a 0.8x to the 2013E sales of $630 million and adding back the $299 million cash results in a fair value of $36.67 per share for CNSI following the spin (based on a 1:10 distribution). One could also argue that VRNT has upside given the merger of the CMVT stake will increase liquidity, the float, and raise the potential that it could be added to ETFs, while also removing the overhang of CMVT control. VRNT’s closest rival NICE Systems Ltd. (NASDAQ: NICE) trades at about 14x consensus current year projected EPS ,compared to an 11x multiple for VRNT. If one considers the higher multiple for VRNT and averages it with the current price, the value of CMVT’s VRNT holdings rises to $4.08 per share. As a result, the sum-of-the-parts valuation for CMVT ahead of the transaction is $7.74 per share (see attached exhibit). If one prefers to consider CMVT based only on the current VRNT share price, the fair value is $7.22.For more background on this transaction, please see the Comverse Technology Spin-Off Report (July 26, 2012).

Shares of The ADT Corporation are scheduled to be distributed to holders of Tyco International (NYSE: TYC) on September 28, 2012, with regular-way-trading commencing on Monday, October 1. The stock is expected to trade under the ticker ‘ADT’ on the NYSE. Shareholders of record as of September 17 will receive one share of ADT for every two shares of TYC. The when-issued market for ADT shares is expected to begin around the record date. The transaction still requires an effectiveness declaration from the SEC. Tyco is also spinning off its Flow Control segment and merging it with Pentair Inc. (NYSE: PNR) in a Reverse Morris Trust transaction.

As noted in our initial Tyco International Spin-Off Report (June 8, 2012), the fair value calculations would be adjusted based on the finalized distribution ratio, capital structure, dividend policy and changes in company/industry fundamentals. No change is made to the $27 per share fair value estimate for the post-spin parent. The Flow Control segment valuation is also unchanged at $10.50 per share based on TYC shareholders’ 52.5% ownership of New Pentair post merger (see the initial Tyco International report for calculations and methodology). The fair value estimate for ADT is raised to $19.50 per share (from $17 per share), or $39 per share, when taking into account the 1:2 distribution, based on stronger cash flow generation following the 2010 Broadview Security Inc. acquisition.

Previously the fair value estimate was based in part on a three-year average free cash flow (2009-11) for the segment of $350 million. Given that ADT is on pace to top $400 million in FCF for the second consecutive year (ending September 30), one might consider applying a multiple to the $400 million in cash flow, which appears sustainable, at least in the near term. In addition, The Spin-Off Report previously applied the multiple paid for the Broadview acquisition in terms of annual sales and customers. Given higher prices and better margins post purchase, the price paid per customer no longer appears valid and is excluded from the methodology. The changes to the valuation are shown in the attached table. As a result, the pre-spin Tyco International sum-of-the-parts fair value estimate is raised to $57 per share (from $54.50). Further revisions could be made following the Tyco International analyst day scheduled for September 18.

On August 30, 2012, SAIC Inc. (NYSE: SAI) announced plans to spin off its government technical services businesses, including enterprise IT operations, from its solutions-focused business via a tax-free distribution to SAI shareholders. The transaction is subject to final approval by the Board of Directors, favorable ruling from the IRS, likely Pentagon review, and effectiveness declaration from the SEC. The separation is expected to be completed in 2H F2014 (ending January 31). Management indicated the primary reason for the separation is to remove organizational conflict of interests (OCI) rules that prevent each entity from pursuing certain projects, particularly related to US Department of Defense (DOD) contracts.

Management estimates that technical services F2013 (ending January 31) revenue will approximate $4 billion, which is likely comprised largely of non-product sales in the current Defense Solutions segment. The solutions-focused business will be comprised largely of SAIC’s current Health, Energy and Civil Solutions, as well as the Intelligence and Cybersecurity segments. About 20% of revenue is generated from commercial enterprises. SAIC could potentially grow the health, engineering and energy businesses organically at a faster rate, in addition to having more M&A opportunities available. Management estimates that F2013 revenue for the solutions-focused business will approximate $7 billion.

The company expects the present dividend will be continued and remain essentially unchanged when divided between the two enterprises. The final capital structure and management team for each entity has not been determined. The technical services enterprise is likely to generate ample cash flow to fund future endeavors. The solutions business will be more likely to tap credit markets to fuel better growth opportunities, particularly in the commercial sector. One might expect the solutions business will receive a higher multiple due to slightly reduced risks related to sequestration and potential margin pressure for government and DOD projects re-competes.

AbbVie Inc. to Begin ‘Regular Way’ Trading on January 2, 2013 On November 28, 2012, Abbott Laboratories (NYSE: ABT) announced that the Board approved the spin-off of the research-based pharmaceutical business AbbVie Inc. Shares of AbbVie will be distributed after the bell on January 1, 2013, to ABT shareholders of record as of December 12, 2012. Shares of AbbVie will commence regular-way trading on January 2, 2013, on the NYSE under the symbol ‘ABBV’. ABT shareholders will receive one share of ABBV for every share of ABT owned. The ‘when-issued’ market for ABBV shares is likely to commence around the record date. The transaction still requires an effective declaration of ABT’s Form 10 by the SEC. ABT has already received a private letter ruling from the IRS declaring the transaction tax-free for US shareholders of ABT.

As noted in our initial Abbott Laboratories Spin-Off Report (September 20, 2012), the fair value calculations would be adjusted based on the final distribution ratio, capital structure, dividend policy and changes in company/industry fundamentals. No change is made to the $27 per share fair value estimate for the post-spin parent (see the initial Abbott Laboratories report for calculations and methodology).

The fair value estimate for AbbVie is raised to $39 per share from $37 per share. The increase is based on management’s expectations to pay an annual dividend of $1.60 per share, above the prior estimate of $1.43. The fair value estimate is derived by utilizing a peer group P/E multiple to projected 2013 EPS and a revised dividend payout assumption, as shown in attachment.

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