On November 13, 2019, after the market close, Smith & Wesson Brands Inc. (NASDAQ: SWBI) (formerly American Outdoor Brands Corp.) announced its intention to separate its outdoor products and accessories business from the company’s firearms business. The tax-free spin-off will create two independent publicly traded companies: Smith & Wesson Brands Inc. and American Outdoor Brands Inc. The transaction, which is expected to be completed in August 2020, is subject to the customary closing conditions. Note that SWBI operates on a fiscal year with an April year-end. Upon successful completion of the spin-off, Jeffrey D. Buchanan, Chief Financial Officer of the company, plans to retire. Deana L. McPherson, currently Chief Accounting Officer, will assume the role of Chief Financial Officer of Smith & Wesson Brands Inc. and H. Andrew Fulmer, currently Vice President, Financial Planning & Analysis, will serve as Chief Financial officer of American Outdoor Brands Inc.

Following the spin-off, Smith & Wesson Brands Inc., based in Springfield, Massachusetts, will continue its firearms business, which includes handgun, long gun, and suppressor products marketed under the Smith & Wesson, M&P, Performance Center, Thompson/Center Arms, and Gemtech brands. The company’s current credit facility, which has a maturity date of October 2021, will become secured upon the spin-off and will remain an obligation of Smith & Wesson Brands Inc.

Based in Boone County, Missouri, American Outdoor Brands Inc. will be a provider of outdoor products and accessories for rugged outdoor enthusiasts. The business is an industry-leading provider of shooting, reloading, gunsmithing, and gun-cleaning supplies; specialty tools and cutlery; fishing accessories; survival products; and electro-optics products. Key brands include Caldwell, Crimson Trace, Wheeler, and Tipton. Brands that will be licensed by the company include Smith & Wesson Accessories, M&P Accessories, Thompson/Center Arms Accessories and Performance Center Accessories, all of which are owned by Smith & Wesson Brands Inc. and will be exclusively licensed to American Outdoor Brands Inc.

On a pre-spin basis, shares of SWBI are fairly valued at $24 per share. With the fair value estimate representing 29% upside to SWBI’s current share price ($19 as of this writing), the transaction appears to unlock incremental upside. As such, we rate the pre-spin shares a BUY. Post-spin, shares of SWBI and AOBC can be valued at $22 and $2, respectively. Note, however, that as of this writing, the company has not filed a Form-10 with the SEC and has not commented on capitalization and other transaction details for the post-spin entities. Thus, our fair value estimates are subject to change as more information becomes available.

SWBI shares have experienced a strong recent run of over 100% year-to-date, having doubled from $9 levels in January, versus a 4% gain for the S&P 500 over the same period. That said, at 8.4x 2021E EBITDA, the shares trade at a discount to their historical peak of  9x (achieved in both 2018 and 2015 as a combined firearms/recreation company) as well as a discount to peer Sturm Ruger & Co. (NYSE: RGR), which currently trades at 10.7x 2021E EBITDA. Following the separation of the lower-margin outdoor business, we would expect SWBI shares to trade closer to RGR as a pure-play firearms manufacturer.  Moreover, a premium multiple may be warranted given near term demand catalysts as SWBI benefits from an acceleration in domestic gun purchasing related to the COVID-19 pandemic. In addition, SWBI should benefit from a leading market share position and growth in adjacent markets. Possible regulatory changes represents a significant potential catalyst, as the current Trump administration’s proposed easing of firearms export procedures, which could be enacted by year-end, would shift oversight of commercial firearms exports from the U.S. Department of State to the Department of Commerce, easing sales of firearms internationally. The National Shooting Sports Foundation (NSSF) estimates that U.S. firearms exports could increase up to 20% under the new regulations. We see post-spin AOBC as a potentially more volatile name in the near term, as the company navigates a more tenuous retail environment amidst COVID-related concerns, , potential earnings erosion from increased tariffs and supply chain disruptions, and because it is a smaller player in a highly competitive outdoor recreation market.

Extended Stay America (NASDAQ: STAY) operates a mid-scale, longer-term occupancy lodging business consisting of two reportable segments: (1) Owned Hotels (98% of sales in 2019), which owns and operates 559 hotels with ~62,175 rooms in 40 U.S. states; and (2) Franchise & Management  (2% of revenue in 2019), which operates 75 Extended Stay-branded locations, with ~7,675 rooms, for third parties. STAY is among the last remaining integrated lodging concerns continuing to buck the industry trend of separating property ownership and brand management. In that context, a lengthy review of the company’s operating structure ended in mid-2019 with no action taken (for the time being). However, recent shareholder developments could prompt STAY to revisit strategic alternatives, including a PropCo/OpCo-type split, or could even portend an outright go-private overture. In that regard, on April 6^th Starwood Capital disclosed an ~8.5% investment in STAY (and it has been reported, by the WSJ, that Blackstone has built a ~4.99% stake in recent months). Interestingly, Starwood controls industry competitor InTown Suites, and Blackstone has twice owned STAY outright (in 2004 and 2010, when it outbid suitors, including Starwood). So, while the lodging space will admittedly remain under pressure in the current environment, we think that, in addition to the potential transactional optionality, the extended-stay niche generally, and STAY specifically, will remain relative outperformers (with industry-leading margins and occupancy). In that regard, we estimate that at 8.5x 2022E EV/EBITDA, STAY is undervalued relative to the sum value of its parts. (As well, in the event that the status quo persists, we think value could be unlocked via the continued monetization of assets, with or without the maintenance of a franchise relationship.) Based on management commentary and peer and M&A valuations, value of $27 per share and $1 per share can be projected for STAY’s current Owned Hotel and F&M businesses. Accounting for corporate costs and projected net debt of $14 per share yields a base case sum-of-the-parts fair value of ~$14 per share. If the company ultimately pursues strategic alternatives, such as an OpCo/PropCo-type split or even a go-private transaction, we estimate incremental value up to ~$16 per share could be unlocked.  Risks include management execution, competition, leverage, and/or a further deterioration of economic activity/prolonged recession

On February 4, 2019, Ecolab Inc. (NASDAQ: ECL) announced plans to spin off its upstream energy business, called ChampionX. The transaction is expected to tax-free to ECL shareholders. ChampionX, which generated $2.3 billion in revenue in 2019, consists of the drilling, completion, and energy production and chemistry sciences operations currently included within Ecolab’s Energy segment. Ecolab will distribute by means of a split-off all of the issued and outstanding ChampionX shares. Immediately after the distribution, a wholly-owned subsidiary of Apergy will merge with ChampionX, with ChampionX surviving as a wholly-owned subsidiary of Apergy and the shares of ChampionX common stock being converted into shares of Apergy. Upon completion of the merger, ChampionX’s stockholders will receive approximately 62% of the outstanding common stock of Apergy on a fully diluted basis. The downstream chemistry solutions business from Ecolab’s former Energy segment will be retained by Ecolab. Ecolab will transfer approximately $492 million in net debt associated with ChampionX to Apergy.

The post-merger company, to be called Apergy Corporation, is a leader in the oil and gas industry in drilling and completion services for both on- and offshore activities. Apergy generated revenue of $2.4 billion, operating income of $170 million and EBITDA of $340 million in 2018 on a pre-merger basis. Post-merger, Apergy is expected to be levered at 2x net debt/EBITDA. The post-spin parent company will be focused on hygiene, food safety, and industrial water markets. The parent company expects to continue its current dividend and highlights its prospects for earnings growth and strong free cash flow generation. Post-merger, Apergy common stock will continue to be listed on the NYSE under its current symbol, “APY.”

For Apergy, the acquisition of ChampionX creates a substantially larger provider of production-optimization solutions, with an expanded and diversified global customer base. The combined business generated 2019 pro forma revenue of approximately $3.5 billion and adjusted EBITDA of approximately $644 million (before synergies). With approximately 87% of revenue from oilfield performance (e.g., product maximization, flow assurance) and the remaining 13% from specialty performance (e.g., drilling and completion, hydraulic fracturing), the ChampionX business is characterized by “sticky” customer relationships with recurring revenue owing to the technical services provided.

In 2019, ECL on a consolidated basis generated $14.9 billion in revenue; on a GAAP basis, the company generated $3.3 billion in adjusted EBITDA and $1.7 billion in net income. As it stands today, ECL reports under four segments: Global Industrial (36% of 2019 sales), Global Institutional (35%), Global Energy (23%), and Other (6%). Global Industrial provides water treatment and process applications, cleaning, and sanitizing solutions to manufacturers, food and beverage processors, chemical, mining, power generation, and other industries. Global Institutional sells specialized cleaning and sanitizing products to foodservice, hospitality, lodging, healthcare, government, education, and retail industries. Global Energy provides chemical and water treatment solutions to the petroleum and petrochemical industries in both upstream and downstream applications. The Other segment provides pest elimination services and equipment care to the foodservice industry.

On a pre-spin basis, shares of ECL are fairly valued at $185 per share. With the fair value estimate approximating ECL’s current share price ($197 as of this writing), the transactions do not appear to unlock upside. Post-spin, ELC can be valued at $180. ECL shares have appreciated approximately 58% from recent lows of $125 in March and are approaching their five-year high. Heightened global concerns surrounding the COVID-19 pandemic, and the company’s exposure to the hospitality, food service and oil and gas markets could further impact sector valuations and our fair value estimates going forward. We value post-merger APY at $11 per share, suggesting minimal upside to the current share price. Given meaningful risks to forward estimates, we do not recommend shares for purchase at this time.

In the near term, reduced consumer activity as a result of the coronavirus is likely to affect Ecolab’s institutional business–75% of which is comprised of restaurants, lodging, and recreation customers. Management has forecast sales to decline over the next three months, but at a slower pace, leading to a gradual recovery over a couple of quarters thereafter. This assumption appears reasonable based on the pace of business re-openings in China. If a similar trend developed in the U.S. and Europe, Ecolab would likely see a large negative impact on second quarter results, a smaller impact on third quarter results, and end the year on a solid footing with a decent fourth quarter. Over the long term, rising freshwater costs globally should lead to increased sales of water management systems for Ecolab’s industrial manufacturing customers. Accordingly, Ecolab’s water treatment business should benefit from a secular trend toward water conservation involving the use of water management systems. This should expand annual revenue growth for the industrial water business to the high-single-digit range. As rising freshwater costs increase Ecolab’s value proposition to its industrial customers, water profit margins should also expand from the 14% range closer to 20%, in line with the institutional business.

For Apergy, declining oil prices and the ensuing reductions in capital spending by oil and gas companies represent a major near-term headwind. Despite the implementation of near-term cost reductions, the current challenging macro environment, coupled with the impending ChampionX merger, raises concerns about Apergy’s 2020 outlook. We see risk to forward revenue and earnings estimates. As such, we rate shares of APY a Hold. Shares of APY, currently at $11, have appreciated almost four-fold from their $3 lows over the same period.

On December 5, 2019, Electrolux AB (ELUX-B.SS) announced its intention to spin off its Professional Products business as an independent publicly traded company, to be called Electrolux Professional AB. Distribution of the shares and the first day of trading in Electrolux Professional is scheduled to take place on March 23, 2020, on Nasdaq Stockholm. In 2019, Electrolux’s Professional Products business, which consists of commercial kitchen and laundry equipment, generated SEK 9,281 million, which represented 7.2% of consolidated Electrolux sales and an organic sales decline of 0.3% year-over-year. The separation follows Electrolux’s previous carve-outs of lawnmower maker Husqvarna in 2006 and seatbelt manufacturer Autoliv in 2005. Following the spin-off of the Professional Products business, Electrolux can focus exclusively on its consumer appliance business, while working toward improving operational efficiencies and increasing its investment in the North America market. 

As an independent company, the Professional business should be in a better position to accelerate organic growth and access capital to pursue mergers and acquisitions, which has been challenging for the company, given the significantly higher valuation multiple in the Professional space. As a standalone entity with a higher multiple, Professional’s growth should be able to create more value going forward. Management has indicated that Professional could seek targets in areas where it has had a smaller footprint, such as North America and quick-service restaurants, and those areas that would accelerate its business in growing emerging markets.

ELUX shares have declined approximately 44% year-to-date, versus a 24% decline for the OMX Stockholm 30 Index over the same period. In recent years, the company has improved its profitability through increased efficiency and by cutting lower-margin products, but the U.S.-China trade war has inflated raw material costs (e.g., steel and aluminum), forcing appliance makers to increase prices. As a result, overall market demand in North America has declined, and the company has forecast that rising costs, coupled with reduced demand in North America—owing to bankruptcy at its largest North American customer, Sears Holdings Corp.—would result in reduced operating efficiencies. In recent months, Electrolux has been working to offset higher costs and the negative impact of currency fluctuations by increasing prices as well as by honing its product line to focus on higher-margin appliances. In addition, the company is investing heavily in new and more efficient manufacturing facilities with increased automation. Price increases have allowed Electrolux to partly mitigate the impact seen in North America from higher raw material costs and tariffs and from lower private-label volumes after Sears, its biggest regional customer, filed for bankruptcy. More recently, however, concerns about the spread of the coronavirus disease (COVID-19) have led consumers to postpone appliance purchases.

On a pre-spin, sum-of-the-parts basis, shares of Electrolux AB are fairly valued at SEK 124 per share, consisting of SEK 19 per share in value from Electrolux Professional, and SEK 105 per share in value from the parent Electrolux. Based on our analysis, the current market valuation is assigning minimal value to the Professional business within the context of the current conglomerate structure. If shares of the parent company were to trade at our estimated fair value, this would imply that just SEK 4.58 in value is currently being assigned to the Professional business, which, based on 2021 estimated EBITDA, implies a trading multiple of 2.2x. Following the separation, the parent company’s commitment to pay a dividend of SEK 8.50 per share in 2020 should help support the Electrolux share price, which lends credence to the thesis that within the current corporate structure, the Professional business is being undervalued. However, given the current macro environment, including the ongoing spread of the COVID-19 virus, we are highly cautious about the company’s future earnings. As such, we rate shares of ELUX a HOLD prior to the separation. In particular, we see the post-spin Professional business at increased risk, as social distancing and other preventative initiatives have already had a significant negative impact on restaurants, cruise ships, hotels, casinos, and other public venues. As such, dramatic declines in occupancy of public spaces and forced closures will likely defer purchase of commercial scale kitchen equipment for the foreseeable future. Further, the potential for a significant increase in unemployment rates may curb revenue trends for the consumer business.

O-I Glass, Inc. (NYSE: OI), a manufacturer of glass packaging products, operates three segments serving distinct geographic markets: (1) Americas (54.5% of 2019 consolidated sales and ~59% of adj. EBITDA); (2) Europe (~36% of sales and 34% of adj. EBITDA); and (3) Asia Pacific (9.5% of 2019 sales and 7% of adj. EBITDA). In our view, with shares trading at less than 5.5x EV/EBITDA as well as a free cash flow yield of ~25%, OI is undervalued relative to the sum value of its parts (as well as the replacement value of its assets). OI has initiated a tactical divestiture program, which we discern primarily targets smaller non-core assets, including the Australian & New Zealand portions of its Asia Pacific business as well as JV interests and property. That said, the company is also conducting a wider strategic review, which we think is, in part, the result of pressure from activist-shareholder, Atlantic Investment, a longtime holder with a current ~5% stake that filed a 13D in September 2018 (and October 2019) calling for, among other things, a wider break-up of the company, including the sale of the European operations, which it estimates would unlock significant value. (Atlantic also pushed the initiation of a dividend and a more robust buyback program, which were both implemented in late-2018). In addition to avenues of transactional optionality, we also see longer-term potential catalysts from the resolution of OI’s legacy-asbestos liabilities (as well as the successful deployment of its MAGMA technology initiative). Risks include management execution, competition/substitution, leverage, cost inflation, currency fluctuations, and/or economic disruptions/recession. Considering financial commentary as well as peer and M&A valuations, value of $32 per share, $16 per share, and $3 per share can be assigned to OI’s Americas, Europe, and Asia Pacific businesses, respectively. Accounting for corporate costs and projected net debt of ~$41 per share yields a sum-of-the-parts value of $10.50 per share.

On November 26, 2018, United Technologies Corporation (NYSE: UTX) announced plans to separate into three independent, publicly traded companies. The separation as it is currently posited will be completed via tax-free spin-offs of the Otis Elevator business, which is to be named Otis Worldwide Corporation (NYSE symbol “OTIS”), and the Carrier HVAC business, which is to be named Carrier Global Corporation (NYSE symbol “CARR”), to shareholders of UTX. For each share of UTX held as of the record date (yet to be announced), shareholders will receive 1 share of CARR and 0.5 shares of OTIS.

The completion of the spin-offs is subject to the customary conditions, including final Board approval, receipt of a tax opinion from counsel, and the effectiveness of the company’s Form 10 filings with the SEC, and the transactions are expected to be completed within 18-24 months from the announcement (targeting April 1, 2020). The announcement was made in conjunction with the completion of the acquisition of Rockwell Collins (previously NYSE: COL). UTX will receive cash distributions of $6 billion and $10.6 billion from Otis and Carrier, respectively.

Additionally, on June 9, 2019, UTX announced that it planned to merge its post-spin Aerospace business (UTC) with defense supplier The Raytheon Company (NYSE: RTN). Under the terms of the transaction, Raytheon shareholders will receive 2.3348 shares of United Technologies for each RTN share held. Post-merger, United Technologies holders will own approximately 57% of the combined business, to be called Raytheon Technologies, with UTX CEO Greg Hayes serving as CEO and Raytheon CEO Tom Kennedy to be named executive chairman. In February 2020, both UTX and RTN shareholders approved the merger. Management expects the transaction to close shortly following the completion of the spinoffs (i.e., in the first half of 2020). Upon completion of the Raytheon merger, the symbol for the new company will become RTX on the NYSE.

UTX is characterized by a balanced growth profile and end-market exposure, as well as a proven track record of operating leverage and execution. The company, which has strong market positions in aerospace and global infrastructure, operates under three general verticals: Aerospace (UTC Aerospace Systems and Pratt & Whitney), which generated $46.9 billion in revenue in 2019; HVAC (including building automation, fire safety, and security products), which generated sales of $18.6 billion in 2019; and Elevators (including escalators and moving walkways), with $13.1 billion in 2019 sales. The COL acquisition added approximately $8.7 billion to UTX’s Aerospace revenue and results in the creation of Collins Aerospace, which is the combination of UTX Aerospace Systems and Rockwell Collins. Collins Aerospace Systems is expected to generate in excess of $500 million in run-rate pre-tax cost synergies over the first four years of combined operations.

In terms of rationale, the separation, which had been telegraphed by UTX management, makes sense given the completion of the acquisition of COL. UTX’s aerospace businesses, including Pratt & Whitney, UTC Aerospace Systems, and COL, have seen revenue growth based on increased aircraft production, while the Elevator and HVAC businesses have experienced more muted growth. The HVAC business appears poised to benefit from an improving housing market, while demand for elevators in U.S. and Europe is being hampered by pricing pressures from China.

Following the merger with Raytheon, the combined company will have a pro forma market capitalization of approximately $156 billion and generate about $75 billion in annual sales, with exposure to several aerospace and defense subsectors. While Raytheon is a defense specialist focused on missiles, radars, missile defense, and electronics, UTX is heavily exposed to commercial aerospace (approximately three-fourths of total aerospace sales). Despite the company’s $23 billion purchase of Rockwell Collins last year, UTX still faces pressure from aircraft manufacturers Boeing (NYSE: BA) and Airbus (AIR EN) to bring down costs. The combined company will leverage a stronger balance sheet to support aerospace product development. In addition, the post-merger company is less exposed to government and commercial sector cyclicality. About 55% of total revenue would come from defense, and less than 5% of combined sales would be from projects that overlap. The new Raytheon Technologies would rank behind only Boeing and Airbus globally in terms of total aerospace sales.

On a pre-spin basis, shares of UTX, including the company’s 57% ownership interest in Raytheon, are fairly valued at $179 per share. On a post-spin basis, CARR and OTIS can be fairly valued at $46 and $59 per share, respectively, based on a 1:1 distribution for CARR and a 1:0.5 distribution for OTIS. With the pre-spin sum-of-the-parts fair value estimate representing over 50% implied upside to the current share price ($115 as of this writing), the transactions appear likely to unlock substantial upside. Note that the markets have been extremely volatile owing to heightened global COVID-19 (coronavirus) concerns, with the Dow declining 7.8% yesterday, the largest decline since October 2008 (UTX shares declined 9% yesterday). As such, continued market weakness could compress sector valuations, and in turn, our fair value estimates considerably going forward. On a pre-merger sum-of-the-parts basis, we value RTN at $241. Following the merger with UTC, Raytheon becomes the third largest Aerospace and Defense company in the world, with a strengthened balance sheet and improving Aerospace product cycle.

On December 17, 2019, Arconic Inc. filed an initial Form-10 with the SEC associated with its planned spin-off of Arconic Corporation, which is to hold the businesses currently comprising Arconic Inc.’s Global Rolled Products (GRP) segment (Rolled Products, Extrusions, and Building and Construction). The businesses currently comprising Arconic Inc.’s Engineered Products & Forgings (EP&F) segment will remain in the existing company, which will be renamed Howmet Aerospace Inc. upon separation. The tax-free separation is expected to be completed before the market open on April 1, 2020. Shareholders of record as of March 19, 2020, the spin-off record date, will receive one share of Arconic Corp. for every four shares of ParentCo held. The spin company, Arconic Corp., will trade on the NYSE under the ticker “ARNC”, while the parent company, Howmet Aerospace Inc., will trade on the NYSE under the ticker “HWM”. New Arconic expects to incur $1.2 billion in debt prior to the distribution and will distribute $800 million of the debt offering proceeds to Howmet Aerospace in conjunction with the separation.

Arconic separated from aluminum producer Alcoa Corp. (NYSE: AA) in November 2016 as part of a strategy pursued by then-CEO Klaus Kleinfeld to invest in finished products and dissociate the company from its tight correlation with the commodity cycle. The separation of the GRP business follows the rejection of a $10 billion offer for the entire company by private equity firm Apollo Global Management LLC in January 2020, a proxy contest against the company by hedge fund Elliott Management, and Kleinfeld’s abrupt departure after allegations of lackluster stock performance, missed profit forecasts, and inefficient spending. Under current management, Arconic has been in the midst of a broader portfolio review to maximize shareholder value. In addition to the separation, Arconic has previously indicated it will consider the sale of businesses that do not best fit into Engineered Products & Forgings or Global Rolled Products. The company also plans to reduce operating costs by approximately $200 million on an annual run-rate basis.

In terms of rationale, the separation appears to make sense from the standpoint of unlocking value. Under the current conglomerate structure, the shares trade roughly in line with the lower-margin Rolled Product group’s peers, obscuring the high-margin, high-free-cash-flow conversion, and the exposure to more aerospace-focused peers of the Howmet business. Upon separation it can be expected that the parent company, Howmet, will be rewarded with a higher trading multiple, which would more than offset New Arconic’s slight multiple contraction. Further, near-term overhangs, including unfunded pension liabilities and the 737 MAX production halt, should correct over the medium term, benefiting longer-term holders of the shares.

New Arconic should be able to benefit from secular tailwinds that include the increasing use of aluminum in light vehicles and aircraft, along with accelerating population growth, particularly in urban areas, with optionality arising from its imminent reentry into the North American packaging industry. Howmet is helped by similar secular tailwinds but is more likely to benefit from the aerospace industry’s current backlog of next-generation planes and increasing use of aluminum structures. The increasing exposure to next-gen planes, with its revenue multiplier effect, should drive above-industry growth for Howmet. We acknowledge exposure to the Boeing 737 MAX program (estimated 2020 impact of $400 million) and a potential slowdown from the impact of the current Covid-19 virus outbreak; however, we expect a return to normal production in coming months that will allow longer-term investors to capitalize on the recent market pullback.

On a pre-spin basis, shares of Arconic are fairly valued at $35 per share, consisting of $25 per share in value from Howmet and $9 per share in value from Arconic. Post-spin shares of Howmet are fairly valued at $25 per share, and shares of Arconic are fairly valued at $38 per share, taking into account the one-to-four share distribution ratio (see Exhibit 26). Given the implied upside from the current share price, we recommend shares of ARNC pre-spin. Following the spin, we favor Howmet Aerospace, as we view the build cycle for new airplanes as a potential long-term boost to the company’s earnings. Note that the markets have been extremely volatile owing to heightened global COVID-19 (coronavirus) concerns, with the Dow declining 7.8% yesterday, the largest decline since October 2008 (ARNC shares declined 11.2% yesterday). As such, continued market weakness could compress sector valuations, and in turn, our fair value estimates considerably going forward.

Online Spin-Off Tracker: Real-Time Tracking of All Spin-Off Announcements, Form-10 Filings, and Recently Completed Spin-Offs, with market prices compared against The-Spin-Off Report’s fair value estimates to highlight investment opportunities.

On September 14, 2018, following a strategic review, Investec plc (INVP LN, INL SJ) announced the spin-off of its asset management business (IAM), to be named Ninety One plc, from its specialist bank and wealth and investment businesses, which is focused on high net worth and high income individuals, and includes corporate and investment banking services such as lending, transactional banking, treasury and trading, and advisory services. The specialist bank and wealth and investment businesses will remain part of the company’s current dual-listed structure. The spin-off business, Ninety One plc, is an asset manager providing investment strategies and third-party investment funds to institutional and advisor clients (68% and 32% of assets under management, respectively) via products in four asset classes: equities, fixed income, multi-asset, and alternatives. The transaction, which is subject to regulatory and shareholder approvals, is expected to be completed on March 13, 2020.

Investec is characterized by a dual-listed company (DLC) structure, comprised of Investec Ltd. (INVP LN), which is listed on the London Stock Exchange, and Investec plc. (INL SJ), which has a primary listing on the Johannesburg Stock Exchange. For simplicity, the combined company will be referred to as Investec. Notably, Ninety One will also be dual listed, with Ninety One plc being listed on the London Stock Exchange and Ninety One Limited being listed on the Johannesburg Stock Exchange (we refer to the combined company as Ninety One). Current Investec shareholders are expected to own approximately 55% of Ninety One. Each Investec ordinary shareholder will receive one share of Ninety One for every two shares of Investec held as of the record date of March 13, 2020 (1:2 distribution). Admission of Ninety One shares to the Johannesburg Stock Exchange and the London Stock Exchange is expected on March 16, 2020. Following the de-merger, Investec is expected to sell up to a 10% position in Ninety One plc via a secondary placing of Ninety One shares while retaining a 15% ownership position. The share sale is not a condition of the de-merger.

Investec, with a current consolidated market capitalization of £4.6 billion, consists of three segments: Specialist Banking, which provides private, corporate and institutional, and investment banking services (53% of revenue); Asset Management, which provides services to both institutional and individual clients (21% of revenue); and Wealth & Investment, which specializes in investing for individual clients, charities, trusts, and clients of professional advisers on a bespoke basis (26%). The consolidated company generated F2019 (March) revenue of £2.6 billion and adjusted net operating income of £591 million. For the period ended March 31 2019, Assets Under Management (AUM) totaled £111.4 billion and customer deposits totaled £13.2 billion. 

In recent years, Investec has focused on simplifying its banking business, divesting non-core assets, and expanding its wealth management platforms. Given the limited synergies between IAM and the remaining businesses, the separation should create incremental value, allowing more strategic focus and capital allocation for each. In particular, Investec’s current dual-listed structure has proved cumbersome for many investors. Notably, the transaction follows an industry trend separating private banking and investment management businesses: Prudential plc spun off M&G Prudential plc, its U.K. and European business, in October 2019; Deutsche Bank AG spun off its asset management business in March 2018; and Old Mutual plc similarly separated its U.K. wealth management and African banking and insurance businesses. The separation of the Asset Management business will give shareholders in Investec a direct stake in the business while allowing the post-spin company to accelerate growth and potentially become a consolidator of assets in the future.

Based on an analysis of operating profit and dividend yield, a pre-demerger fair value estimate of £4.75 can be derived for Investec. Post-demerger, INVP and Ninety One can be fairly valued at £3.94 and £2.48, respectively, based on a 1:2 distribution ratio and a 25% ownership position in Ninety One by Investec (15% retained and 10% to be sold in initial Ninety One trading). With the fair value of the pre-demerger company approximating the current share price (£4.41 as of this writing), the separation does not appear to unlock significant value for shareholders. In particular, we view the current challenging macroeconomic backdrop and currency headwinds, coupled with market-specific risks in the U.K. and South Africa, as likely to remain an overhang on growth. While we view positively the effort to refine and refocus the business and acknowledge the potential for cost-cutting actions to modestly improve profitability, we see little in the way of short-term catalysts for the shares. Other key risks include the potential for lower than anticipated capital deployment, and in turn lower growth and returns in the U.K. and South Africa markets. It should be noted that INVP shares have declined approximately 3% year-to-date, versus essentially flat performance for FTSE 100 Index over the same period.

Hawaiian Electric Industries, Inc. (NYSE: HE) is a holding company with two primary business segments focused on serving residents in the state of Hawaii: (1) Electric Utility (~88.5% of sales and ~63% of net income in 2019E), a regulated public utility operating electric power grids on five Hawaiian islands; and (2) Bank (~11.5% of revenue and 37% of net income), which controls ~$7 billion of assets and provides banking and other financial services to Hawaiian communities via a network of ~50 branches. (The “Other” segment comprises corporate-level activities as well as the results of Pacific Current, which invests in non-regulated renewable energy and sustainable infrastructure projects.) For context, HE had planned to spin-off its Bank operations as part of a merger with NextEra Energy, which valued the consolidated company at $33.50 per share, in a deal that was ultimately scuttled by regulators in July 2016. Currently, despite the involvement of activist investor ValueAct Partners, a 1.5% owner that has advocated for a new chief executive (from outside the company) as well as a more aggressive push toward the use of renewable energy sources, we think management commentary indicates a view that the current business mix enhances its ability to “capture strategic value” and that the low tax basis of the Bank operations is a significant impediment to certain potential transactions. As a result, we think a catalyst for any incremental re-rating is unlikely in the near term. Moreover, with the shares up 36% since the beginning of 2019, HE is currently trading at ~22.5x 2021E EPS and with a dividend yield of ~2.6%, which is a marked premium to peers as well as its own historical average forward trading multiples of ~17.5x and 3.65%, respectively. In fact, our estimates suggest that HE shares, on a sum-of-the-parts basis, may be overvalued (or at least at risk of entering a period of underperformance), particularly considering the risks associated with an evolving regulatory environment and the potential for sector rotation as well as the asymmetric risks inherent in HE’s geographic concentration/location (e.g., economic dislocations, hurricanes, earthquakes, tsunamis, and/or volcanic eruptions).  Based on management commentary, peer and M&A valuations, value of $31 per share and $12 per share can be assigned to HE’s Electric Utility and Bank businesses, respectively. Accounting for corporate & other costs of ~$5 per share yields a base case sum-of-the-parts fair value of roughly $38.50 per share.

On April 30, 2019, Ingersoll-Rand plc (NYSE: IR) announced plans to spin off its Industrial business and then immediately merge it with industrial pumps and compressors manufacturer Gardner Denver Holdings Inc. (NYSE: GDI). The merged company is to be named Ingersoll-Rand plc (“New Ingersoll”, “New IR”) and will trade under Ingersoll-Rand’s existing ticker, IR. The current Ingersoll-Rand will change its corporate moniker to Trane Technologies plc and is expected to trade on the NYSE under the ticker “TT”. Current IR shareholders are expected to own 50.1% of the post-merger combined New Ingersoll. The transaction, which is tax-free to shareholders, is expected to be completed in early 2020.

Ingersoll-Rand, headquartered in Ireland, is a diversified industrial company that currently reports in two segments: (1) Climate (79% of revenue and 79% of EBITDA in 2018); and (2) Industrial (21% of sales and 21% of EBITDA in 2018). For its part, Gardner Denver is a provider of flow control and compression equipment, aftermarket parts, consumables, and services to the Industrial (~49% of revenue and ~41% of segment EBITDA in 2018), Energy (~42% of revenue and ~48% of segment EBITDA in 2018), and Medical (~10% of revenue and ~11% of segment EBITDA in 2018) industries.

Post-merger, New IR will be a diversified industrial company that is expected to generate 2019 pro forma revenue and adjusted EBITDA of $6.6 billion and $1.6 billion, respectively. Adjusted EBITDA includes anticipated annualized synergies of $250 million, to be achieved by the end of year three following the close of the transaction. The company will become the second-largest global manufacturer of pumps and compressors.

The post-spin parent company, to be named Trane Technologies plc, will be focused on climate control for the building, home, and transportation sectors, and includes heating, air conditioning, and transport refrigeration solutions under the Trane and Thermo brands. Trane will receive a $1.9 billion cash dividend to be funded by newly issued debt assumed by Gardner Denver/New IR in connection with the merger, of which $600 million to $1 billion will be used for debt repayment and $900 million to $1.3 billion for share repurchases and potential mergers and acquisitions. From a strategic perspective, the transaction allows the post-spin climate company to focus on its larger, higher-margin business, while providing financial flexibility to fund targeted mergers and acquisitions and, at the same time, generate high free cash flow conversion. For Gardner Denver, the larger scale and the diversification of its business in terms of both end-markets (particularly in relation to a significant reduction in exposure to energy markets) and regions should stabilize the company’s earnings growth prospects. Additionally, similarly to post-spin TT, New Ingersoll will be a significant free cash flow generator that has opportunities to expand margins and cash flow conversion due to synergies with the current IR’s Industrial segment.

We assign a pre-merger fair value estimate of $37 per share to Gardner Denver (post-merger New Ingersoll). Pre-spin IR is assigned a fair value estimate of $146 per share, which is comprised of $115 per share in value from the current Ingersoll-Rand operations (ex the Industrial segment spin-off) and $32 per share in value from shares of New Ingersoll that current IR shareholders will receive. Post-spin, Trane Technologies is assigned a fair value estimate of $115 per share. Risks to our fair value estimates include concerns that the HVAC replacement market may have peaked, along with general industrial investment cyclicality and the resultant impact on earnings growth and comparable multiples.

We recommend purchase of shares of Ingersoll-Rand prior to the spin-off transaction. Our recommendation is based on our belief that the company can achieve mid-single-digit top-line revenue growth and cost savings that will expand margins by about 100 basis points, which, when combined with multiple expansion and issuance of shares of New Ingersoll, offers potential upside exceeding 10% following the spin-off with additionally optionality on further margin and multiple expansion. With respect to the current GDI (which will become New Ingersoll), it is our opinion that the shares appear appropriately valued based on current trading levels of 13.7x 2021E EV/EBITDA versus 12.7x for a broader set of diversified industrial conglomerates. Following the separation, the Trane Technologies business will compare directly with that of Lennox International (NYSE: LII), which currently trades at 14.9x forward 2021E EV/EBITDA. We expect TT’s multiple to expand from IR’s current level of 12.1x to more closely approximate that of LII.

Given GDI’s trading levels, and minimal potential upside to our fair value estimate, the shares of GDI are not recommended for purchase prior to the merger with IR’s industrial business. Further, pre-spin IR shareholders may wish to exit the position in New Ingersoll following the distribution of new shares, as the stock may experience selling pressure in initial trading, and given the longer-term potential for a larger share sale from KKR’s remaining equity stake.

Online Spin-Off Tracker: Real-Time Tracking of All Spin-Off Announcements, Form-10 Filings, and Recently Completed Spin-Offs, with market prices compared against The-Spin-Off Report’s fair value estimates to highlight investment opportunities.