On March 14, 2018, Prudential plc (PRU LN) announced plans to demerge its U.K. and Europe business, M&G Prudential, from its international operations, resulting in two separately listed, publicly traded companies, both of which will be headquartered and listed in London. The international business, Prudential plc, a leading international insurance group focused on high-growth opportunities in Asia, the U.S., and Africa, will be led by current group Chief Executive Mike Wells. The U.K. business will be led by its current Chief Executive John Foley. Timing of the demerger is subject to a number of factors, including completion of the sale of £12 billion in U.K. annuities assets to Rothesay Life, as well as the transfer of the company’s Hong Kong insurance subsidiaries to Asia from Britain, the latter of which is subject to regulatory approval. 

On completion of the demerger, shareholders will hold interests in both Prudential plc and M&G plc. Shares of M&G are expected to begin trading on the LSE on October 21, 2019, under the symbol “MNG”. M&G will pay a 2019 ordinary dividend of £310 million and a one-time special dividend of £100 million, equivalent to 3.85 pence per share. Prudential expects to declare a second interim ordinary dividend of £510 million, equivalent to approximately 19.6 pence per share.

Prudential plc, with a market capitalization of £36.2 billion and £657 billion in total funds under management (as of December 31, 2018), provides a wide range of insurance investment products and services. The company reported consolidated 2018 operating profit (after-tax) of £3.0 billion. The separation of the company’s European operations has been under consideration for several years, as Prudential, like its insurance peers, has been struggling to reduce exposure to capital-intensive insurance products following the introduction of rigorous European solvency rules two years ago, while also seeking ways to deal with growing fee pressure. By spinning off savings- and investment-focused M&G Prudential, Prudential plc can turn its attention to its more profitable life insurance and asset management businesses in the rapidly expanding markets of Asia and Africa and the U.S., all of which are less tightly regulated than Europe. Notably, Prudential currently derives about a third of its consolidated earnings from Asia, which is benefiting from an expanding middle class and growing insurance coverage. Household wealth in Asia is predicted to rise from $53 trillion to $78 trillion over the next five years, creating a substantial growth opportunity for asset managers and insurers. By moving the legal entity for its Hong Kong insurance subsidiaries to Asia from Britain, the company will further reduce its exposure to more rigorous European capital rules.

Based on an analysis of projected earnings and dividend yield, a pre-spin sum-of-the-parts fair value estimate of £16 for Prudential plc can be derived. Post-spin, shares of Prudential plc and M&G plc can be fairly valued at £10 and £6 per share, respectively, based on approximately 2.6 billion post-spin shares outstanding, representing a 1:1 distribution ratio. With the pre-spin fair value estimate approaching the current share price (£14 as of this writing), the transaction does not appear likely to unlock meaningful near-term upside. Accordingly, we do not recommend the pre-spin shares for purchase and initiate coverage with a HOLD recommendation. In particular, we view the current declining interest rate environment as likely to pressure earnings in the near term, owing to reduced income from the company’s interest-bearing instruments, resulting in a potential negative impact on Prudential’s 12%-14% ROE guidance. For post-spin Prudential, new entrants in the pension risk transfer market are likely to result in price competition, which may impact the company’s market share. Equity and credit market fluctuations will also affect shareholders’ returns. Other key risks include the potential for lower growth and returns in the U.S. and international businesses, and higher than anticipated capital deployment.

Conduent Inc. (NYSE: CNDT), a provider of outsourced business process (BPO) services, operates 11 reportable business lines across three broader operating segments: (1) Commercial Industries (54% of consolidated continuing sales and 49% of adj. EBITDA in 1H 2019); (2) Government Services (29% of sales and 38% of adj. EBITDA in 1H 2019); and (3) Transportation (17% of continuing sales and 13% of adj. EBITDA in 1H 2019). Conduent, which was spun off from Xerox in January 2017, is in the early stages of a strategic and operational review amid pressure from activist investor Carl Icahn, who controls roughly 18% of the shares (and has designated 3 of CNDT’s 9 Board members). In our view, the potential strategic options presented to CNDT’s new interim CEO include the spin-off/sale of an entire segment (e.g., Transportation), the piecemeal monetization of individual business units (e.g., HR Services, Government Healthcare, Payments), as well as a sale of the entire enterprise. While the asset monetization option could potentially unlock the greatest value, we view a segment spin-off/sale as the most attractive when factoring in potential timing/execution risks. An outright sale of Conduent would also likely be a favorable outcome for shareholders, although we perceive a dearth of natural buyers given the diversity of CNDT’s business.  In any event, we think many of CNDT’s assets have significant strategic value, which, if unlocked, could offer attractive upside from current levels. Considering financial commentary as well as peer and M&A valuations, value of $15 per share, $11 per share, and $7 per share can be assigned to CNDT’s Commercial, Government, and Transportation businesses, respectively. Accounting for corporate costs and net debt of ~$25 per share yields a sum-of-the-parts value of $8 per share, reflecting a well-below-peer multiple of ~7.0x.  (For context, the bull and bear cases stand at $10 and $6 per share, respectively).  Potential catalysts include the spin-off/sale of assets, a go-private/LBO transaction and/or improved operational execution. Significant risks include incremental business deterioration, due to uncertainty, competition, execution or recession, and leverage.

On May 6, 2019, after the market close, The Ensign Group Inc. (NASDAQ: ENSG) announced that it planned to spin off its home health and hospice businesses. The spin entity, to be named The Pennant Group Inc., will include Ensign’s home health and hospice operations, substantially all of Ensign’s senior living operations, and Ensign’s mobile diagnostic and clinical laboratory business. Pennant has applied to list its shares on the NASDAQ stock market under the ticker symbol “PNTG”. The post-spin parent company, The Ensign Group Inc., will include transitional and skilled services, rehabilitative care services, healthcare campuses, post-acute-related new business ventures, and real estate investments.

The spin-off, which is tax-free to ENSG shareholders, is scheduled to be completed on October 1, 2019. Shareholders of record as of September 20, 2019 will receive one share of PNTG for every two shares of ENSG owned. Trading in the “when-issued” market is expected to begin on or about September 19, 2019, with shares of Pennant trading under the symbol “PNTGV” on the NASDAQ. The transaction is still subject to the receipt of a tax opinion from counsel, effectiveness declaration of the Form 10 filing by the SEC, and Pennant’s stock being accepted for listing on the NASDAQ. Regular-way trading is expected to begin on October 2, 2019.

The Ensign Group Inc. (NASDAQ: ENSG), incorporated in 1999, is the owner and operator of non-acute healthcare facilities in the U.S. that offer skilled nursing, assisted living, home health, hospice, home care, and ancillary services. Skilled nursing, assisted living, and rehabilitative care services are provided via 254 skilled nursing and assisted living facilities, with approximately 20,700 operational skilled nursing beds and 5,900 senior living units.

Post-spin Pennant becomes a publicly traded pure-play home health and senior living company and will consist of 62 home health and hospice agencies, 51 senior living operations, and mobile diagnostics and lab operations located across 13 states. Pennant anticipates that 23 of the senior living assets will remain subject to leases with third-party landlords. In addition, Pennant will operate 28 senior living communities pursuant to long-term triple-net leases with Ensign subsidiaries. Daniel Walker, President of Ensign’s Cornerstone (home health) subsidiary, will become the Chairman, CEO, and President of Pennant following the spin-off. Ensign’s transitional and skilled services portfolio, as well as its rehabilitative care services, health care campuses, post-acute new business ventures, and the company’s existing owned real estate holdings, will continue to operate as The Ensign Group. One-time separation costs are expected to approximate $14 million. As an independent company, Pennant expects to issue $30 million of debt and have a cash balance of $5 million. Proceeds from the debt offering will be used to fund a dividend to Ensign in connection with the spin-off.

Over the course of ENSG’s history, the company has employed a growth-via-acquisition strategy. The company has completed numerous acquisitions in which the purchased properties are underperforming, with Ensign transforming the targets into market leaders, resulting in improved financial performance (revenue and profitability). Owing to these acquisitions, ENSG’s revenue has increased at a CAGR above 15% over the past ten years, with EBITDA more than doubling in the same period.

Going forward, both companies will continue the growth-via-acquisition strategy. Management has commented that they have purposely kept dry powder to aggressively make acquisitions in what they believe is an increasingly attractive buyers’ market. Pennant’s ability to find and complete attractive acquisitions and subsequently improve profitability will be the key driver for the spin company’s earnings growth prospects. As for ENSG, its management has a solid track record of acquiring properties and improving operational results to widen profitability at its properties.

Overall, the outlook for both post-spin companies appears to be positive, for two main reasons. First, the aging demographics of the U.S. and increasing focus on controlling health care costs suggest the existence of a steady supply of customers for the parent company. Second, the majority of independent operators of both skilled nursing facilities and home health and hospice operators continue to be small “mom and pop” operators, thus providing an ample pipeline for future acquisitions.

On a sum-of-the-parts basis, shares of ENSG are assigned a fair value estimate of $50 per share, incorporating current net debt of $246.6 million and 53.4 million shares outstanding (see Exhibit 16). The fair value estimate consists of $8 per share in value from PNTG’s operations and $47 per share in value from post-spin ENSG’s operations. On a post-spin basis, shares of Pennant are fairly valued at $15 per share based on the above valuation exercises and a one-for-two share distribution ratio. Post-spin ENSG shares are fairly valued at $47 per share. Given minimal upside to the current share price, shares of ENSG are not recommended for purchase prior to the spin-off of Pennant. Following the separation, we would look for a sell-off in the smaller spin company, offering opportunities to take positions in the fast-growing Pennant Group. Given our expectations that PNTG will be far smaller in market capitalization (under $500 million versus above $2.5 billion) it could be expected that holders may exit their positions, providing attractive entry points. We would anticipate that management’s history of smart acquisitions and ability to improve margins at acquired properties would continue at PNTG and offer a compelling earnings growth story going forward, however we would remain cautious in the event of interest rate increases as a reversion to the mean multiple may provide downside risk.

Verint Systems Inc. (NASDAQ: VRNT), a provider of primarily software solutions, operates two distinct business segments: (1) Customer Engagement Solutions (~65% of sales and ~77% of adjusted EBITDA in January-ending F2019), which allows clients to take an enterprise approach to improving customer service; and (2) Cyber Intelligence Solutions (~35% of revenue and ~23% of EBITDA), which helps organizations, primarily governments, increase security (i.e., prevent crime, terrorism and/or cyberattacks).  VRNT’s two businesses both broadly provide so-called “actionable intelligence” solutions, offering clients the ability to collect/capture large amounts of structured and unstructured data, analyze the information (utilizing, among other things, predictive analytics and artificial intelligence), and ultimately produce insights that can be readily digested/deployed by decision-makers. That said, the segments have little in terms of operational/financial synergies, serve distinct markets/customer bases, have divergent growth/margin profiles, require differing R&D priorities, and, based on their respective peer groups (and sector M&A), seemingly trade at discounted valuations. In fact, as part of an F2017 initiative, VRNT took steps to provide CES & CIS with additional autonomy and the “operational flexibility and agility” necessary to drive growth in their respective markets. In that context, while the CIS business is somewhat “lumpier,” we think it is gaining the scale/diversification needed to operate independently (or potentially be merged with a strategic competitor), which we estimate would unlock value. Notably, at a recent investor conference, VRNT’s CFO conceded that a separation could be “just a matter of time.”  Based on management commentary, peer and M&A valuations, as well as discounted cash flows, value of $56 per share and $15 per share can be assigned to VRNT’s CES and CIS businesses, respectively. Accounting for projected net debt of ~$2 per share yields a base case sum-of-the-parts fair value of roughly $70 per share. Potential catalysts include the separation/monetization of assets, better than expected growth/margins, FCF generation, share repurchases, and/or tuck-in acquisitions. Potential risks include execution, particularly on the cloud evolution, integration, competition, technological disruption, cost inflation, currency fluctuations, geopolitical instability, and/or budget constraints in a recession.

On March 1, 2019, Eaton Corporation plc (NYSE: ETN) announced plans to spin off its lighting business, part of its Electrical Products segment. The transaction, which will be tax-free to shareholders, is expected to be completed by the end of 2019.

Eaton, headquartered in Dublin, Ireland,  is a diversified power management company that provides energy-efficient solutions for electrical, hydraulic, and mechanical power. It operates through five segments: Electrical Products; Electrical Systems and Services; Hydraulics; Aerospace; and Vehicle. (A sixth segment, eMobility, was added in 1Q 2018.) The company generated 2018 sales of $21.6 billion. The lighting business, a leading provider of LED lighting and control solutions serving customers in commercial, industrial, residential, and municipal markets, generated 2018 sales of $1.7 billion.

Despite a recent recovery in its Hydraulics business, Eaton’s organic revenue growth and margins have lagged industrial peers such as Honeywell International Inc. (NYSE: HON), Parker-Hannifin Corp. (NYSE: PH), Schneider National Inc. (NYSE: SNDR), and Emerson Inc. (NYSE: EMR). Over the past five years, the company has suffered from negative top-line growth, owing to weaker demand for its power management products, largely driven by a cyclical downturn in the industrial sector. ETN shares declined 13% in 2018, versus a 4% decline for the S&P 500 in the same period. For some time, investors have pondered whether the company would undertake a major restructuring such as a sale, spin-off, or large-scale acquisition.

Given the negative impact of cyclicality across its businesses, a key strategic priority for Eaton over the last several years has been the execution of a large, multiyear restructuring program intended to reduce costs and increase margins. Despite negative top-line trends, Eaton grew earnings by over 20% during the past five years. In 2018, the company experienced an improvement in demand and increased EPS by 16% year-over-year, owing primarily to a considerable tax reduction. At the same time, Eaton generated strong operating cash flow of $2.7 billion in 2018. The company expects 9% EPS growth in 2019 (midpoint of guidance). Historically, the company has achieved growth by combining organic growth with acquisitions.

The yet-to-be-named independent lighting company (to be called “Lighting Company” throughout this report), is a part of Eaton’s Electrical Products segment. It was formerly called Cooper Lighting—part of Eaton’s $11.2 billion acquisition of Cooper Industries in mid-2012. The company, which will include Eaton’s lighting business, its Airport Lighting business, and the Mains Lighting and Intrusion Systems businesses, generated 2018 revenue of approximately $1.7 billion, and management has commented that those businesses’ margins were dilutive to overall Eaton margins. In recent years, the business has been negatively affected by declines in average selling prices of LEDs. From a strategic perspective, the spin-off follows the recent trend of solid-state lighting (SSL) businesses separating from a parent, including GE’s recent divestiture of its Current unit and Philip Lighting’s name change to Signify.

On a pre-spin sum-of-the-parts basis, shares of ETN are fairly valued at $80 per share, implying approximately 3% upside from the current share price ($78 as of this writing). Note that pro forma estimates and capitalization information have not been announced as of this writing, and thus, our fair value estimates are subject to change as more information becomes available. With the fair value approximating the current stock price, we initiate coverage with a HOLD recommendation.

Shares of ETN currently trade at 10x 2019E consensus EBITDA, a discount to conglomerate peers in similar industries/end-markets, which are generally trading between 11x and 15x 2019E consensus EBITDA. Year to date, ETN shares are essentially flat, versus an 11% gain for the S&P 500 over the same period. While we expect ETN to deliver continued growth in 2019, we see limited opportunity for incremental multiple expansion, given a product mix of earlier-cycle segments (i.e., Vehicle and Hydraulics) and later-cycle segments (i.e., Electrical Products and Electrical Systems). Note that as of this writing, Eaton has not yet filed a Form-10 for the spin-off. As such, our estimates are largely preliminary and will be updated as more information becomes available.

EnPro Industries (NYSE: NPO) is a diversified industrial conglomerate operating six divisions and 32 business units across three distinct operating segments: (1) Sealing Products (62% of 2018 consolidated sales and 63% of adj. EBITDA); (2) Engineered Products (21% of sales and 22% of adj. EBITDA); and (3) Power Systems (17% of sales and 15% of adj. EBITDA). Following a reconsolidation of previously asbestos-liability impaired assets in July 2017, EnPro, which has a history of both acquisitions and divestitures (e.g., GRT, Franken Plastik), could look to potentially unlock value via the separation/monetization of portions of its portfolio, either by individual business unit/division (e.g., CPI, GGB, Stemco) or by operating segment (e.g., Power Systems). Notably, at NPO’s 2019 Investor Day, the incoming chief executive, Marvin Riley, indicated that he considered the perceived undervaluation of Fairbanks Morse, the engine business that is the primary component of the Power Systems segment, a “serious issue” and indicated a willingness to “look at its options” if the current situation persists. (Anecdotally, the company is also in the process of developing and ultimately bringing to market a new, “game-changing” engine, Trident OP, which could result in a partnership or joint venture with a larger engine concern.) In that context, it is our view that at less than ~7x 2021E EV/EBITDA and a ~7% free cash flow yield, NPO is undervalued relative to the sum of its parts (as well as the potential optionality presented by its engine development efforts).Considering financial commentary, peer valuations, and discounted cash flows, value of $63 per share, $20 per share, and $21 per share can be assigned to NPO’s Sealing Products, Engineered Products, and Power Systems businesses, respectively. Accounting for corporate costs and projected net debt of ~$23 per share yields a sum-of-the-parts value of roughly $81 per share, implying near 30% of potential upside.  Risks include a lack of management execution, variabilities in U.S. military spending, license/patent expirations, of which the most material is not until 2029, labor disputes associated with negotiations scheduled to take place in August 2020-November 2021, warranty reserves/charges for product liability, raw material pricing, currency fluctuations, competition, technological disruption as well as weakening end-market demand, particularly associated with downturns in industrial production.

Nuance Communications to Spin-Off Automotive Business 

On November 19, 2018, Nuance Communications Inc. (NASDAQ: NUAN) announced the separation of its Automotive business (“Nuance Auto”) in a tax-free spin-off to shareholders. The transaction is targeted for October 1, 2019, subject to several conditions, including Form 10 effectiveness and the approved listing of Nuance Auto’s common stock on a national securities exchange selected by Nuance. Nuance intends to appoint an independent management team and nominate members to a separate Board of Directors for Nuance Auto before the transaction is completed.

Nuance Auto (approximately 13% of consolidated revenue) will be headquartered in Boston and maintain a significant presence in Montreal and in Aachen, Germany, among other global locations. The company will become a pure-play, next-generation automotive software company specializing in conversational AI (artificial intelligence) technologies that help automotive manufacturers deliver connected and personalized experiences for drivers and passengers. Nuance’s deeply integrated and customizable solutions enable automotive assistants to be seamlessly integrated into the in-vehicle connected ecosystem. Nuance’s Automotive business claims virtually every automobile manufacturer as a customer, including Audi, BMW, Daimler, Fiat, Ford, GM, Hyundai, SAIC, and Toyota, as well as virtually every major tier-one automotive supplier. Nuance Auto’s technology can be found today in more than 200 million cars, with voice commands recognized in more than 40 languages. The business generated F2018 (Sep) sales of $279 million, with 8% organic growth and a 39% segment margin.

Nuance Communications, based in Burlington, MA, with a current market capitalization of $4.8 billion and revenue of approximately $2 billion, is a pioneer and leader in speech recognition and conversational AI innovation. The company, which has grown substantially through acquisitions, reports four operating segments: Healthcare, Automotive, Enterprise, and Imaging. In February 2019, Nuance sold its Imaging business to Kofax Inc. for $400 million as part of a broader reorganization effort to streamline its business and focus on the Healthcare and Enterprise segments.

Healthcare, which generated F2018 revenue of $985 million, focuses on clinical speech and clinical language-understanding solutions for increasing productivity – including transcription, clinical document improvement (CDI), and coding solutions. The Enterprise business, which generated F2018 revenue of approximately $483 million, provides software that is leveraged to implement automated customer service solutions that are integrated with a wide range of on-premise third-party IVR (integrated voice response) and contact center platforms. The company’s technologies include speech recognition, voice biometrics, transcription, text-to-speech, dialog, and analytics. In the mobile segment, Nuance is perhaps best known for its relationship with Apple Inc. (NASDAQ: AAPL) and involvement with Apple’s Siri application, which combines speech recognition with advanced natural-language processing. The Imaging business, which was sold to Kofax Inc. for $380 million, net of fees and taxes (closed in February 2019), is essentially a legacy business that provides software for document and information processes.

While guidance for F2019 (updated in the most recently reported FQ2 in May), calls for very modest 2-4% organic revenue growth on a consolidated basis, Nuance Communications remains on a path to transform into a global AI leader, and is well under way with a multi-year plan to simplify the business, invest in innovation where appropriate, and cut costs. With artificial intelligence opening up new addressable markets, in our view the spin-off should help Nuance simplify its operations and focus its voice recognition and natural language computing technology on core growth opportunities in its Healthcare and Enterprise businesses. In addition, the company will wind down its subscription revenue services and consumer devices businesses.

On a pre-spin sum-of-the-parts basis, shares of NUAN are fairly valued at $18 per share, implying minimal upside from the current share price ($17 as of this writing). Post-spin, based on capitalization assumptions of $700 million in debt for Nuance Automotive, Nuance Communications and Nuance Automotive can be fairly valued at $15 and $3, respectively. Note that pro forma estimates and capitalization information has not been announced as of this writing, and thus, our fair value estimates are subject to change as more information becomes available. With the fair value approximating the current stock price, we initiate coverage with a HOLD recommendation. While we view favorably management’s efforts to streamline the business, accelerate share buybacks, and repay debt, we remain concerned about near-term operational performance. Specifically, near-term revenue growth may be offset by more rapid declines in non-core businesses. In addition, competition from larger technology companies remains a concern. While Nuance’s Healthcare and Enterprise businesses tend to be subject to stricter regulatory requirements, which may provide some insulation from competition, we think that unlocking this value may take time. NUAN shares have appreciated 26% year-to-date (nearing a 52-week high of $18), versus 14% for the S&P 500 over the same period.

Landec Corporation (NASDAQ: LNDC) operates two business segments: (1) Curation Foods (formerly Apio; ~87.5% of sales and ~48% of EBITDA in F2018), which primarily sells a range of natural foods, including fresh vegetables, salads, guacamole, specialty olive oil & vinegar, as well as plant-based soups; and (2) Lifecore Biomedical (formerly Biomaterials; ~12.5% of revenue and ~52% of EBITDA), which produces sodium hyaluronate (HA) and provides contract development & manufacturing (CDMO) services, primarily focused on FDA-regulated pharmaceutical products. In our view, recent acquisitions, particularly the purchase of Yucatan Foods in December 2018, have increased Curation Foods’ exposure to several higher-growth/higher-margin verticals in the natural foods market as well as increased the scale (and stability) of the business, which we think has markedly improved LNDC’s flexibility to evaluate potential value-unlocking alternatives. To that end, we discern optionality in LNDC’s Lifecore subsidiary, which operates in a sector that is likely to see ongoing consolidation and is forecasted to post 10%-15% top-line growth and a consistent 30%-plus EBITDA margin profile over the next five years. (Anecdotally, LNDC indicates it constantly evaluates all options to maximize value, particularly as Lifecore scales toward a revenue base of ~$100 million.)  As well, the company has a minority investment in privately-held Windset Farms, which could potentially be monetized.  Based on management commentary, peer and M&A valuations, as well as discounted cash flows, value of $7 per share and $13 per share can be assigned to LNDC’s Curation Foods and Lifecore Biomedical businesses. Accounting for corporate costs, projected net debt and other investments of $6 per share yields a base case sum-of-the-parts fair value of roughly $14 per share (with bull and bear cases of $15.50 and $12.50 per share, respectively). Potential catalysts include the monetization/separation of assets, better than expected sales growth/margins, improved free cash flow generation and/or tuck-in acquisitions. Potential risks include execution, particularly on integrations and project ramp-ups, competition, weather/supply-chain volatility, cost inflation, currency fluctuations, shifting consumer preferences and/or a recession.

On December 6, 2018, Mallinckrodt plc (NYSE: MNK) announced plans for the separation of its Specialty Generics business, to be named Mallinckrodt Inc., in a tax-free spin-off to shareholders. The transaction is expected to be completed in 2H 2019, subject to several conditions, including Form 10 effectiveness. The Specialty Generics business will retain the Mallinckrodt corporate name, while the parent company will adopt a new corporate moniker, Sonorant Therapeutics Inc. Following the separation, Mallinckrodt will focus on specialty generic products and active pharmaceutical ingredient (API) manufacturing, while the parent company will focus on “innovative specialty pharmaceutical brands.”

MNK’s generics business, which is to be based in St. Louis, MO, largely manufactures opioid drugs. The post-spin company will include a leading acetaminophen business, as well as a portfolio of API and generic finished-dose forms of controlled substances and other drugs. Additionally, the generics business will include the company’s laxative product, Amitiza (acquired in its $1.2 billion purchase of Sucampo in 2014), and a strong U.S. manufacturing footprint. The new generics business is expected to launch up to five new products in 2019. In 2018, the business reported revenue of $909 million.

Since 2016, Mallinckrodt has explored the sale of its generics business as a means of shifting the business toward higher-margin branded drugs. Despite the formidable size of the generics business, it has experienced a decline in recent years, particularly because many of its products are opioid-based painkillers, which have fallen out of favor with prescribers. For 2018, consolidated revenue of $3.2 billion was essentially flat. However, the company is facing a number of opioid-related lawsuits and is expected to experience a continued revenue decline due to falling generics prices. It should be noted that the generics business has been up for sale since late 2016 and has had two possible buyers express interest, according to industry media reports, but talks were ultimately unsuccessful.

The post-spin parent, Sonorant Therapeutics, will become a specialty pharmaceutical brands company and will focus on its portfolio of marketed and development products. The company will be led by current president and chief executive officer Mark Trudeau.

MNK currently trades at 5.7x consensus 2019E EBITDA, a significant discount to specialty pharmaceutical peers (which trade between  10x and 16x), owing to several headwinds, including: (1) declining Acthar sales, driven by payer pressure in the near term and by brand competitors expected to reach the market in 2021; (2) a combination of loss of exclusivity and brand competition in 2020-2021, particularly with the genericization of INOmax in 2020; and (3) pipeline programs that either target niche markets and/or have not yet demonstrated clinical efficacy.

At $16 currently, MNK shares are trading at one fifth of the 2015 peak of $134. In our view, shares of both post-spin companies will likely remain under pressure owing to several headwinds, and as such, we do not view the spin as a value-unlocking event. In addition, we see potential downside risk to revenue and earnings for both companies over the next 12 months. For Sonorant Therapeutics, competitor overhangs on the Acthar and INOmax franchises, which collectively accounted for over 70% of post-spin revenues, remain a primary concern. We expect a marginal revenue and earnings contribution from pipeline programs, given that terlipressin, inhaled xenon gas, OCR-002, and CPP-1x/sulindac lack strong clinical validation. For post-spin Mallinckrodt, pricing pressure in generics, coupled with opioid-related litigation risk remain key overhangs. Based on an analysis of revenue growth and EBITDA, we arrive at a pre-spin sum-of-the-parts fair value estimate of $17 for MNK. Post spin, Mallinckrodt and Sonorant are estimated to trade at enterprise values of $5.0 billion and $1.6 billion, respectively. Note, however, that final distribution ratio and capitalization have not been announced as of this writing; although management has noted that this will be a “levered spin.” For the purposes of this analysis, we assume $1.3 billion in debt is transferred to Mallinckrodt (approximately 5x 2020E EBITDA), which generates post-spin fair value estimates of $14 and $3 for Sonorant and Mallinckrodt, respectively. We note, however, that post-spin fair value estimates are subject to revision as more information on post-spin capitalization becomes available. With the pre-spin valuation approximating the current share price ($16 as of this writing), and the potential for several downside risks to revenues and earnings for both-post-spin companies over the next several months, pre-spin MNK shares are not recommended for purchase.

On August 13, 2018, VF Corporation announced that its Board of Directors intends to separate the company into two independent, publicly traded companies: VF Corporation, a global apparel and footwear company, and Kontoor Brands Inc., which will hold VF’s Jeans and VF Outlet businesses and will be a global leader in the denim category. The company expects to create these companies through a tax-free spin-off of Kontoor to VF’s shareholders. The transaction is subject to final approval by the company’s Board of Directors, customary regulatory approvals, and tax and legal considerations. The post-spin parent company will a move its corporate headquarters from Greensboro, NC, to Denver, CO. The spin entity will be based in Greensboro.

The separation will be completed on May 22, 2019, with regular-way trading in Kontoor Brands beginning on May 23, 2019. Shareholders of record as of May 10, 2019, are expected to receive one share of Kontoor stock for every seven shares of VFC owned. Shares of Kontoor Brands will trade on the NYSE under the symbol “KTB”. Shares of VF Corp. will continue to trade under the symbol “VFC”. It is expected that shares of Kontoor Brands will begin trading in the when-issued market on or about May 9, 2019, under the symbol “KTB WI”.

VF Corporation is an American-based apparel and footwear company, with headquarters in Greensboro, NC. Currently, the company has over 20 well-known brand names under its corporate umbrella, generally falling into one of four categories: Outdoor, Active, Work, and Jeans. In F2017 the company generated $11.8 billion in revenue (7.1% growth), gross profit of $5.9 billion (50.6% gross margin), and $1.9 billion in EBITDA (15.8% margin). Recent sales performance has been substantially driven by mid-20% growth from its streetwear brand Vans, which is part of the company’s Active reported segment.

Whereas VFC’s Active segment (primarily the Vans brand) has been the highlight of the company’s performance, the clear laggard has been the  Jeans segment, which encompasses primarily Wrangler and Lee branded apparel. The Jeans business has struggled in recent years to keep pace with the sales trends at the other five top brands within the current VFC corporate structure. In this respect it makes sense for the stronger brands to be separated from the weaker. The remaining parent company brands exhibit a wider margin profile and better growth trends, excluding the Kontoor Brand portfolio. In general, we believe these two attributes should allow for a re-rating of the parent company’s shares to a higher multiple. VFC already trades at a premium to most other apparel and footwear companies, with a current EV/EBITDA multiple of 16.3x 2020E consensus. However, several companies, including Under Armour Inc. (NYSE: UA), Nike Inc. (NYSE: NKE), Lululemon Athletica Inc. (NASDAQ: LULU), and Canada Goose Holdings Inc. (NYSE: GOOS), trade at or above approximately 20x 2020E consensus. Notably these companies are experiencing significant revenue growth (except Nike, at ~9% annual sales growth forecast) and have similar margin profiles to VFC. In our view, the pace of growth at the Vans brand, and improving trends at The North Face and Timberland brands, should justify a multiple approaching that of UA, NKE, LULU, and GOOS. Conversely, we expect to see the spin company trade at a lower valuation than it has enjoyed within the larger VFC portfolio.

In order for the spin-off of the Jeans business to unlock value, shares of post-spin VFC need to be re-rated sufficiently higher to offset the decline in the trading multiple that Kontoor is likely to experience. Additionally, management must be able to improve performance at the North Face and Timberland brands in order to  offset any potential slowdown in sales at the Vans brand.

On a pre-spin basis, shares of VFC are fairly valued at $104 per share, consisting of $7 per share in value from Kontoor Brands operations and $97 per share from post-spin VFC shares. Post-spin shares of VFC and KTB are fairly valued at $97 per share and $51 per share, respectively. Given that the post-spin fair value estimate for VFC shares is higher than the current share price, it could be implied that negative value is being assigned to Kontoor within the current corporate structure. When combined with implied upside of just over 10% to the pre-spin fair value estimate, shares of VFC are recommended for purchase ahead of the spin-off and rated BUY. Post-spin, we would expect to see shareholder turnover in shares of Kontoor as investors favor the momentum at VFC’s brands versus the struggling Jeans division. In that context, we would suggest buyers of pre-spin VFC treat the distribution as a free dividend and exit KTB if the shares trade near our fair value. Investors with a longer time horizon may wish to hold KTB shares, or purchase the shares with a significant margin of safety (approaching 6x EBITDA) post-distribution in the expectation that management can right the current sales trends.