There is some confusion among clients regarding the actual rule allowing a SpinCo or ParentCo to be acquired following a tax-free spin-off. This arises because the IRS rules governing the tax-free nature of spin-off transactions, and an entity’s ability to keep that status in the event of an acquisition (or certain other post-spin transactions, including share repurchases and issuances), are written in dense, vague, and confusing legal verbiage, while various market participants have long disseminated arbitrary opinions about the matter without factual substantiation. The most common measuring stick cited is a general two-year time period following a spin-off before a company can be acquired. However, even this is often presented with a general caveat that either side of the transaction could be acquired within the two-year time frame if the company satisfied certain conditions.

In the following report, we attempt to clarify whether a company (SpinCo or ParentCo) can be acquired, without tax ramifications, following a tax-free spin-off of shares of a SpinCo to ParentCo shareholders. Our conclusion is that there is no hard-and-fast rule on the acquisition of a ParentCo or SpinCo following the distribution. However, we will walk through Internal Revenue Code Section 355 (“355”), which governs tax-free spin-offs, and address the issues that may affect a transaction’s tax status at both the corporate and shareholder levels following the spin-off, with the goal of providing a clearer picture of the factors that go into management’s (and counsel’s) decision to plan for a company to be acquired.

In subsequent publications, we will highlight spin-offs that have recently occurred (going back four years) and that we currently find attractive. It should be noted that The Spin-Off Report is not necessarily asserting that these companies will be acquired, or even could be acquired, in the near or long term, but rather that certain company-specific characteristics likely make companies attractive investments—characteristics that may also pertain to an acquisition. These characteristics include company and sector-specific attributes.

On September 7, 2016, TEGNA Inc. (NYSE: TGNA) announced its intention to separate its Cars.com digital publishing business from its independent broadcast station business via a tax-free distribution of shares. Cars.com is expected to list on the NYSE under the symbol “CARS”. TEGNA shareholders will receive one share of CARS for every three TGNA shares held as of the record date of May 18, 2017. Following the distribution, TEGNA will continue to trade on the NYSE under the symbol “TGNA”. Regular-way trading of CARS is expected to begin on June 1, 2017. TEGNA also announced that it is evaluating strategic alternatives for CareerBuilder, a global leader in human capital solutions (TGNA owns 53%). TEGNA also announced that upon completion of the transaction, CEO and President Gracia Martore will retire, and David Lougee, currently President of TEGNA Media, will take over both roles. Alex Vetter, currently CEO and President of Cars.com, will continue in that role for the independent company.

TEGNA, based in McLean, Virginia, was separated from publisher Gannett (NYSE: GCI) in June 2015. At that time, the spin-off of Gannett’s publishing business represented the culmination of a strategy that had been under way at Gannett for several years, to protect the company’s broadcast and digital businesses from the decline in print advertising. Currently, TEGNA is the largest independent broadcaster among major network affiliates in the top 25 markets, operating 46 television stations and spanning 36 million households. The company is the largest group owner of stations affiliated with NBC and CBS. In 2016, the Media business generated $1,933.6 million in sales (15% year-over-year growth) and $908.1 million in adjusted EBITDA.

Launched in 1998, Cars.com claims to be the largest automotive classified advertising website for consumers (as measured by revenue). The site, which serves dealers and OEMs (original equipment manufacturers), averages 35 million monthly visits. TEGNA’s investment in Cars.com originates with Gannett, one of the business’s original investors. In October 2014 TEGNA acquired the remaining 73% of the company for $1.8 billion (a lofty 20.7x EV/EBITDA). In July 2016, Cars.com acquired DealerRater, the industry’s largest automotive consumer review website. In 2016, Cars.com generated $633 million in revenue (19.4% CAGR for 2013-2015) and $259.8 million in EBITDA. The market for automotive digital advertising spending appears robust, with growth expected from the $9.9 billion forecast for 2017 (12.8% of total digital advertising spending) to $14.1 billion in 2020 (13.4% of total spend). Despite a healthy demand backdrop, however, Cars.com has underperformed in the past several quarters, posting lower sequential revenue growth despite several small acquisitions. The business reported 0.4% revenue growth in 1Q 2017 (below its high-single-digit/low-double-digit long-term growth rate). With consensus estimates having been recently revised downward, revenue growth guidance is increasingly back-end loaded for later this year and into 2018. That said, better performance is expected following the ramp-up of direct sales initiatives and higher growth from affiliates, lower investment spend on digital in general, and the DealerRater acquisition.

Nearly two years after the acquisition, TEGNA is spinning off Cars.com. Notably, TEGNA shares underperformed in 2016, declining 14% versus a 11% increase for the S&P 500, largely due to questions over the underlying health of the core broadcast business and mixed performance of the company’s digital assets, most evident in the stock’s underperformance in what should have been a record broadcast year in 2016, with Super Bowl benefiting one of its major affiliate groups, as well as the Olympics and the presidential election.

TEGNA has reduced its guidance across multiple business segments, which has led to heightened uncertainty over whether the company can achieve its long-term growth targets. After facing investor scrutiny over the past two quarters owing to lighter political advertising spending, management guided for Media Segment revenues in the low-to-mid-single digits for 2Q 2017. This year-over-year comparison will be negatively impacted by approximately $10 million owing to lower political ad spending. In light of the more cautious revenue outlook, the company’s long-term EBITDA margin guidance range of 43%-50% in broadcast appears aggressive (most local broadcasters are trending in the low 30% range), particularly as TEGNA enters a period of increasing margin pressure owing to reverse transmission fees, as agreements with broadcast networks come up for renewal over the next several years. While the broadcast outlook appears generally favorable, given that approximately 40% of digital subscribers are scheduled for renewal this year, it is unclear to what extent TEGNA can offset the gap associated with these accelerating fees through incremental top-line growth and cost cutting.

Following the spin-off and sale of its digital assets, TEGNA is expected to bolster its balance sheet to pursue investment in organic growth and opportunistic acquisitions and to maintain a $0.28 annual dividend (currently a 2.3% yield). Prior to the separation, Cars.com is expected to pay a $650 million cash dividend to TEGNA; existing debt is expected to remain at the post-spin parent company.

Based on an analysis of projected revenue, EBITDA, EPS growth, and dividend yield, a pre-spin sum-of-the-parts fair value estimate of $28 for TGNA can be derived, consisting of $17 and $11 per share for TGNA and CARS, respectively. Post-spin, CARS can be fairly valued at $34 based on a 1:3 distribution ratio. With the implied fair value estimate representing 18% upside to TGNA’s share price ($24.05 as of this writing), the transaction should generate significant upside. As such, pre-spin shares are recommended for purchase. At 7.5x EV/2018E EBITDA, TEGNA trades at a premium to its 10-year average of 6.1x. The bear case centers around headwinds this year from: 1) cost growth associated with reverse retransmission fee payments to legacy NBC stations; and 2) sluggishness in the core advertising business. That said, we see several important catalysts. First, there is the potential for post-spin TEGNA to unlock further value from its interest in CareerBuilder, which could generate a higher valuation as a public company than the current implied multiple within consolidated TEGNA. Second, deregulation will likely fuel investor sentiment despite a softer fundamental backdrop for the first half of the year. Broadcast combinations have historically resulted in significant earnings leverage and multiple expansion. TEGNA shares have appreciated approximately 12% year-to-date (compared with 7% for the S&P 500 over the same period), despite weak results and guidance over the past two quarters. The recent rally in broadcast stocks is predicated on the expectation that a more benign regulatory environment may fuel merger and acquisition activity among broadcasters. Any easing of cap limits would in turn increase the scale of potential acquisitions.

EnPro Industries (NYSE: NPO) is an industrial conglomerate operating six businesses across three distinct operating segments: (1) Sealing Products (63.5% of 2016 pro forma sales and 72% of pro forma EBITDA); (2) Engineered Products (21% of sales and 17.5% of EBITDA); and (3) Power Systems (15.5% of sales and 10.5% of EBITDA).

While this publication typically focuses on the potential value-unlocking benefits of business separations, in this report we highlight a potential reconsolidation opportunity. In June 2010, NPO deconsolidated a group of subsidiaries, collectively referred to as GST, and filed those entities for Chapter 11 bankruptcy protection in response to mounting asbestos-related personal injury claims. Currently, NPO is on the verge of resolving all current and future claims, via the funding of a 524(g) trust, and the company could move to reconsolidate the businesses, which have generated consistent profits and free cash flow, in 2H 2017.

In our view, the removal of this overhang will not only greatly simplify NPO’s financials but also present a near-term opportunity for the market to revalue the company, which on a “pro forma” basis is levered at less than 2.5x and trades at ~10.5x EV/EBITDA (compared with the respective figures of 5x and 15x at which it currently trades on an “as reported” basis). As well, the resolution should allow for a reallocation of management focus and capital toward the realization of recently articulated performance targets, which, if achieved, likely portend incremental upside for longer-term investors.

Considering financial commentary, peer valuations and discounted cash flows, value of $85 per share, $20 per share, and $13 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 ~$31 per share yields a sum-of-the-parts value of roughly $88 per share, which implies ~25% potential upside.

Lundin Petroleum, a Swedish independent oil and gas company, announced on February 13, 2017, its decision to spin-off its non-Norwegian assets into a new publicly-traded company. The new firm, International Petroleum Corporation (“IPC”), will be listed on the Toronto Stock Exchange and likely maintain a secondary listing on the NASDAW Stockholm stock exchange. The demerger is expected to be completed within April 2017.

The purpose of the spin-off is to create two more focused companies—with management teams better able to optimize each company’s performance. Lundin Petroleum’s Norwegian operations are poised to grow organically, primarily as a result of the development of the giant Johan Sverdrup field. At the same time, the company will have to incur several billion dollars in capital expenditures to bring the field online. International Petroleum, on the other hand, will control assets in France, the Netherlands and Malaysia with significantly more limited reserves; it will also be debt-free. Therefore, the new entity will strive to maximize the value of its existing assets while at the same time using leverage to expand.

Post-spin Lundin Petroleum will focus on its Norwegian operations. Its operations will comprise three major projects and several exploration prospects. The giant Johan Sverdrup field is still under development; as a result, the firm’s capital expenditure requirements for the near term will be very high, while operating expenses are very low. Using a discounted cash flow model to estimate post-spin Lundin Petroleum’s net asset value based on its existing proven and probable reserves, we arrive at an estimate equity valuation of US$6.4 billion, or SEK 166 per share.

International Petroleum Company will comprise Lundin Petroleum’s assets in France, the Netherlands and Malaysia. These assets have moderate operating expenses and, at the current rate of production, these reserves should last for eight years. Capital expenditures are limited, and primarily focused on development. The company has no debt on a pro forma basis, although it will probably borrow almost US$100 to fund its share buyback. Nonetheless, that level of debt is easily manageable based on IPC’s expected free cash flow. Going forward, the firm is expected to pursue an acquisitive strategy, with a focus on low-risk jurisdictions such as those it currently operates. Valuing IPC on a conservative basis—assuming its reserves are not replaced, but rather fully produced over a period of eight years, and that oil price remains at US$55 per boe—we arrive at a net asset value of $580 million. Incorporating the effect of the buyback, IPC’s shares are valued at US$5.8, or C$7.7 (SEK 16.9 per share on a pre-spin basis).

Pre-spin Lundin Petroleum’s sum-of-the-parts valuation stands at SEK 182 per share, within 1% of the company’s current stock price. It should be understood that since this is the sum of two sets of discounted future cash flow exercises, purchasing shares at, essentially, NAV-base fair value (assuming the exercise is correct), is not like purchasing a closed-end fund at NAV. In this case, NAV being calculated at a 10% annual discount rate, one should earn that discount rate going forward, all else equal. Upside optionality is also held in the form of higher future oil prices as well as management’s ability to more productively deploy excess cash flow (and the Lundin family has proved to be very adept asset allocators).

On October 5, 2016, MetLife Inc. (NYSE: MET) filed a Form 10 registration statement with the SEC to spin off its domestic life insurance and annuity product provider into a standalone public company, to be called Brighthouse Financial Inc. MetLife plans to distribute at least 80.1% of Brighthouse to shareholders via a pro rata distribution of shares, with the transaction expected to be completed in 1H 2017. The distribution of shares, which is expected to be tax free to MET shareholders, is subject to final Board approval, favorable IRS and tax advisor opinions, and an effectiveness declaration of the company’s Form 10 filing by the SEC.

MetLife is a global provider of life insurance, annuities, employee benefits, and asset management. MET currently reports operations in six segments: U.S., Asia, Latin America, EMEA, MetLife Holdings, and Brighthouse Financial. As a standalone company, Brighthouse had assets of $241 billion and shareholders’ equity of $15.7 billion as of September 30, 2016. Additionally, the company had $630 billion in life insurance face amount in force as of year-end 2015 (year-end 2016 data not yet available as of this writing).

The separation of the domestic retail business does not come as a surprise, considering that in January 2016 the company announced its intention to separate the business, although the ultimate structure of the separation (sale, IPO, or spin) was not determined at the time. The separation is part of management’s plan to make the company smaller against a background of tighter government oversight in relation to the December 2014 designation of MetLife as a non-bank systemically important financial institution (SIFI). In March 2016, MET challenged the Financial Stability Oversight Council’s (FSOC) designation in federal court, where the original ruling was overturned. The U.S. Department of Justice (on behalf of the FSOC) has appealed that decision, and the case is now with the U.S. Court of Appeals. If designated as a non-bank SIFI, the retail business, which will become Brighthouse Financial, would face higher capital requirements that would place the business at a competitive disadvantage, according to the company. For its part, management does not believe that any part of the current company structure is systemically important.

The decision to file for a spin-off comes after it was widely expected among industry observers that the separation would be via a sale or an IPO. It appears that the decision to spin off rather than IPO the segment may reflect management’s views on the current equity markets; in that respect, CFO John Hele noted in September that a spin-off can “generally occur even if the IPO markets are a bit choppy.”

Following the separation, Brighthouse (which is expected to trade on the NYSE under the ticker “BHF”) will become a U.S.-focused annuity and life insurance provider that utilizes outside marketing firms to sell its products. Post-spin MET will focus on its core international business providing life insurance, annuities, employee benefits, and asset management on a global basis. Insurance companies typically trade in a range based on price-to-book value (ex AOCI), with the determining variable being the company’s ability to generate excess return on shareholders’ equity. Life insurance companies typically trade at multiples closer to book value (roughly 1.0x) versus non-life insurers (property and casualty, etc.), which trade at a premium (approximating 1.5x) based on current trading levels.

Brighthouse will enjoy far fewer benefits of a geographically diversified business than it currently does within MetLife. Exposure to the U.S. annuity and life insurance markets will tie the company’s prospects primarily to the state of the U.S. economy, including potential regulatory changes and the changing demographics of the U.S. population.

Following the spin-off, the parent company’s ROE should increase, while the cost of capital could be reduced over the longer term. Thus, the parent entity should experience a degree of multiple expansion, while the spin company’s valuation multiple is likely to remain near MET’s current level (approximately 1.0x book value ex AOCI).

Pre-spin, MET shares are fairly valued at $59 per share, consisting of $47 per share in value from post-spin MET and $12 per share from BHF’s operations. The pre-spin fair value estimate approximates 11% potential upside from the current share price. Post-spin shares of BHF are fairly valued at $10 per share based on 1.4 billion shares outstanding on an assumed one-for-one share distribution ratio to MET shareholders and 270.1 million shares retained by MET, representing 19.9% ownership. Post-spin shares of MET are fairly valued at $49 per share, which includes $2.46 per share in value from the retained BHF ownership position.

It should be expected that following the separation, MET will be re-rated higher than its current multiple, reflecting an improved operation and the removal of the non-bank SIFI overhang, while BHF’s multiple will likely remain around the current MET multiple. Given this re-rating scenario, and the likelihood that shares of BHF may be sold by investors given the disparity in relative market capitalizations and business fundamentals, post-spin shares of MET would be preferable to those of BHF.

Above, please find The European Spin-Off & Restructuring Report Compendium focusing on Daily Mail and General Trust PLC (DMGT LN), Axel Springer SE (SPR GY), Mota-Engil, SGPS, S.A. (EGL PL), and Braemar Shipping Services plc (BMS LN).

Domtar Corporation (NYSE: UFS), a forest & consumer products company, reports two distinct operating segments: (1) Pulp & Paper (82% of sales and EBITDA in 2016); and (2) Personal Care (18% of sales and EBITDA).

With a portion of UFS’s primary business, the manufacture of uncoated free sheet paper, in secular decline, the company has diversified into the expanding personal care/absorbent hygiene product space, which has favorable demographic tailwinds and is projected to demonstrate durable growth in coming years. In addition to the markedly divergent product sets and growth profiles, which results in a wide valuation disparity among standalone peers, the businesses require different manufacturing processes, technology, and marketing strategies.

In our view, with UFS trading at less than 6x 2017E EV/EBITDA and with a free cash yield better than 10%, the stock is undervalued, particularly relative to the growing contribution from UFS’s personal care business (and its improving overall growth profile). As a result, we see the potential for organic multiple expansion (along with the accretive deployment of free cash flow) to drive near-term upside as well as the longer-term possibility that the businesses could be separated if the market fails to appropriately re-value UFS’s evolving portfolio. (As well, given the stock’s low valuation and free cash flow potential, we also would not rule out UFS attracting acquisition attention.)

Considering financial commentary, peer, and M&A valuations as well as discounted cash flows, value of $51 per share and $21 per share can be assigned to UFS’s Pulp & Paper and Personal Care businesses. Accounting for corporate costs and projected net debt of ~$20 per share yields a sum-of-the-parts value of roughly $51 per share, which implies ~35% upside (not including UFS’s $0.41 quarterly dividend, which implies a 4.4% annual yield and is likely to be increased for the seventh consecutive year in 2017).

On October 28, 2016, Huntsman Corporation (NYSE: HUN) filed a Form 10 registration statement with the SEC to spin off its Pigments and Additives, Textile Effects, and related businesses as a separate, publicly traded company, to be called Venator Materials Corporation. The spin-off will be a tax-free distribution of shares via a pro rata distribution to shareholders of record. The spin-off is expected to be completed in 2Q 2017, subject to market conditions.

As of this writing, details concerning Venator’s post-spin capital structure have not been finalized. Following the distribution, there will be two classes of Venator stock. Class A stock, which will be retained entirely by Huntsman Corporation, will represent 19.9% of the voting power of all outstanding common stock. Huntsman will also retain 40% ownership in post-spin Venator. Class B stock, which will be distributed to HUN shareholders, represents 80.1% of the voting power of all outstanding common stock. Venator’s Class B common stock will trade on the NYSE under the symbol “VNTR”.

Huntsman Corp., a chemical producer, reports in five segments: (1) Polyurethanes (38% of revenue, 16% EBITDA margin); (2) Performance Products (22% of revenue, 15% EBITDA margin); (3) Advanced Materials (10% of revenue, 22% EBITDA margin); (4) Textile Effects (8% of revenue, 10% EBITDA margin); and (5) Pigments and Additives. Pigments and Additives, which includes Huntsman’s titanium dioxide (TiO2) offerings, contributed 22% of sales in 2016 and generated a 6% EBITDA margin (a doubling over 2015 levels, owing to stronger pricing and demand trends). The company had previously announced that it was exploring a separation of its cyclical TiO2, additives and textiles businesses via a strategic combination, initial public offering (IPO), or spin-off. On August 3, 2017, HUN agreed to sell its European surfactants business to Innospec Inc. (NASDAQ: IOSP) for $225 million (or about 9.4x estimated EBITDA of $24 million).

The rationale for the spin-off transaction is to reach higher trading multiples through separation. Huntsman, in its current configuration, trades at a 2018E EV/EBITDA multiple of 6.9x, a significant discount to integrated chemicals producers such as Eastman Chemical Company (NYSE: EMN) and Celanese Corp. (NYSE: CE), which trade at 7.7x and 8.9x, respectively. That said, Eastman and Celanese have been reliable generators of free cash flow for many years, with EBITDA margins exceeding those of Huntsman.

The ownership interest in Venator would allow Huntsman to capture the anticipated appreciation in value associated with an improving titanium dioxide cycle, while strengthening the company’s balance sheet. That said, other chemical companies tend to offer higher free cash flows at comparable multiples and at lower risk from slowing global economic growth, owing to greater diversification and mix shift toward more specialized, higher-margin products. Note that diversified chemicals peers have focused their businesses in specialized markets with high barriers to entry (e.g., durable goods markets) and have divested lower-margin product lines. Eastman Chemical Company, for example, sold its polyethylene business and related assets in late 2006, its European and Latin American polyethylene terephthalate (PET) business in 2007, and its U.S. PET business in 2010, while acquiring specialized assets such as alkylamines. Similarly, Celanese Corp. has focused product development in more integrated and specialized downstream product lines, particularly in Advanced Materials in the automotive end-markets.

Based on an analysis of projected revenue, EBITDA, EPS, and estimated dividend yield, a pre-spin sum-of-the-parts valuation of $24.27 can be derived for HUN. Post-spin, HUN and VNTR can be fairly valued at $21.20 and $3.07 per share, based on 40.0% ownership of VNTR by HUN shareholders and an assumed 1:1 Class B share distribution ratio to HUN shareholders. (Note that as of this writing, SEC filings have not provided details surrounding Venator’s post-spin leverage) These fair value estimates assume an estimated debt/EBITDA of 3.6x for post-spin VNTR.

The pre-spin fair value estimate represents 8% upside from HUN’s current share price ($22.51), suggesting that the shares are approaching a full valuation for the transaction. HUN shares currently trade at an EV/EBITDA ratio of 6.9x– in line with their 10-year average. Note that HUN shares have appreciated approximately 70% in the past 12 months, versus a 15% gain in the S&P 500 for the same period– suggesting that the market is discounting the benefits of the transaction and recent improvement in the TiO2 business. Accordingly, pre-spin shares are not recommended for purchase.

On May 24, 2016, Hewlett Packard Enterprise Company (NYSE: HPE) announced that it intended to spin off its Enterprise Services business (via subsidiary Everett Spinco Inc.), which will immediately be merged with Computer Sciences Corp. (NYSE: CSC) in a Reverse Morris Trust (RMT) transaction. The spin-off and merger, which are expected to be completed via tax-free transactions, are scheduled to be completed on or around April 1, 2017, subject to regulatory and shareholder approvals and receipt of a favorable tax opinion from counsel.

The transaction (at the time of the announcement) valued to HPE shareholders at approximately $8.5 billion, including $4.5 billion in shares of the newly combined CSC (50.1% ownership for HPE shareholders), $1.5 billion via a cash dividend, and the assumption of $2.5 billion in debt and other liabilities. In addition, HPE will make cash contributions to the company’s non-U.S. defined benefit pension plans to reduce the net level of liabilities to $570 million. In addition to the divestiture of the Enterprise Services business, HPE announced on September 7, 2016, the spin-off of its non-core Software assets and their planned merger with Micro Focus International Plc (MCRO LN), with an anticipated closing date on or around August 31, 2017. For more details, please refer to The Spin-Off Report Flash report dated September 8, 2016.

Both HPE and CSC have recently been involved in separate spin-off transactions. In October 2015, HPE was spun off from HP Inc. (NYSE: HPQ) in the separation of HP’s enterprise and legacy PC and printing businesses. In November 2015, CSC spun off its government services business as CSRA Inc. (NYSE: CSRA). For HPE, the divestiture of the Enterprise Services and Software businesses is essentially an adaptation to a contracting addressable market, owing to the industry’s rapid shift to cloud computing. Cloud-computing leaders such as Amazon.com Inc. (NASDAQ: AMZN) and Microsoft Corp. (NASDAQ: MSFT) have enabled “metered” access to computing power over the Internet, causing demand for HPE’s network equipment to decline as customers favor lower-cost cloud services over building and maintaining their own data centers. Late to the race for public cloud dominance, CEO Meg Whitman appears to be doubling down on the market for customers to build their own private cloud-like facilities—a target market in between these two. Accordingly, the spin/merger transactions will focus HPE more tightly on hardware sales—a stark contrast to the mega-merger strategy of computing rival Dell (recently merged with storage supplier EMC Corp.), while repudiating the company’s legacy growth strategy, which was cultivated by large, expensive acquisitions.

A technology deficiency in cloud will require HPE to make heavy investments in research and development and/or strategic acquisitions and partnerships (particularly in key areas such as security and storage) in order to grow. Given what appears to be a conservative acquisition strategy, it is reasonable to assume management may contemplate another major restructuring, further shedding of assets, or possibly a complete break-up of the company. Recent speculation that private equity firms may be interested in various assets fits with this narrative, as breaking up the assets may be easier in a private environment, even if the likelihood of a leveraged buyout of the complete post-spin company is low given the relative size of such a transaction.

HPE’s Enterprise Services segment originates from the 2008 acquisition of Electronic Data Systems ($14 billion transaction consummated under former CEO Mark Hurd), likely one of the worst acquisitions in HP’s history. The business has experienced steady revenue declines, generating F2016 sales of $18.9 billion (-5% year-over-year). Despite a strong market leadership position as the second largest IT services company (and third in private and hybrid cloud services), Services (40% of revenue) has been a sore spot for HPE, with declining revenue exacerbated by macro and currency headwinds, lower margins, and an unwieldy cost structure. The business generated a F2016 operating margin of 7.7%, aided by headcount reductions and targeted productivity improvements, including offshoring 60% of headcount.

CSC is a provider of IT and professional services ranging from virtual desktop solutions, data center management, and cyber security as well as end-to-end applications services, consulting, and big data services. On a pro forma basis, accounting for the spin-off of CSRA, CSC generated $7.1 billion in revenue and $1.1 billion in EBITDA in F2016 (March year-end). The merger with HPE’s Enterprise business will add considerable scale, with the new CSC expected to generate annual revenue of approximately $26 billion. Operational improvements are a key element of the story, with the company expected to realize $1 billion in first-year cost synergies, with a year-end run rate of $1.5 billion (post-close).

Post-merger, assuming 282.2 million shares outstanding, CSC can be fairly valued at $81 per share. While we appreciate the strategic value of the combination and the potential for continued earnings upside over the next several quarters, our post-spin fair value estimate represents 12% potential upside to the current share price ($70.82 as of this writing), suggesting the shares appear to be approaching a full valuation for the transaction. Note that shares of CSC have appreciated approximately 96% since the acquisition announcement in May 2016 (compared with 11% for the S&P 500 over the same period) and currently trade at an enterprise value-to-EBITDA ratio of 9.7x, a significant premium to the shares’ 10-year average of 4.3x.

Based on an analysis of projected 2018 revenue growth, EBITDA, cash flow, and assets, and accounting for the company’s 50.1% interest in CSC, a pre-spin fair value estimate of $30 per share can be derived for post-spin HPE, representing 23% potential upside to the shares’ current price at the time of this writing (approximately $23.99). Notably, at 12x forward earnings, HPE trades at a significant premium to its 9.2x average since its 2015 spin-off from HP and at the upper end of its 6x-12x range. Post-spin/merger, HPE can be fairly valued at $23.

While the above valuation exercises suggest modest upside, it is important to consider that these figures do not fully account for the second (Software) spin/merge transaction with MCRO. Nor does this valuation analysis take into account the potential for additional asset divestitures. Accordingly, a preliminary analysis of the “final” HPE (post both the spin and merge transactions) may prove useful, as this exercise will more accurately represent the company’s operating structure. This exercise generates a fair value estimate of $33 for “final” HPE, which represents 39% upside from current levels. Note, however, that this analysis does not account for the potential value-unlocking from further asset sales, which would likely provide upside to the fair value estimate given HPE’s historically depressed multiple relative to networking peers. Given the sharp recent appreciation in CSC shares, we view HPE as the better way to play the spin/merge transactions at this time.

On November 17, 2015, after the market close, Citrix Systems Inc. (NASDAQ: CTXS) announced its intention to spin off the GoTo family of products, which is to be merged with LogMeIn Inc. (NASDAQ: LOGM) in a Reverse Morris Trust transaction. The GoTo family of products includes GoToAssist, GoToMeeting, GoToMyPC, GoToTraining, GoToWebinar, Grasshopper, and OpenVoice.

Under the terms of the spin-off, Citrix will distribute all of the shares of common stock of its wholly owned subsidiary, GetGo, Inc., to Citrix stockholders as of the record date of January 20, 2017, by means of a pro rata distribution. Shares of Citrix and LogMeIn will trade in the when-issued market under the temporary symbols “CTXSV” and “LOGMV,” respectively. Immediately following the spin-off, GetGo will merge with a subsidiary of LogMeIn Inc. It is currently expected that in connection with the spin-off, approximately 26.9 million shares of GetGo common stock will be distributed to Citrix stockholders as of the record date, and each share of GetGo common stock will be converted into the right to receive one share of LogMeIn common stock pursuant to the merger. Based on the number of shares of Citrix common stock outstanding on January 5, 2017, Citrix stockholders would receive approximately 0.1718 of a share of LogMeIn common stock for each share of Citrix common stock as a result of these transactions. The actual number of shares of LogMeIn common stock that Citrix stockholders will receive with respect to each share of Citrix common stock will be determined based on the number of shares of Citrix common stock outstanding on the record date.

The spin-off and merger are expected to be completed following the close of business on January 31, 2017, subject to the satisfaction of certain remaining conditions, including, among other things, approval by LogMeIn stockholders. The LogMeIn stockholder vote is scheduled to be held at a special meeting of LogMeIn shareholders on January 25, 2017. Upon completion of the merger, Citrix equity holders are expected to collectively own approximately 50.1% of the shares of LogMeIn common stock on a fully diluted basis, and current LogMeIn equity holders are expected to collectively own approximately 49.9% of LogMeIn on a fully diluted basis.

Citrix provides a broad platform of software, appliances, and online services that enable secure, scalable access to enterprise applications. In recent years, a combination of strategic acquisitions and internal development has expanded the company’s addressable markets beyond access to legacy Windows applications to include desktop and server virtualization, online collaboration, and application networking. While Citrix has enjoyed 16.0% and 15.5% revenue and net income CAGR from 2009-2013, revenue growth has slowed considerably (4.2% in 2015), largely owing to a maturation of the virtualization market coupled with share loss to industry leader VMWare (NYSE: VMW).

In the face of slowing revenue growth, Citrix has focused on improving profitability and return to shareholders. In conjunction with the spin-off announcement, Citrix announced a corporate restructuring, which included plans to (1) eliminate 1,000 positions; (2) focus investment resources on application and data delivery, including XenApp, XenDesktop, XenMobile, ShareFile, and NetScaler products; and (3) eliminate some non-core product platforms. Moreover, the company expects to reduce operating costs by more than $200 million by 2017. Additionally, Citrix’s board of directors has authorized an ongoing stock repurchase program worth up to $6.3 billion, of which $400.0 million was approved in January 2016. Under this program, Citrix may repurchase stock “at any time until the approved amount is exhausted”; as of September 30, 2016, approximately $404.0 million was still available. The combination of the spin-off, cost reductions, and share repurchases should allow Citrix to return significant capital over time. Management expects that following the completion of these strategic actions, operating margins will expand to over 30% and the company can capture revenue growth of 4%-5% in 2017 (on a consolidated basis).

The GoTo products are cloud-based software-as-a-service (SaaS) products that facilitate communication and collaboration solutions, primarily for small businesses. Separation of this product line (classified within Citrix’s Mobility Apps business segment) has been posited since July 2015, when the company announced that it was exploring strategic alternatives for the GoTo products as well as for the ByteMobile business. Management’s rationale for the separation appears rooted in a refocusing of effort and investment on the core business of application virtualization and security.

Based on an analysis of comparable revenue, projected 2017 revenue growth, EBITDA, cash flow, and assets, and accounting for an estimated market capitalization of $2,897 million for the company’s 50.1% interest in the new LogMeIn, a pre-spin fair value estimate of $96 per share can be derived for CTXS, representing 6% potential upside to the shares’ current price at the time of this writing (approximately $90.90). Accordingly, the benefits of the company’s restructuring and the value of the GoTo/LogMeIn combination appear largely reflected in the current valuation. Notably, at 17x forward earnings, CTXS trades just above its 10-year historical average of 15x and at the upper end of its 13x-18x range. We expect valuation to remain range-bound as the company grapples with single-digit revenue growth associated with a combination of the divestiture of its fastest-growing segment and more competitive end-markets. With these challenges coupled with a strategic shift toward operating improvements and shareholder returns, we expect Citrix’s valuation to re-rate from a growth to a value orientation. Post-spin, CTXS can be fairly valued at $78.

Post-merger, assuming approximately 52 million shares outstanding (50.1% interest held by CTXS shareholders), LogMeIn can be fairly valued at $111 per share. The post-spin fair value estimate for LOGM represents 11% potential upside to the current share price ($100.40) as of this writing, suggesting the shares are approaching a full valuation. Note that shares of LOGM have appreciated approximately 58% since the acquisition announcement in July 2016 (compared with 5% for the S&P 500 over the same period) and are currently trading at an enterprise value-to-sales ratio of 6.3x, a significant premium to the shares’ 10-year average of 4.6x. As such, we believe that in the near term the market has largely priced in the strategic and operational gains associated with the merger, as well as potential upside to earnings associated with incremental cost synergies. We also note that the considerable market capitalization divergence between the two entities could cause current Citrix shareholders to rotate out of LogMeIn following the distribution, resulting in some near-term volatility.