TrustPower Ltd is a New Zealand-based electricity generator and retailer. On March 11, 2016, the firm announced its decision to spin off its wind and solar energy assets into a new company named Tilt Renewables Ltd. The decision to pursue this demerger follows a December 2015 press release indication that the company was examining such a transaction as the best way to facilitate the expansion of its renewables business. The spin-off was initially expected to be completed by October 12, 2016. However, due to a storm affecting South Australia’s power system—where TrustPower’s largest wind farms are located—the company decided to postpone the spin-off by a few weeks. It should be noted that TrustPower’s generation assets were not damaged by the storm, but due to damage to the region’s transmission system its wind farms are limited to the amount of electricity they can produce and distribute through the grid. On October 19, the firm announced that the last day of trading on a cum-distribution basis will be October 26. Shares of Tilt Renewables will commence trading two days later. TrustPower’s shareholders will receive one Tilt Renewables share for every share owned; for New Zealand—and potentially Australian—investors, the distribution will not be taxable. At the same time, shares of the spin entity will also be listed on the Australian Stock Exchange and quoted in Australian dollars.

While both post-spin entities will be electric utilities, they intend to pursue significantly different business strategies. Post-demerger TrustPower will have limited opportunities to expand within a stagnant market, primarily through acquisitions. Nevertheless, it will be able to generate substantial cash and return the majority of its free cash flow to shareholders. Tilt Renewables, on the other hand, has a very ambitious growth plan. The spin-off will also facilitate Tilt Renewables’ expansion, by providing independent access to capital markets, and will allow the two companies will to optimize their capital structures.

New TrustPower will own a portfolio of hydroelectricity power stations primarily located in New Zealand. The company is also a supplier of electricity, gas and telecommunication services to retail customers in its home country. Its hydroelectric generation network spans 41 facilities with total capacity of 570 MW. On the retail side, TrustPower has 280 thousand electricity clients, 31.5 thousand gas customers and 65 thousand telecom clients. The company’s end markets are not benefiting from secular growth. Energy consumption in New Zealand is negatively affected by increasing efficiencies. Furthermore, environmental permits for new hydropower stations are very hard to obtain. Consequently, new TrustPower will expand—if it decides to do so—its generation capacity through acquisitions of existing plants. The retail environment is also suffering from cutthroat competition. TrustPower is using bundled service offerings to attract new clients and retain existing ones. Due to the competitive nature of the industry, further customer additions will also be obtained through acquisitions of competitors.

That being said, the generation and retail business are generating substantial cash flows and require limited capital expenditures. As such, the company’s strategy calls for distributing 70% to 90% of its free cash flow as dividends. Viewed against its New Zealand peers, post spin-off TrustPower is valued between NZ$4.6 and NZ$5.3 per share.

As a standalone company, Tilt Renewables will be an owner, operator and developer of wind and solar power stations. The company currently owns seven wind farms in Australia (four) and New Zealand (three), with aggregate generation capacity of 582 MW. Two-thirds of the installed capacity is located in Australia. The firm has an ambitious expansion plan that could add up to 2,000 MW of installed capacity—half of it by 2020. As such, it will incur substantial capital expenditures and anticipates the need to raise additional equity. In order to de-risk its business model, Tilt Renewables typically enters into long-term purchase power agreements (“PPAs”) at a mutually agreed price. That operating model will allow the firm to operate more like a contracted/regulated infrastructure company, and consequently increase the maximum amount of debt each project can incur. That said, Tilt Renewables will commence operations with a pro forma net debt of NZ$674 million, already 5.6x its EBITDAF[1], and limited liquidity; as a result, secondary equity offerings will be required from time to time to cover the company’s equity contribution to each project. Tilt Renewables’ dividend strategy entails distributing 25% to 50% of its free cash flow after debt servicing. Given its high leverage and expansion capital expenditures, this financial metric may even be negative during certain periods. However, the company expects to pay even a nominal dividend at all times.

TrustPower entered Australia’s renewable energy market to capitalize on the country’s renewable energy policy that required the development of significant renewable energy capacity by 2020. Based on the existing framework, Australia still requires a further 5,000 MW of renewable generation capacity by that year. While presenting an attractive opportunity for Tilt Renewables, this policy framework could be adjusted, with the renewable energy target lowered. In this case, reduced growth opportunities along with an already levered balance sheet would materially reduce the valuation investors would be willing to assign to the spin entity. Having said that, based on the current environment and peer trading multiples, Tilt Renewables is valued between NZ$2.3 (A$2.1) and NZ$3 (A$2.9) per share.

Pre-spin TrustPower’s sum-of-the-parts valuation ranges from NZ$6.8 to NZ$8.4 per share. The base case target price of NZ$7.6 implies a 7% upside from the company’s current stock price. Thus, shares of TrustPower are not recommended for purchase prior to the completion of the spin-off.

On October 20, 2015, Yum! Brands Inc. (NYSE: YUM) announced its intention to spin off the company’s China operations from its global franchise operations. The separation will be completed via a tax-free distribution to YUM shareholders. The new entity, to be called Yum China Holdings, will be led by Micky Pant, Chief Executive Officer of the company’s China operations, while Yum! Brands will be led by Greg Creed, current YUM Chief Executive Officer.

On September 26, 2016, YUM’s Board of Directors announced that it had approved the separation, to be effective on October 31, 2016, with regular-way trading scheduled to begin on November 1, 2016. Yum China Holdings Inc. will trade on the NYSE under the symbol “YUMC”. It is expected that shares of YUMC will begin when-issued trading on October 17, 2016, under the symbol “YUMC WI”. In conjunction with the announcement, YUM also increased its quarterly dividend to $0.51 per share (from $0.46 per share) and announced plans to repurchase $1.1 billion in shares before the end of 2016.

YUM is the one of the largest restaurant companies in the world, in terms of both restaurant count and market capitalization. The company’s restaurant system comprises over 43,000 restaurants in over 130 countries and territories. The company owns and operates approximately 21% of the restaurant base, while the remainder are operated under franchise or license agreements. YUM has arguably been the most successful Western restaurant company to operate within China, given its nearly 30-year history in the country. However, due to recent food safety issues and other outside headwinds, the China division is currently struggling to regain positive comparable results, which has negatively affected YUM’s valuation.

The separation makes sense in terms of the differing business models that the two companies employ, while separating the currently underperforming China assets from the rest of the system should allow for multiple expansion at the parent company. YUM is primarily focused on being a franchisor of its restaurant concepts, with a goal of being 98% franchised by year-end 2018, which should provide for high-margin free cash flow generation. The China operations are almost all company owned under the current corporate structure and require significant capital to finance expansion. The spin-off of YUMC allows for a higher proportion of franchised restaurants at YUM, while providing opportunities to return capital to shareholders through increased dividends and share repurchases. YUMC will be spun out with a net cash position and a dedicated management team that allows for unit expansion and opportunities to grow same-store sales. Franchisors of restaurant concepts trade at a 24% premium to company-owned restaurant companies. YUM currently trades at a 7% discount to franchisor peers, and thus the separation should allow for a re-rating of YUM’s multiple as it moves to become a highly franchised system.

Following the separation, YUMC’s strategy will continue to be to capitalize on China’s growing middle class and urbanization of the country through aggressive unit expansion in an effort to regain positive sales momentum. YUMC is assigned a fair value estimate of $30 per share based on earnings growth and peer comparables.

The post-spin prospects for the parent company are tied to a combination of improving domestic operations, developed-country and emerging market expansion, and the move to a more highly franchised system. The company has increased its use of financial leverage and looks to return significant amounts of capital to shareholders over the next several years. Based on earnings and cash flow growth, combined with share repurchases, post-spin YUM shares are fairly valued at $65 per share.

On a pre-spin, sum-of-the-parts basis, shares of YUM can be fairly valued at $101 per share, consisting of $36 per share in value from YUMC and $65 per share in value from post-spin YUM. Given the implied upside to the fair value estimate, shares of YUM are recommended for purchase prior to the spin-off. Following the transaction, shares of YUM are preferable to those of YUMC, as the optionality arising from a sizeable return of capital to shareholders offers additional potential upside to our post-spin fair value estimate of $65 per share. In light of YUMC’s most recent quarterly results, it could be expected that shareholders would exit their YUMC positions following the distribution. Shares of YUMC would be attractive at levels 20%-25% below our post-spin fair value estimate of $30 per share, where we believe a significant margin of safety would compensate for the unknown timing of a return to positive same store sales. – The Spin-Off

On September 28, 2015, Alcoa Inc. (NYSE: AA) announced its intention to separate the company’s upstream business from its downstream value-added services businesses (Global Rolled Products, Engineered Products and Solutions, and Transportation and Construction Solutions). The spin entity, which will be named Alcoa Corporation (and will retain the AA symbol), consists of five business units that currently comprise the Global Primary Products division—Bauxite, Alumina, Aluminum, Casting, and Energy. The post-spin parent company will be renamed Arconic, Inc. (and is expected to trade on the NYSE under the symbol ARCN). In light of volatile debt and commodity markets, Arconic will retain a 19.9% ownership interest in Alcoa Corp. The retention allows Alcoa Corporation to be separated with relatively low leverage (net debt to estimated 2017 EBITDA of approximately 2x, excluding pension liabilities), and provides some insulation against market cyclicality. At the same time, the retention reduces Arconic’s reliance on Alcoa Corporation raising debt in the current high-yield market environment to fund payments to Arconic to optimize its own capital structure. For Arconic, this structure strengthens the balance sheet with a liquid security that can be monetized or exchanged to accelerate debt reduction and/or fund future growth initiatives.

The transaction is expected to be completed before the market open on November 1, 2016, to shareholders as of the record date of October 20, 2016. Arconic, Inc. is to trade on the NYSE under the ticker “ARNC.” Shares are expected to begin trading on a when-issued basis on or about October 18, 2016.

Klaus Kleinfeld, AA’s current Chairman and Chief Executive Officer, will lead Arconic as Chairman and Chief Executive Officer. Following the spin-off, he will also serve initially as Chairman of Alcoa Corp. in order to assist with the transition. The transaction is subject to certain conditions, including obtaining final approval from Alcoa’s Board of Directors, receipt of favorable tax opinion from counsel, and an effectiveness declaration of the company’s Form 10 registration statement.

Alcoa is a global leader in bauxite, mining, aluminum refining, and aluminum production, with 64 facilities worldwide and approximately 17,000 employees. The company generated consolidated 2015 revenue and EBITDA of $22.5 billion and $3.9 billion, respectively. Alcoa’s products, which include aluminum, titanium, and nickel, are used worldwide in aerospace, automotive, commercial transportation, packaging, building and construction, oil and gas, defense, consumer electronics, and industrial applications. The company is the largest aluminum producer in the United States and the fourth largest globally.

Global aluminum demand is forecasted to grow 5% in 2016 and is expected to double between 2010 and 2020. However, a dramatic increase in aluminum supply, the market’s inability to rationalize supply through a shutdown of smelting capacity, and concerns over slowing growth in China and Chinese manufacturers’ attempts to export their products have caused prices to decline dramatically. As a result, AA’s consolidated revenue fell 6% year-over-year in 2015 and are projected to decline 7% in 2016 ($20.8 billion). AA has attempted to navigate this commodity volatility by growing its downstream businesses while rationalizing costs in its upstream operations. This strategy has failed to generate significant value creation, as Alcoa had essentially been using its relatively low-multiple stock as currency to acquire higher-value-added and higher-multiple companies. Moreover, cost reduction efforts have been largely offset by falling commodity prices. With commodity markets under significant pressure, the spin-off and realignment of the company’s downstream business, which is higher growth and less commodity price sensitive, makes sense.

Post-spin AA will remain a leader in bauxite, mining, aluminum refining, and aluminum production, generating 2015 revenue and EBITDA of $11.2 billion and $1.9 billion, respectively. Since 2007, the company has undergone several productivity enhancements to streamline its cost structure, having reduced operating capacity by 1.4 million metric tons, or 33%, while capturing $2.1 billion in productivity gains. These cost reductions should help the company maintain margins better than in previous cycles.

Post-spin Arconic, which comprises the company’s downstream operations, is a differentiated supplier to the high-growth aerospace industry, with leading positions on every major aircraft and jet engine platform. The company is also leveraged to rising demand for aluminum-intensive vehicles through its recent rolling mill capacity expansions and the commercialization of new technologies. Pro forma revenue for 2015 totaled $12.6 billion, with $1.9 billion in pro forma EBITDA. Notably, EBITDA margins for Alcoa’s value-added portfolio have increased from 8% in 2008 to 15% in 2015.

Based on an analysis of comparable EBITDA, forward EPS, and cash flow, a pre-spin sum-of-the-parts fair value estimate of $34 for AA can be derived. The pre-spin fair value estimate implies 27% potential upside relative to AA’s current share price ($27.11 as of this writing), suggesting that the transaction should unlock incremental upside. As such, pre-spin shares are recommended for purchase. Post-spin, AA can be fairly valued at $30, based on approximately 146.2 million shares outstanding (1:3 distribution). Post-spin ARNC can be fairly valued at $26, assuming 19.9% ownership of AA.

For post-spin ARNC, the separation should allow the company to command a higher multiple and gain more flexibility in achieving growth without the drag from the upstream business. That said, the balance sheet represents a key concern, as ARNC will have a larger pension funding allocation than previously expected ($2.4 billion). Following the spin-off, and after receiving $975 million in cash from the new Alcoa, Arconic will have net debt/EBITDA of approximately 3.2x, excluding any value from its 19.9% equity stake in the new Alcoa (also excluding pension liabilities). This net debt level for Arconic is higher than for most commercial aerospace companies, whose net debt/EBITDA typically averages closer to the 1.0x-2.0x range.

For post-spin AA, the longer-term path to value creation is less clear. Some industry observers have suggested that the spin-off may be one step toward creating incremental value by ultimately combining the remaining upstream business with another sizable upstream aluminum producer. Notably, in 2007 Alcoa attempted a hostile acquisition offer for Alcan, which was subsequently acquired by Rio Tinto (RIO LN). A combination with a similar-sized producer could allow the resulting entity to better navigate the current environment of depressed aluminum prices by gaining incremental scale, reducing supply, and encouraging additional consolidation.

Chemed Corporation (NYSE: CHE) operates two distinct businesses: (1) VITAS Healthcare, a hospice provider (72% of revenue and 66% of EBITDA in 2015); and (2) Roto-Rooter, which provides plumbing and drain cleaning services (28% of 2015 revenue and 34% of EBITDA).

CHE’s two wholly owned subsidiaries are clearly unrelated, with disparate growth drivers, margin profiles, and capital requirements. The businesses are separately managed, and synergies are essentially nonexistent. Thus, an elimination of CHE’s conglomerate/holding company structure, which offers little strategic or economic benefit, could unlock value for shareholders. Moreover, whether the businesses are separated as standalone entities or via a Morris Trust transaction, we think that as both businesses are relatively predictable and highly cash flow generative, each could attract a premium multiple from potential acquirers, both strategic and financial.

CHE, which itself was spun out of W.R. Grace & Co., has a long history of acquiring and divesting businesses, including Omnicare. Commentary suggests that management is cognizant of potential strategic alternatives and that it would be open to a range of transactions if a buyer emerged with a premium bid or if the stock’s discount to its sum-of-the-parts value became persistently egregious. Anecdotally, CHE views itself primarily as a healthcare company, which is seemingly reflected in its shareholder base.

Considering management’s financial commentary, peer and M&A valuations, and discounted cash flows, value of $110 per share and $74 per share can be assigned to CHE’s VITAS and Roto-Rooter businesses, respectively. Accounting for corporate costs and projected net debt of ~$18 per share yields a base-case sum-of-the-parts value of roughly $166 per share. Notably, our bull-case scenario suggests upside to $192 per share, while a more bearish case implies a valuation of $140 per share.

Element Financial Corporation is a Canadian fleet management and equipment finance company with operations in its home country, the US, Australia and New Zealand. On February 16, 2016, it announced its plan to split into two companies, Element Fleet Management Corp—focused on fleet management—and ECN Capital Corp—focused on commercial finance. The decision to pursue a spin-off followed a strategic review of the company’s units that commenced in October 2015. The transaction was approved by Element Financial’s shareholders, and is expected to be completed in a tax-free manner, at least for Canadian residents. Shareholders as of September 30 will receive one share of ECN capital for each share owned, with trading in the spin entity commencing on October 3.

The spin-off aims to create two companies with distinct operating models: The first one, Element Fleet Management, will be an operating company alongside a traditional leasing/financing corporation, earning a substantial amount of revenue from management and other fees. ECN Capital, on the other hand, will focus on vendor and equipment financing as well as financing for railcar and aviation assets. As standalone companies, the two post-spin entities will be able to have a narrower, sharper focus and better execute on their respective strategies. That is particularly important for ECN Capital, as it aims to transform itself into a pure fund management company, deploying institutional capital alongside its own in order to fund commercial finance assets. Lastly, as separate entities, Element Fleet Management and ECN Capital will be able to optimize their capital structures, with the fund management corporation taking advantage of leverage to increase its ROE.

Following the spin-off, the parent company will be renamed Element Fleet Management, and will be the largest publicly-traded fleet management services corporation in the world, with assets of almost C$15 billion. Prior to the demerger decision, Element Financial completed a series of acquisitions that transformed the company into a world leader in this industry and necessitated the spin-off. They primarily acquired GE Capital’s fleet management operations in the US, Mexico, Australia and New Zealand in mid-2015 as well as its Canadian operations in 2013. Consequently, three-quarters of its earning assets are located in the US, with the remaining in the other three countries. Element Fleet Management derives a significant portion of its revenue from fee income, such as fleet management fees. That amount comprises more than half the company’s net financial income. As a vehicle leasing company, it deploys leverage to increase its return on equity, as its business model requires significant investment in capital assets. As of June 30, 2016, debt comprised 90% of its finance assets. The high leverage can, however, be supported from the firm’s fee income that does not require high capital expenditures to be generated. Element Fleet Management generated net income and cash adjusted net income of C$72 million and C$116 million, respectively. Based on vehicle rental as well as commercial finance peer trading multiples, the company is valued at between C$10.8 and C$13.5 per share, with a price target of C$11.3 per share.

ECN Capital will be a commercial finance company providing equipment, vendor, rail and aviation financing. Similarly to its former parent, the company’s assets are primarily financed through securitized financing; debt comprises 78% of its finance assets, but leverage should increase in the future. More than 80% of its earning assets are located in the US, with the balance almost exclusively in Canada. Going forward, ECN Capital intends to transform itself into an asset management company catering to yield-seeking investors. As part of this process, ECN Capital will gradually wind down its proprietary aviation investments. The firm has already raised a commercial aviation fund with C$2.2 billion in assets. Additional funds are being put together, targeting aviation assets as well as railcars and equipment. It appears that ECN Capital’s goal is to replace asset-backed financing as its main source with institutional capital, thus de-risking its balance sheet and increasing the volume of assets it can purchase. However, the benefits of this new strategy over the existing, proven operating model are unclear, as are the duration required for the transition and the company’s potential earnings power. It should also be noted that the company’s income is highly dependent on business capital expenditures that are very cyclical. These two risks—business transformation and dependence on business capital expenditures—indicate that ECN Capital should not receive a premium over its inexpensively-valued commercial finance peers such as CIT Group Inc, despite its impressive growth rate. Consequent, the company’s valuation ranges from C$2.6 to C$3.6 per share.

The resulting sum-of-the-parts target price range for Element Financial Corp is C$13.4 to C$17.1 per share, offering essentially no upside. With the pre-spin entity fairly valued, investors should await for the valuation of the two standalone firms once they commence trading. While their share prices in relation to their fair values will be the ultimate determinant of an investment decision, Element Fleet Management should be considered a superior and higher quality company due to its scale, high fee income, lower exposure to cyclical capital expenditures and lack of business transformation risk impacting ECN Capital.

On August 4, 2015, RR Donnelley & Sons Company (NYSE: RRD) announced its intention to separate into three standalone, publicly traded companies: a financial communications and data services company (Donnelley Financial Solutions, symbol DFIN), publishing and retail-centric print services (LSC Communications, symbol LKSD), and a customized multi-channel communications management company (post-spin RR Donnelley & Sons). The separation is to be completed on October 1, 2016, via a tax-free distribution of DFIN and LCS to RRD shareholders. RRD shareholders will receive one share of LKSD and one share of DFIN for every eight shares of RRD owned as of the record date September 23, 2016. DFIN, LKSD, and RRD will begin regular-way trading on the NYSE effective October 3, 2016.

When-issued trading is expected to begin around September 21, 2016. RRD will distribute 80.75% of the outstanding shares in both companies and retain 19.25% ownership interest of each. The company also approved a 1:3 reverse stock split effective October 1, immediately following the distribution, which will result in a share count reduction to approximately 69.8 million common shares outstanding for the parent company.

RRD is the largest commercial printing company in North America and counts among its customers 100% of the Fortune 100 companies, 98% of the Fortune 500, and 95% of the Fortune 1000 (over 60,000 customers in total). The company reports four operating segments: Publishing and Retail Services, Variable Print, Strategic Services, and International. In 2015, RRD generated revenue and EBITDA of $11.26 billion and $1.2 billion, respectively. Over the past 15 years the company has transformed from being primarily a publishing and retail services-focused entity (print and ship) to a more diversified provider of communications services, including data analytics, content optimization, and multi-channel marketing, primarily through acquisitions in the highly fragmented industry. Acquisitions have been particularly focused in the area of Variable Print services, which grew to 33% of revenue in 2015 from just 4% in 2000. At the same time, the Publishing and Retail segment has become less of a focus, as the industry has experienced a secular decline in demand. Publishing and Retail generated $2.5 billion in revenue in 2015, representing 24% of total sales versus 64% of sales in 2000 (approximately $3.3 billion). The separation appears to be the next step in the company’s plan to diversify away from the shrinking legacy business and create three distinct entities that have differing growth profiles.

Based on an analysis of comparable revenue, EBITDA, and assets, a pre-spin sum-of-the-parts fair value estimate of $18 for RRD can be derived. The pre-spin fair value estimate implies 13% potential upside relative to RRD’s current share price ($15.97 as of this writing), suggesting that the pre-spin shares are approaching a full valuation. As such, pre-spin shares are not recommended for purchase. Post-spin, RRD, LSC, and DFIN can be fairly valued at $39, $31, and $9, respectively. Note that the post-spin share count for RRD is expected to be approximately 70 million shares outstanding, resulting from the company’s planned 1:3 reverse stock split effective October 1, 2016.

RRD shares have been under recent pressure, declining approximately 18% from recent highs in July–owing likely to longer-term concerns surrounding the secular decline of the print and related businesses. The company recently received a debt downgrade by Moody’s (to B1 from Ba3). While the spin off significantly helps post-spin RRD with debt reduction, the company also spins out almost 50% of its EBITDA base, posing concerns about earnings growth amidst competitive end markets.

Secular trends at post-spin LSC will likely remain challenging, in our view, owing to the continued trajectory toward digital media and online communications. Further industry consolidation may also exacerbate competitive price pressures. Accordingly, gaining economies of scale through acquisitions may be a preferred longer-term strategy. The post-spin company will also likely continue to lower its cost structure and try to differentiate its products and service offerings.

At post-spin DFIN, the company will remain highly sensitive to market and economic conditions and financial markets activity. Fluctuating corporate funding requirements, stock market activity, prevailing interest rates, and other general economic factors will likely result in more quarterly volatility for DFIN relative to LKSD and RRD.

At post-spin RRD, the outlook for multi-channel communications demand appears relatively healthy, in our view, supported by underlying trends for big data and analytics, which allow for more targeted communication and marketing optimization. Reduced debt levels may accelerate the company’s growth-through-acquisition strategy, which poses some transaction-related risk.

On May 12, 2016, Honeywell International Inc. (NYSE: HON) announced that it intended to spin off its resins and chemicals business as an independent, publicly traded company, to be named AdvanSix Inc. The spin-off is expected to be tax-free to shareholders. On September 7, 2016, HON’s board of directors declared a pro rata dividend of AdvanSix common stock to be made on October 1, 2016 to HON shareholders of record as of September 16, 2016. Shareholders of record will receive one share of AdvanSix for every 25 shares of HON owned as of the record date. AdvanSix shares will begin regular-way trading on the NYSE under the symbol “ASIX” on October 3, 2016; when-issued trading is expected to begin on or about September 14, 2016, two days prior to the record date.

Honeywell International is a multi-industry, global industrial conglomerate, with annual sales in excess of $38 billion. The company operates under three segments: Aerospace, Automation and Control Solutions (ACS), and Performance Materials and Technologies (PMT). Aerospace is the largest contributor to revenue and operating income at 39.5% and 43.1%, respectively. ACS contributes 36.6% and 31.0%. AdvanSix, which is currently part of the PMT segment, is a leading manufacturer of nylon 6, a polymer resin that is a synthetic material used in a wide range of products, including engineered plastic, fibers, filaments, and films, that in turn are used in automotive and electronic components, carpets, sports apparel, and industrial packaging, among other end products. AdvanSix generated $1.3 billion in revenue in 2015.

HON has employed a strategy of growth through acquisitions and divestitures, which has begun to benefit the top line for the company, while operational improvements (plant efficiencies) have increased margins. The most significant headwind to overall revenue growth has been currency (i.e., a stronger dollar), as it appears organic sales growth has generally begun to return across the segments, albeit at a low-single-digit rate. Moving forward, the company should benefit from a cyclical upswing in demand, easing of currency headwinds, and the operational efficiencies previously mentioned to drive earnings growth. The exception to the return of organic growth has been at PMT, which has seen revenue fall due to commodity price declines and increased competition from Chinese manufacturers. As a standalone entity, ASIX may have more focus and strategic flexibility to pursue its own growth-via-acquisition strategy.

On a pre-spin, sum-of-the parts basis, HON is assigned a fair value estimate of $123 per share, consisting of $1.15 per share of AdvanSix and $121.35 per share of post-spin Honeywell. On a post-spin basis, by our calculations, shares of ASIX are fairly valued at $29 per share, reflecting the 1:25 distribution ratio.

It should be noted that the pre-spin sum-of-the-parts could be viewed as if a pre-spin purchase of HON would result in shares of ASIX being distributed as a free dividend. Additionally, a significant portion of the implied upside comes from the parent company being rerated. HON currently trades at 10.2x and 15.4x consensus 2017E EBITDA and P/E, respectively, representing a 15% and 20% discount to the peer group average. Initial trading in HON post-spin may approximate the current trading multiple. In the longer term, HON’s share performance following the spin-off of ASIX will likely depend on the company’s financial performance over the next two to four quarters before a full rerating comes to fruition.

Investors should consider the potential post-spin trading patterns of the separate entities. In our view, the ASIX shares are likely to encounter selling pressure upon separation for a couple of reasons, the most prominent being the difference in the relative size and focus of the two companies. AdvanSix is far smaller than the large-cap Honeywell; as such, it will likely not be included in the S&P 500 as the parent currently is. Additionally, the scarcity of shares should also be noted, as, with only 30.4 million shares outstanding, the stock is likely to be fairly illiquid. Second, the investor base that currently owns HON likely does so for exposure to the industrial component rather than for exposure to the currently depressed specialized chemical business. Given these characteristics, a degree of volatility should be expected in the initial trading of ASIX shares.

However, a longer-term fundamental case for owning ASIX can be made for investors willing to ride out the current depressed earnings ASIX is experiencing given its commodity exposure. Pricing for caprolactam, nylon 6, and nitrogen-based fertilizers is currently depressed due to low input costs and increased exports from China. The timing of a pricing rebound is uncertain; however, if the company is able to expand EBITDA margins modestly, shares of ASIX could be valued at over $35 per share. ASIX’s backward integration, plant yields, and low-cost producer status provide a competitive advantage, which would appear to make margin expansion achievable in a better commodity pricing environment. Considering the expectation that initial trading in ASIX could come under pressure, a timely buy of ASIX shares in initial regular-way trading at levels below our fair value estimate may provide attractive returns for a longer-term investor.

On September 16, 2015, after the market close, Air Products and Chemicals Inc. (NYSE: APD) announced its intention to separate the company’s Materials Technologies business into a separate, standalone publicly traded company to be named Versum Materials, Inc. The separation is to be completed via a tax-free distribution to APD shareholders and is expected to be completed on October 1, 2016 to shareholders. Air Products stockholders will receive one share of Versum common stock for every two shares of Air Products common stock as of the September 21, 2016 record date. When-issued trading of Versum and APD shares is expected to begin on the NYSE under the symbols “VSM WI” and “APD WI,” respectively, beginning on September 19, 2016. Regular way trading of Versum shares is expected to begin on the NYSE on October 3, 2016, under the symbol “VSM.” Guillermo Novo, the current executive vice president of the Materials Technologies business, will assume the CEO role; Seifi Ghasemi, APD’s current CEO, will maintain that role and will also hold the role of non-executive chairman at Versum. The potential that such a transaction could be announced has been highlighted in The Spin-Off Report Radar Screen since July 2015. APD has always had a spin rather than a sell bias because of the low tax basis of the operations to be divested.

APD is a global leader in the production and sale of industrial gases, with consolidated F2015 (FY end Sept.) sales of $9.9 billion, operating income of $1.9 billion, and EBITDA of $3.0 billion. The company provides atmospheric, process and specialty gases, and related equipment. End-markets include metals, food and beverage, refining and petrochemical, and natural gas liquefaction.

The Materials Technologies business, to be spun off as Versum, includes applications technology for a broad range of global industries through chemical synthesis, analytical technology, process engineering, and surface science. Key products include epoxy curing agents, polyurethane additives, and specialty additives for use in coatings, inks, adhesives, civil engineering, personal cars, cleaning/sanitizing, mining, oilfield, and other markets. The Materials Technologies segment generated almost 20% of consolidated revenue and adjusted EBITDA (including corporate costs) in 2015.

The spin-off is a pivotal step in the company’s previously outlined “five-point plan,” a restructuring plan aimed at focusing on APD’s core business, industrial gases, while divesting non-core businesses and targeting more effective capital allocation. With the environment weakening in the merchant gas business (served by tanker/trailer as opposed to bulk gases, which are typically served by pipeline), APD has successfully boosted earnings growth by large cuts in overhead expenses. Despite a 5% contraction in F2015 sales, APD was able to generate 8% year-over-year EBITDA growth and has since executed eight consecutive quarters of double-digit earnings growth. In conjunction with this restructuring plan, in May 2016 the company announced the planned sale of its Performance Materials business (approximately $240 million in EBITDA) to Evonik (EVK GY) for $3.5 billion, or approximately 15x EBITDA (expected close by year-end).

Following the spin-off, Air Products will receive $975 million in cash. Accordingly, the post-spin parent company will have more flexibility regarding the deployment of its capital, including share repurchase in the event of an economic downturn and dividend increases. With the spin-off of Materials Technologies coupled with the sale of its Performance Materials business, the percentage of gas the company supplies via more stable on-site sales is likely to be approximately 48% versus 38% currently, which also may lift its trading multiple given the greater durability and quality of the cash flow stream. Accordingly, Air Products’ valuation should compare favorably with other higher-quality specialty chemical companies, such as Praxair, Inc. (NYSE: PX) and Ecolab, Inc. (NYSE: ECL). In our view, the post-spin parent’s balance sheet should become materially stronger, its free cash flow generation should improve, and its potential for shareholder value creation from asset purchases should grow. That said, industrial gas demand has more recently been depressed due to weakness in the energy sector. It may be the case that demand from this key sector will improve as comparisons ease. In this respect, the sharp cost-reduction measures taken at Air Products may lead to very good incremental margins.

Based on an analysis of peer multiples of estimated revenue, EBITDA, assets, and free cash flow, pre-spin APD can be fairly valued at $157 per share, consisting of $151 per share for APD and $5.78 per share for Materials Technologies (Versum). Post-spin, assuming approximately 108.3 million shares outstanding (a 1:2 distribution), Versum can be fairly valued at $11.75 per share.

With the pre-spin fair value estimate approximating APD’s current share price ($155.89 as of this writing), pre-spin APD shares appear fairly valued for the transaction and are not recommended for purchase. Notably, APD shares have appreciated approximately 21% year-to-date, and at 21x P/E, the shares are currently approaching the upper end of their five-year historical range of 14x-26x P/E. For post-spin APD, while investors may appreciate the improvements to the capital structure, margin upside appears substantially more limited following an over 900-bp expansion, and macro headwinds are likely to subdue growth prospects, in our view.

On December 1, 2014, E.ON SE announced its plan to create a new unit comprising its Power Generation, Global Commodities and Upstream businesses and distribute a majority stake to its shareholders. Since that first announcement, E.ON has reorganized its operations and altered its original plan. By far the most important change was the decision to keep at the parent company the German nuclear power operations—an arrangement that was in all likelihood the result of political pressure from the German government out of fear that the spun off entity will be unable to support the billions in nuclear asset retirement obligations associated with that business. Furthermore, E.ON divested almost the entirety of its Upstream division, with a remaining interest in its last natural gas field folded into the Global Commodities unit. It should also be mentioned that the firm’s hydroelectric power plants—a renewable source of energy—will be spun off as well. The spin-off was approved at E.ON’s Annual Shareholders Meeting held in June 2016. According to the terms of the demerger, E.ON will distribute 53.35% of the spin entity—called Uniper SE—to its shareholders, while retaining the remaining 46.65%—a stake that the company expects to wind down over the medium term. Shareholders as of September 9, 2016, will receive one Uniper share for every 10 E.ON shares. The spin entity’s shares will start trading on September 12.

The past few years have been extremely challenging for E.ON as well as other German electric utilities. The country’s shift towards renewables along with the gradual phase-out of nuclear power has been implemented through a series of regulations that have greatly harmed conventional power generators. Thus, the spin-off will serve as a way for E.ON to divest its less profitable, shrinking operations, to the benefit of its more promising assets. Viewed through a more romantic prism, it is a division between the “old” and “new” energy worlds—the focus on clean, renewable energy and the gradual extinction of fossil fuels. It is also noteworthy that the majority of E.ON’s net economic debt comprises its nuclear asset retirement obligations. The transfer of the nuclear business to Uniper—as originally contemplated—would have heavily burdened the new entity’s balance sheet, while the expected declining profitability would only increase its leverage. In that context, the German government’s concerns seem appropriate. For E.ON, however, the decision means that the parent entity will remain overlevered—even though the spin-off represented a unique opportunity to dispose of both unwanted assets as well as most contractual liabilities.

As a standalone company, Uniper will be organized under three divisions: European Generation, International Power and Global Commodities. The first two own and operate conventional power plants that run on fossil fuels (coal and natural gas), hydropower and nuclear power. European Generation’s primary markets are Germany, Sweden, the UK, France and the Netherlands. International Power controls assets in Russia and Brazil. Lastly, the Global Commodities unit focuses on the transportation, storage and trading of commodities—primarily gas—as well as the sale and trading of electricity. While the Global Commodities unit has been performing satisfactorily, the power generation businesses have been suffering from declining profitability. Developments at the European Generation unit are of the greatest concern, as it is Uniper’s biggest EBITDA contributor, having generated over 60% of 2015 EBITDA. Also at issue is the company’s leverage. At EUR 3.6 billion, net economic debt—i.e., net debt plus pension obligations and asset retirement provisions—stands at 2.1x 2015 EBITDA, and will likely follow an upward trajectory. Uniper’s strategy is focused on free cash flow generation, primarily through cost reductions, with a focus on maintenance capital expenditures. It also intends to return most of its free cash flow to shareholders. For 2016, the firm is proposing a dividend of EUR 200 million, a number that will likely increase in the future. Uniper’s valuation range is quite wide, and will ultimately depend on several factors such as the company’s effectiveness in generating stable free cash flow, its dividend policy and the valuation multiple the market will ascribe to the European Generation unit, given that almost half of its power generation capacity is located in Germany. Based on enterprise value-to-EBITDA, dividend yield and free cash flow yield measures, Uniper can be valued between EUR 14.9 and EUR 33.5 per share.

Following the spin-off, E.ON will comprise the Renewables, Energy Networks and Client Solutions operations. The firm’s renewable power generation assets are located in Europe and North America, and include onshore and offshore wind turbines as well as solar plants. The Energy Networks—i.e., electricity grid/distribution—segment is post-spin E.ON’s major EBITDA contributor due to its substantial regulated asset base, and Customer Solutions focuses on projects such as on-site energy generation, energy efficiency and sustainability. While all these assets benefit from either earnings stability or decent growth prospects, E.ON was forced to retain its German nuclear operations. This factor could be a drag on the company’s valuation in two ways: Firstly, as the country is phasing out nuclear energy, the company’s reactors should all be decommissioned by 2022. Secondly, the division has substantial asset retirement obligations, to the magnitude of EUR 18.1 billion—leading to a pro forma economic net debt of EUR 24.8 billion. Based on enterprise value-to-EBITDA multiples, post spin-off E.ON is valued between EUR 7.9 and EUR 14.4 per share.

The resulting sum-of-the-parts target price range for pre-spin E.ON is EUR 9.4 to EUR 17.7 per share, offering 15% to 117% upside. Consequently, shares of the company are recommended for purchase prior to the spin-off. However, neither company appears to be an appropriate long-term investment given the numerous challenges and risks they are facing that will be detailed later in this report. Rather, one should consider this investment in pre-spin E.ON as an opportunity to invest in the post-spin entity at its fair price, while receiving Uniper shares for free. It is also likely that Uniper will trade at a very low price following the spin-off, as many index funds will opt to divest this smaller business (E.ON is Germany’s largest utility and thus included in most major index funds) while active managers may be sellers due to their aversion to low quality or low growth companies.

On July 9, 2015, The Procter & Gamble Co. (NYSE: PG) announced that the company had signed a definitive agreement to merge 43 of its Beauty brands with Coty Inc. (NYSE: COTY). PG will complete the transaction via a tax-free split-off of its beauty brands, which would immediately merge with COTY in a Reverse Morris Trust (RMT) transaction. The brands included in the transaction include PG’s global salon professional hair care and color, retail hair color, cosmetics, and fine fragrance businesses, along with select hair-styling brands. As a condition of the RMT, JAB Cosmetics B.V., which controls all of COTY Class B shares, has agreed to convert all Class B shares into Class A common stock. PG has initiated an exchange offer for those shareholders who wish to exchange shares of PG, which expires at 12:00 midnight ET on September 29, 2016.

Assuming a split-off, at the close of the transaction shareholders electing to exchange their PG shares will control 54% of the newly merged COTY, valued at $13.2 billion when accounting for the assumption of $2.9 billion of debt by the RMT brands. The actual level of debt will vary between $1.9 billion and $3.9 billion, depending on COTY’s share price prior to the close of the transaction, subject to a collar on COTY shares of $22.06-$27.06.

This RMT transaction is the final step in what has been a significant portfolio restructuring for PG. The company had previously announced the sale of pet food brands, including Iams, the Duracell battery business, and other small beauty and overseas laundry brands. Following the portfolio restructuring, the company will focus on 10 categories and approximately 65 brands, which have historically provided higher-margin results than the products that are being divested.

In terms of creating a smaller, more focused, and more profitable company, the asset divestitures make sense for PG. The company has struggled to drive revenue growth over the past five years (excluding divestitures); however, it has been quite successful in improving profitability through cost reductions. The company’s focus on fewer brands, while retaining approximately 85% of sales, should allow PG to return to revenue growth, in our view. Further, cost reductions and the jettisoning of less profitable brands should improve profitability metrics and may foster earnings expansion.

Completion of the split-off of brands marks the final milestone in PG’s portfolio rationalization, thus making the transaction largely strategic versus financial for the company. However, its growth story moving forward largely hinges on margin expansion rather than accelerating top-line growth. With the company having garnered most of the low-hanging fruit of cost cuts, potentially slower margin expansion, combined with a historically high valuation multiple, brings into question the sustainability of the current valuation.

It should be noted that PG’s current valuation is likely a factor of two drivers. First, the search for yield in the current interest rate environment has benefited the shares; PG currently yields 3.0%. Second, as PG is a member of the S&P 500 and is a large, well-known consumer staples company, the shares are widely held in ETFs. As such, ETF inflows, rather than valuation, dictate demand for its shares. An eventual increase in interest rates, whenever that happens, will likely diminish the equity search for yield, which may reduce demand for the shares, in our view.

Over the past several years, the investment thesis on PG has largely been centered on its portfolio streamlining and margin enhancements. With the imminent completion of the portfolio pruning and the low-hanging margin opportunities largely realized, the focus will shift to the company’s ability to deliver on revenue growth, which has been elusive in recent years even when excluding the impact of divested brands.

The Reverse Morris Trust transaction seems to make more financial sense for COTY than PG. With revenue projected to double to near $9 billion annually following the RMT, the PG Beauty brands add significant size to COTY’s operations, transforming the company into a leader in the global beauty business. COTY has committed to raising its dividend to $0.50 per share and expects to realize up to $780 million in cost synergies over the next four years, which should help accelerate earnings growth despite a challenging sales environment.

On a pre-split basis, shares of PG are assigned an $88 fair value estimate. COTY shares are fairly valued at $24 per share post-merger, while post-split PG shares are assigned an $88 fair value estimate (accounting for a 4.4% reduction in shares outstanding for the exchange offer). Given that the fair value estimates approximate the current trading values, and considering the noted historical high multiples for low-single-digit revenue growth at both entities, neither PG nor COTY shares are recommended prior to the split-off. However, heading into the September 29 exchange offer expiration, investors should be cognizant of COTY’s share price. In split-off RMT transactions, the merger entity typically sees pressure into the exchange offer, as merger arbitrage strategies attempt to capture the enticement discount offered to the parent company shareholders (in this case 7%). As a result, short interest climbs, a process that has already begun with COTY. If COTY shares decline beyond current levels, a purchase of COTY stock could be considered for a short-term trade, as the selling pressure and short interest is expected to diminish following completion of the merger.