Tiptree announces intent to take Fortegra public via an IPO; posts 3Q 2023 top- and bottom-line growth of ~15% and ~24%, respectively, driven by growth of ~24.5% and 51.5%% at Fortegra; maintain our base case fair value of $24.50 per share posts top- and bottom-line growth of 19% and 20%, respectively, driven by growth of 31% and 59% in sales and net income at Fortegra; maintain our base case fair value estimate of $24.50 per share

• Last night, after the market close, Tiptree, in conjunction with 3Q 2023 results, announced its intent to take its specialty insurance business, Fortegra, public via an initial public offering (IPO).
• The company indicated it intends to maintain a majority stake in Fortegra and the primary use of proceeds from the offering will be to support its growth (which, we note has been 20%-plus on both the top and bottom lines since 2017).
• Management will hold a conference call to discuss details of the transaction and 3Q 2023 results this morning at 10:30 a.m. (ET); dial-in at (877) 407-4018.
• In terms of 3Q 2023 results, TIPT reported consolidated 3Q 2023 top-line growth of 14.6% to $416.5 million with 23.9% growth in adj. net income to $24 million. Consolidated return on equity (ROE) rose 280 basis points to 17.6%. Year-to-date, consolidated sales are up 17% to ~$1.2 billion with adj. net income growth of 33.4% to $65.1 million and ROE up 190 bps to 16.1%
• At Fortegra, the company’s primary operating business, 3Q 2023 sales increased 24.4% to $406.8 million with a 9.6% rise in gross written premiums and equivalents (GWPE) while adj. net income advanced ~51.5% to $30 million. The combined ratio improved 90 bps to 90.2% and Fortegra’s return on equity improved 1,080 bps to 22.9%, largely driven by continued growth in the company’s capital-light warranty business. Year-to-date, Fortegra’s sales are up 28.4% to $1.16 billion with a 24.7% jump in GWPE while net income has increased 38.5% to $83.1 million.
• The book yield on Fortegra’s $1.24 billion investment portfolio rose to 3.2% in 3Q 2023 (from 2.0% 3Q 2022 and 3.1% in 2Q 2023) while the overall rating of its holdings was AA. The average duration is 2.4 years (compared with ~2.1 years in the previous quarter).
• Sales at Tiptree Capital fell ~66% to $42.7 million, in part driven by the sale of the company’s shipping assets in 2022, while net income was $248K (compared with ~$9.8 million in 3Q 2022). Net income at the mortgage business, Reliance, was slightly positive in 3Q 2023 (vs. a ~$0.9 million loss in 3Q 2022).
• Corporate expenses were essentially flat at $8.4 million in 2Q 2023 (versus $8.3 million in the prior year quarter) and the company continued to maintain no corporate level debt at quarter-end.
• Our base case fair value for TIPT remains $24.50 per share based on a 12.5x multiple of projected 2024E net income at Fortegra (pro-rated for TIPT’s ultimate 68.6% ownership as well as a ~$41 million deferred tax liability) and a 0.5x multiple of book value, ex-NCI, at Tiptree Capital (see Exhibit #1 on page 2).

Alert: Western Digital to Separate HDD and Flash Businesses via Spin-Off

Western Digital Corp. (NASDAQ: WDC) has announced that the company’s Board of Directors has approved a plan to separate its HDD and Flash businesses into two independent, standalone, publicly traded companies. The transaction is intended to be completed via a tax-free spin-off and is targeted to be completed in the second half of calendar 2024 (WDC operates on a June fiscal year). The spin-off is subject to customary closing conditions including an effectiveness declaration of a Form 10 filing with the SEC, final Board approval, and receipt of opinions or rulings as to the tax-free nature of the transaction, amongst others.

For context, in September 2020, WDC, under the leadership of new chief executive David Goeckeler, who took the helm in March 2020, announced that it would reorganize itself into two distinct operating segments: (1) Hard-disk drive (HDD), which generated 50.8% of June-ending F2023 consolidated sales; and (2) Flash, which generated 49.2% of F2023 consolidated sales. Concurrently, WDC announced the hiring of Robert Soderbery, formerly of Symantec/Veritas (private) and Cisco (NASDAQ: CSCO), to be the general manager of the Flash business and shortly after announced it had hired Ashley Gorakhpurwalla, formerly of EMC Dell (NYSE: DELL), to run the HDD segment. At the time, management indicated the realignment of its portfolio would improve the profitability, growth, and agility of each business, but such moves have, at times, been the precursor to an eventual separation transaction.

Subsequently, in October 2021, it was reported in the Wall St. Journal, that WDC may be pursuing a merger with Kioxia Holdings, a privately held maker of flash memory chips based in Japan. More recently, in May 2022, activist-investor Elliott Management disclosed a ~1.2 million share stake in WDC and called for a full separation of the HDD and Flash businesses, which, among other things, it contends could yield a stock price of ~$100 per share by the end of 2023. In addition to its public equity investment in WDC, the investor indicated that it would also offer ~$1 billion of incremental capital into the Flash business, at a valuation of $17-$20 billion, to facilitate the separation. In June 2022, WDC announced that it was reviewing strategic alternatives, which could include the separation of its Flash and HDD businesses. More recently, in early-February 2023, activist investors Elliott Management and Apollo Global purchased $900 million of preferred stock in WDC, in an effort to provide the financial flexibility and “facilitate the next stages of Western Digital’s strategic review.

Notably, on November 26, 2023, one trading day prior to the spin announcement, it was reported in the business press that talks between Kioxia and WDC to merge had fallen apart due to an objection from Korean chip maker SK Hynix, which is part of the Bain Capital investment group that holds a majority stake in Kioxia.

In F2023 (June-ending), HDD segment sales decreased 30.8% to $6.3 billion, with gross profit of $1.5 billion (implying a margin of 24%), while Flash segment sales were declined 37.8% to $6.1 billion, with gross profit of $433 million (implying a margin of 7.1%). Through 1Q F2024, HDD declined 40.7% and Flash declined 9.6% versus the prior year period. On a consolidated basis, F2023 adjusted EBITDA declined by 94% to $234 million with the company reporting an adjusted net loss of $1.1 billion ($3.59 per share).

Based on management commentary and current consensus estimates, it can be projected that WDC’s HDD and Flash segments could generate F2025E sales of $7.0 billion and $8.4 billion, respectively. Applying EV/ sales multiples of 1.25x and 1.5x, which are discounts to respective peers Seagate Technology (NASDAQ: STX) and Micron Technology (NASDAQ: MU), implies segment values of $8.8 billion for the HDD business and ~$12.6 billion for the Flash business.

Accounting for current net debt of ~$4.7 billion yields a sum-of-the-parts fair value of ~$16.7 billion, or $51 per share (based on a share count of 324 million).

International Trade Commission (ITC) rules in favor of MASI in its patent trial against Apple; grants “limited exclusion” and “cease and desist” orders, portending a potential import ban on certain Apple Watches that could ultimately lead to a royalty deal between the two parties

Last night, after the market close, the International Trade Commission (ITC) granted limited exclusion and cease and desist orders prohibiting the unlicensed entry (i.e., import) of wearable electronics with light-based pulse oximetry functionality by Apple Inc. (NASDAQ: APPL) that infringe on MASI patent numbers 10,912,502 or 10,945,648 (see the link on page 2 for the actual court document).

We note this decision comes after a preliminary ruling by an ITC administrative judge in January 2023, which essentially came to the same conclusion that the Apple Watch had infringed on certain MASI patents related to the use of light sensors for measuring the oxygen content in the blood. (Anecdotally, we note that the administrative judge’s ruling is very rarely overturned in the Commission’s final decision).

Clearly, give its statements last night, Apple will appeal the decision and we would also note that the Biden Administration has 60 days to review and ultimately veto the ITC’s decision.

In that context, despite Apple’s undoubtedly significant political influence, we would note that the Administration did not elect to exercise its veto authority in the recent case of AliveCor’s suit against Apple (just back in February 2023) and while we do not normally delve into politics in this forum we point out, simply as a statement of fact, that MASI’s CEO, Joe Kiani, has hosted fundraisers/raised funds to support President Biden’s political campaigns and is on the President’s Council on Science & Technology. As well, perhaps more salaciously, it seems evident the two men have personal ties considering it was widely reported that President Biden’s son, who has been subject to a fair degree of media scrutiny of late, used Mr. Kiani’s vineyard in Santa Barbara, CA earlier this year (at a time when media attention was at a particularly feverish pitch) as a “get away” (see a link to a sample article from the NY Post on page 2).

Assuming a veto is not in the cards (and appeal attempts are dropped or defeated), Apple will face a so-called import ban on certain of its Apple Watch devices (specifically which ones remain unclear, as of now, but it would presumably be the newer versions as MASI has alleged Apple’s patent infringement began with the release of the Series 6 Apple Watch).

To that end, while not a foregone conclusion, to say the least, if the ruling holds up as currently decided Apple may be pressured to enter into a royalty agreement with MASI (not unsimilar to the company’s deal with Medtronic in 2006-2018). In that case, without considering any payments for damages, if one just takes estimates suggesting Apple will sell 55-65 million watches in 2023-2024 even a royalty of $1-$2 per unit would be a significant source of upside for MASI (i.e., based on a gross margin of ~90% and ~26% tax rate it could add ~$0.65-$1.55 to EPS, which at a multiple of 15x-20x multiple could be worth ~$10-$31 per share, in terms of the stock price).

That said, while this is clearly a positive for MASI (i.e., its stock is indicating up ~10% this morning in pre-market trading) there is still a lot of uncertainty regarding the ultimate outcome as well as its timing; as such, we are not factoring any impact, either way, in our forecasts.

Our $146 per share fair value estimate applies multiples of 19.5x and 7.5x, respectively, to our 2024E forecasts for MASI’s core Healthcare and Non-Healthcare segments and incorporates projected net debt (see Exhibit #1).

Additionally, we would note that, by our calculation, assuming the Non-Healthcare segment (i.e., Sound United) , which was bought for ~$1.0575 billion in April 2022, is worth zero, the core Healthcare business is currently trading at ~13.5x 2024E EBITDA (compared with peers at ~21.5x forward estimates and MASI’s own forward EV/EBITDA multiple of 17.5x, 26.1x and 26.2x and 21.1x over the last 1-, 3-, 5- and 10-year periods).

Takeaways from yesterday’s technology/investor event: GTX is not a shrinking “ICE” cube, at least anytime over the next decade, and it will generate its market capitalization, at least, in free cash over the next 5-years 

• Yesterday afternoon, GTX held a technology/investor event; a lot of interesting technical information was provided, particularly regarding the company’s innovations in the zero emissions (ZEV) space, including its high-speed oil-less fuel cell and E-cooling compressors as well as its high-speed E-powertrain products, which management estimates will contribute ~$1 billion of sales (at a margin profile in-line or above the company’s current levels) by 2030.
• That said, for the sake of brevity, we will focus on some of the financial topics that we hear about most during our discussions with clients (and, frankly, we think support many of the points we have been stressing for some time).
• First, management clearly articulated, for the first time publicly that we can recall, their contention that the core turbocharger business will be bigger in 2030 than it is today while adding that the core business is likely to be roughly flat with current levels in 2033, as on-going share gains (i.e., a win rate above 50% in recent years) will offset a likely peak in light vehicle turbos and a plateau in commercial vehicle & industrial late this decade (see Exhibits #1 & #4).
• Within this conservative context, management, which has solid visibility into demand over the next 5-years considering that more than 80% of sales have already been awarded to them by its OEM customers, anecdotally asserted, again, for the first time publicly that we can recall, that GTX will generate free cash that equals or exceeds the company’s current market capitalization over the next five years. In terms of allocating that capital, management will continue to repurchase shares, reduce leverage and may ultimately instate a dividend.
• On the valuation front (see Exhibits #2 & #3), the company highlighted its significant outperformance versus peers, in terms of adj. EBIT, EBITDA and EBITDA less capex metrics, while juxtaposing that against the sizeable discount its stock trades at on an EV/EBIT, EV/EBITDA and free cash flow (FCF) yield basis (which is a factor that we think clearly informed management’s decision to repurchase ~8% of the company’s stock in 3Q 2023 alone).
• In terms of a broader long-term financial framework (see Exhibit #4), the company is targeting an adj. EBITDA margin profile of greater than 16% with research & development costs and capital expenditures remaining below 5% and 3%, respectively.  FCF conversion is projected to remain around 60% (of adj. EBITDA) and the company is targeting a leverage ratio of 2.0x or less (a goal that will likely be met in 2024).

Our base case fair value estimate for GTX remains ~$11 per share, reflecting an 8.0x multiple on our 2024E adjusted net income forecast of ~$331 million and a fully diluted share count of ~252.5 million (see Exhibit #5 on page 4).

GTX reports 3Q 2023 results; narrowed outlook, driven solely by currency headwinds, implies a slight reduction at the midpoint when compared with its most recent guidance but still remains well-above the company’s initial outlook; GTX repaid $200 million of debt and repurchased $161 million or nearly ~8% of the stock (at $7.59 per share) in 3Q 2023

• This morning, before the market open, GTX reported 3Q 2023 sales up 2% (or down 1% on a constant currency basis) to $960 million along with 4% growth in adj. EBITDA to $52 million (on a 40bps expansion in margin to 15.8%).  Net income and adj. free cash flow (FCF) were both $57 million (compared with $105 million and $120 million, respectively, in the prior year period).
• Year-to-date, GTX posted sales growth of nearly 9% to $2.94 billion with ~14% growth in adj. EBITDA to $390 million.  Net income and adj. FCF were $209 million and $285 million, respectively, compared with $278 million and $181 million in the prior year period.
• The company repaid $200 million of debt during 3Q 2023 and ended the quarter with a net leverage ratio of 2.3x (compared with 1.64x at the end of 2022 and 2.15x at the end of 2Q 2023).  The company remains on track to meet its leverage target of 2.0x by the end of 2024 (and we note that 80% of GTX’s long-term debt is fixed at less than 3.2% over the next three years with no significant debt maturities until 2028).
• Notably, GTX repurchased $161 million worth of stock during 3Q 2023 (compared with $17 million in 2Q 2023) at $7.59 per share, implying ~21.2 million shares or nearly 8% of the total outstanding share count.  (Additionally, management indicated that it has already repurchased an additional $5 million worth of stock so far in 4Q 2023, implying that ~$67 million is left of its previous $250 million share repurchase authorization).
• In terms of guidance, management narrowed its full-year outlook, implying a modest reduction at the mid-point when compared with its most recent guidance but we note that the current outlook still remains well above its initial outlook (see Exhibit 1 on page 2); net sales are now projected to be $3.83-$3.9 billion (versus prior guidance of $3.84-$4.03 billion), implying constant currency growth of 7-%-9% (previously 6%-11%) with adjusted EBITDA and FCF of $615-$645 million and $350-$400 million, respectively (versus prior guides of $620-$670 million and $340-$440 million).  GAAP net income is projected to be $252-$272 million (compared with the previous range of $255-$290 million).
• In terms of the guidance revision, we think it important to note that the only update to management’s underlying assumptions is that the current forecast now calls for a Euro/Dollar exchange rate of 1.08 (previously 1.10).  GTX continues to expect R&D and capital expenditures will comprise less than 5% and 3% of net sales, respectively, of which 50% and 20% will be devoted to electrical technology innovation.
• On the latter electric vehicle (EV) or zero-emission vehicle (ZEV) front, GTX continues to garner pre-development projects for its E-Powertrain, E-Cooling Compressor and H2 Fuel Cell solutions/systems and it continues to target ~$1 billion of EV/ZEV sales (at or above the company’s existing margin profile) by 2030.
• Our base case fair value estimate for GTX remains ~$11 per share, reflecting an 8.0x multiple on our 2024E adjusted net income forecast of ~$331 million and a fully diluted share count of ~252.5 million (see Exhibit #2 on page 2).

NCR Completes Atleos Spin-Off; Rate NCR Voyix at BUY with a $23 FVE; Rate NCR Atleos at NEUTRAL with a $21 FVE

• On October 16, 2023, after the market close, NCR Corp. (formerly NYSE: NCR) completed the previously announced spin-off of its ATM-focused businesses.
• The spin company has adopted the corporate moniker NCR Atleos LLC and now trades on the NYSE under the ticker symbol “NATL”. The parent company has also changed its corporate name to NCR Voyix Corp. and now trades under the ticker “VYX”.
• NCR shareholders of record as of October 2, 2023, received one share of NATL for every two shares of NCR held.
• For reference, in when-issued trading, shares of VYX closed yesterday at $16.85 per share.
• We adjust our VYX fair value estimate to $23 per share (previously $27 per share) as we adjust our growth and margin expectations, as well as temper our valuation multiple to 9.0x (previously 11.0x), to reflect latest management commentary, pro forma capitalization, and current peer valuations.
• At current levels shares of Voyix trade at approximately 7.7x our 2024 EBITDA estimate of $614 million. (Again, our fair value estimate is based on a 9.0x multiple.)
• We rate shares of VYX at BUY as we view the current implied valuation as too heavily discounting the company’s growth potential as it transitions customers to its SaaS platform. Based on expectations, VYX is positioned to grow revenue at a mid-single digit rate through 2027 and expand EBITDA margins over that time from ~17% to 21-22% as high margin recurring SaaS revenue accelerates earnings and free cash flow generation.
• Shares of NATL closed yesterday at $20.94. We adjust our NATL fair value estimate to $21 per share (previously $16 per share) as we increase our valuation multiple to 6.0x from 5.0x. Our revised valuation multiple reflects increased confidence in NATL’s plan to accelerate revenue and earnings as it transitions customers to its ATMaaS platform. Based on our fair value estimate, and when-issued pricing, shares currently trade with an implied 3.8% dividend yield (based on an expected $0.20 quarterly dividend to be instituted in 1Q 2024) and a free cash flow yield of ~10% (based on management’s guidance for $150 million in FCF in 2024).
• We rate shares of NCR Atleos at NEUTRAL and note that shares of NATL may experience volatility in initial trading as we expect investors to favor the parent company over the ATM business, which could result in selling pressure on shares in initial trading. We would become incrementally more positive on shares of NATL if they trade at a significant discount to our fair value estimate.
• For more details, please refer to The Spin-Off Report dated July 20, 2023, and UPDATE dated August 3, 2023, and September 25, 2023.

Drop Coverage of Vista Outdoor Inc. Effective Immediately

• On October 16, 2023, Vista Outdoor Inc. (NYSE: VSTO) announced that the company has entered into a definitive agreement to sell its Sporting Products business to Czechoslovak Group for $1.91 billion in an all-cash transaction.
• VSTO shareholders at the time of closing will receive shares in the Outdoor Products business, to be rebranded as Revelyst, and aggregate cash of $750 million, which will be treated as “a taxable sale of a stockholder’s Vista Outdoor shares for the Outdoor Products shares and cash consideration they receive in the merger, allowing stockholders to recover tax basis and recognize built-in gain and loss in their Vista Outdoor shares.”
• The sale is expected to be completed in calendar year 2024.
• At the purchase price, the transaction values the Sporting Products business at 5x enterprise value, including standalone corporate costs. For reference, our prior fair value estimate for the standalone Sporting Products business assigned a $1.6 billion enterprise value using a 4x multiple.
• Given the proposed transaction, VSTO will not spin off the Sporting Products business. As such we DROP coverage of Vista Outdoor effective immediately.
• Our prior estimates and fair values for VSTO should no longer be relied on.

IDT reports 4Q F2023 and full-year results; buybacks accelerated during 4Q F2023 (and into 1Q F2024) while the net cash balance expanded to nearly $6 per share; fair value moves to $52 per share on F024E forecasts

Last night, after the market close, IDT reported full-year F2023 consolidated sales down 9% to ~$1.24 billion, as growth across the NRS (up 50%), net2phone (up 24%) and BOSS Money (up 38%) businesses was offset by on-going/expected declines at the Traditional Communications segment (down 16%). Adjusted EBITDA rose 9% to $86.2 million while GAAP and Non-GAAP EPS increased to $1.58 and $1.86, respectively (versus $1.03 and $1.12 in the prior year).

For 4Q F2023 specifically, consolidated sales declined 8% to $304 million, as declines at Traditional Communications again offset gains at IDT’s “growth businesses”. Adj. EBITDA fell 25% to $18.1 million while GAAP and Non-GAAP EPS were $0.31 and $0.66, respectively (versus $0.36 and $0.67 in 4Q F2022).

During F2023, the company repurchased 511,546 common shares for $13.1 million, of which 231,416 were bought back in 4Q 2023 (from $5.6 million), representing nearly 2% of the outstanding shares. (Anecdotally, the company indicates it has repurchased an additional 124,530 shares so far in 1Q F2024, for $2.8 million or ~$22.50 per share, suggesting management was astutely aggressive on the repurchase front prior to the favorable court decision received in early-October; please see our note from 10/3/2023 for more info).

Despite the repurchase activity, IDT ended F2023 with no debt and ~$152 million (or ~$6 per share) compared with ~$138 million (or ~$5.40 per share) at the end of F2022.

Looking into F2024E, while IDT does not provide formal financial guidance, management sees the strong growth in its terminal & payments footprint during 4Q F2023 as a tailwind to growth at NRS (despite on-going weakness in the advertising market). At net2phone, IDT thinks pending introduction of two premium services, net2phone AI and Call Center Essentials, as being accretive to both growth, ARPU and margins. At Boss Money, IDT expects the synergies between its retail & DTC channels along with the continued roll out of its new mobile banking app, Elroy, as tailwinds to further growth. Traditional Communications will continue to be managed to preserve profitability/cash flow (in fact, tight control of SG&A will be a priority across the organization in F2024).

Our base case fair value estimate for IDT moves to ~$52 per share (from $55 per share), which values IDT’s Traditional Communications segment at 1.0x F2024E EBITDA (previously 2.5x 2023E EBITDA), applies sales multiples of 2.0x (previously 2.5x) and 6.0x (previously ~7.5x) to the company’s net2phone and Fintech businesses, respectively, and accounts for projected net cash (see Exhibit #1 on page 2).

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APG favorably reprices its term loans, resulting in annual cash savings of ~$4 million, and extends maturities until 2029; remains committed to its 2.0x-2.5x leverage target by the end of 2023; fair value remains $31 per share

• This morning, before the market open, APG disclosed had it successfully re-priced its 2026 and 2029 Term Loans; resulting in a 25 basis point reduction in the applicable margin (previously SODR plus 2.5% and 2.75%, respectively) and ~$4 million of annual cash savings.
• As well, following an $100 million prepayment on its 2026 Term Loan, to be paid when the transaction closes, the maturity on the remining ~$420 million will be extended to 2029 (on the same terms as its 2029 Loan).
• Following the transaction, management indicates that it will have ~$1.91 billion of term loan debt (compared with ~$2.2 billion at the end of 2022) and its remains committed to achieving its 2.0x-2.5x leverage target by the end of 2023.  (For our part, we forecast the company’s leverage ratio will be ~2.35x at year-end.)
• Recall that following 2Q 2023 results in early-August, APG increased its full-year 2023 sales and adjusted EBITDA guidance to $7.015-$7.075 billion (versus the prior guide of $6.875-$7.025 billion and its initial range of $6.8-$6.95 billion) and $765-$785 million (up from $740-$780 million previously and $735-$775 million initially), respectively. The company maintained the expectation that free cash flow conversion would be at or above 65% (of adj. EBITDA).
• For 3Q 2023 specifically, the company projects sales of $1.86-$1.89 billion and adj. EBITDA of $215 million-$225 million (see Exhibit #1 on page 2), representing growth of 7%-9% and 16%-21% growth, respectively.  Anecdotally, the company also hinted that following the completion of a $35 million acquisition within the core Safety Service segment at the end of 2Q 2023 that it expected to complete at least two more bolt-on transactions, again within the core Safety Services segment, during 3Q 2023. For context, the combined annual net revenue contribution from these three acquisitions was projected to be ~$35 million (as well as immediately accretive to the company’s EBITDA margin.)
• Anecdotally, the company has maintained its long-term (i.e., 2025) financial goals, which target generating ~60% of its sales from inspections, services & monitoring as well as a consolidated adjusted EBITDA margin of 13%. Free cash flow conversion is targeted to be 80% (relative to adj. EBITDA and up from ~65% in 2023).

Our base case fair value estimate for Api Group Corporation (APG) remains $31 per share, reflecting a blended multiple of ~11.5x on F2024E adjusted EBITDA of ~$885 million along with projected net debt of ~$1.30 billion (see Exhibit #2 on page 2).

Following Initial Selloff, Upgrade WK Kellogg to BUY; Maintain $15 Fair Value Estimate

• On October 2, 2023, before the market open, Kellanova (formerly Kellogg Co.) (NYSE: K) completed the spin-off of its North American Cereal business into a stand-alone publicly traded company. The spin company adopted the corporate moniker WK Kellogg Co. and now trades on the NYSE under the ticker “KLG”.
• Since the close of when-issued trading on September 29, 2023, shares of KLG have declined by 30.6% and have traded 40.9 million shares. (For context, KLG has 85.6 million shares outstanding.)
• Given the precipitous sell-off, which was somewhat to be expected given the spin company’s exclusion from the S&P 500 (while K remained in the index) as well as company specific issues (discussed below); that said, we now view shares as attractively priced and consequently upgrade shares of KLG to BUY.
• We note that shares may still exhibit volatility over the next several trading days, however we view most of the forced selling has likely been completed and we would expect volumes to normalize in coming days, which should reduce volatility.
• At the current share price, KLG is trading at less than 5.0x our 2024 EBITDA estimate of $256 million. For reference, peers General Mills Inc. (NYSE: GIS) and POST Holdings Inc. (NYSE: POST) trade at 11.6x and 9.2x their respective 2024 consensus EBITDA estimates.
• For its part, KLG management’s 2024 EBITDA guidance is $255 million to $265 million (implying <10% margin at the mid-point), and it projects “mid-teens” EBITDA margins by year-end 2026.
• We fully acknowledge that KLG operations are in the early stages of a turnaround, including efforts to stabilize sales in a declining category and plans to revamp production lines, which management highlights as a reason for the company’s below peer margins. That said, with shares trading at less than 5.0x we now view KLG’s share price as too heavily discounting the industry and company-specific risks; thus, we now recommend shares for purchase.
• More broadly, if WK Kellogg’s management is able to successfully implement its turnaround plan, investors may be seeing an early opportunity to invest in a “classic spin-off” where an “unloved” and underinvested in entity is able to significantly improve operations and offer significant out-sized returns over the longer term.
• In terms of company specific priorities, management is focused on stabilizing sales and widening margins by approximately 500 basis points by 2026, which would bring the company’s margins in line with peer POST (which, again, trades at more than 9.0x). To accomplish its financial targets, the company will incur debt in the near term to fund capital expenditures but following the investment phase, the company’s earnings and free cash flow profile will significantly improve, which will help reduce leverage and likely lead to the initiation of a dividend.
• Our $15 per share fair value estimate is based on a 6.5x multiple on our 2024 EBITDA estimate. We view the discounted multiple versus peers as appropriate given the current state of KLG’s business. (For reference our valuation Exhibit shows an illustrative example of widened margins and the expected offsetting debt levels valued at a constant 6.5x multiple.)

For more details, please refer to The Spin-Off Report dated August 16, 2023, and UPDATEs dated September 11, 2023, and October 2, 2023.