On March 27, 2015, The Madison Square Garden Company (NYSE: MSG) filed an initial Form 10 with the SEC confirming its intention to spin off the company’s sports and entertainment businesses from its media business. The company had previously announced that it was exploring a possible separation. The spin-off, which will be conducted as a tax-free distribution of shares, is expected to be completed in 2015, and is subject to an effectiveness declaration of the company’s Form 10 filing, receipt of a private letter ruling from the IRS regarding the tax-free nature of the spin-off, and final Board approval. Following the separation, the parent entity will change its name to MSG Networks, and the spin entity will operate under The Madison Square Garden Co. corporate moniker. MSG and MSG Networks will continue to be controlled by Charles F. Dolan and members of his family.

The spin entity will control MSG’s current Sports and Entertainment divisions. Sports’ primary assets are the New York Knicks (NBA) and New York Rangers (NHL) teams but also include the New York Liberty (WNBA) and Westchester Knicks (NBADL), as well as the Hartford Wolf Pack (AHL). MSG Entertainment primarily owns or leases iconic venues such as Madison Square Garden, Radio City Music Hall, The Beacon Theatre, The Chicago Theatre, the Wang Theatre, and the Forum, for the purpose of promoting live events. The parent company, MSG Networks, will control the regional sports networks MSG and MSG+.

In recent years MSG’s operating results have been subdued due to major renovations at The Garden and the Forum, with total costs in excess of $1 billion. With renovations complete and a reduced expense cost structure at the sports teams, post-spin Madison Square Garden Co. will look to increase available booking dates across its portfolio of venues in order to drive increased revenue and earnings. With reduced capital expense requirements and an expected net cash position, post-spin MSG could become a more aggressive aggregator of event venues as it looks to leverage a recent joint venture in talent management. As a standalone entity, MSG Networks should prove to be a consistent cash flow generator, which should allow the company to reduce financial leverage in the short term with the ability to become a return-of-capital story over time.

Rationale for the separation is likely two fold. First, the nature of the company’s assets, which primarily arise from the value of the sports franchises and owned property, are undervalued in the current corporate structure. Separating the sports and entertainment businesses may allow the Knicks and Rangers franchises to be rerated and valued more in line with recent private market transactions – most notably the highly publicized sale of the Los Angeles Clippers in 2014. Secondly, the structure of the transaction is such that the regional sports networks company will be the legal parent entity, which positions the company to be more easily acquired than if MSG Networks is the legal spin company. Regional sports networks have shown the ability to generate high margin revenue from increasing affiliate fees in recent years, as such may garner a premium valuation in a takeout scenario. The cash flow generation potential of a dominant regional sports network could be an attractive asset to larger media conglomerates who own arrays of broadcast stations.

Valuation of the post-spin MSG is difficult in that the company’s worth largely stems from the value of its sports franchises and owned venues. Recent comparable transactions suggest significant value for the Knicks and Rangers, while The Garden and associated air rights also have significant value. The issue is that the value of both is largely subjective, although for differing reasons. Sports teams are largely viewed as trophy purchases for which values can be astronomical for the right buyer, whereas The Garden’s value is likely higher than the assessed value to the right buyer interested in participating in redeveloping Manhattan’s West Side. MSG Networks has a far easier identifiable worth in that the company’s earnings stream can be compared to other cable network operators.

Based on earnings potential, estimates for the sports team franchises, and event venue valuations, shares of MSG pre-spin can be assigned a fair value of $99 per share, consisting of $82 per share of MSG post spin and $17 per share of MSG Networks. The fair value estimates are subject to change based on finalized capital structure, share distribution ratios, and changes in company or industry fundamentals.

Based on improving fundamentals for the entertainment and sports divisions, the transaction’s ability to unlock value, and potential upside from the current share price ($71.11 as of this writing), the shares are recommended for purchase prior to the spin-off.

• Actuant Corporation (NYSE: ATU) is a mini industrial conglomerate that designs, manufactures, and distributes a range of products through three main operating segments: (1) Industrial, which was 30% of sales and 44% of EBITDA in F2014; (2) Energy (33% and 31%); and (3) Engineered Solutions (37% and 25%).

• A separation of ATU’s businesses could improve underlying performance, in terms of growth, margins, and capital allocation, creating incremental value above any potential initial re-rating, particularly of the Industrial business, which boasts a durable competitive position, ~30% EBITDA margins, and attractive free cash flow characteristics. Moreover, it is reasonable to surmise that as a standalone entity the Industrial business could fetch a premium multiple from a wide variety of strategic (or financial) buyers, particularly amid a robust M&A environment in the so-called electrical equipment & multi-industry (EE/MI) sector.

• ATU’s stock is down 25% year to date and more than 40% over the last 12 months (versus an about 5% decline in the S&P 500’s Industrial Index). The shares have also materially underperformed relevant indexes over both the last three- and five-year periods. While macro end-market weakness, which has pressured results over the last year, is partially to blame for the anemic stock performance, recent examples of sub-optimal capital allocation, in terms of acquisitions and stock buybacks, leave the company vulnerable to potential criticism from activist investors seeking improved performance/value creation. As well, the CEO’s recent departure could present an opportunity for an activist shareholder to influence succession and more quickly effect change.

• Based on multiples of earnings, value of about $25 per share can be ascribed to ATU’s Industrial business, with $11 and $6 per share, respectively, for the Energy and Engineered Solutions segments. Accounting for corporate costs and net debt of ~$14 per share yields a sum-of-the-parts fair value of about $28, which implies almost 40% upside.

On October 10, 2014, Blackstone Group (NYSE: BX) announced a plan to spin off the bulk of its financial advisory business from its core asset management business via a tax-free distribution to shareholders and concurrently merge the entity with PJT Capital LP, a privately held independent financial advisory firm. The spin entity, which will be a publicly traded C-corp named PJT Partners Inc., will include BX’s mergers & acquisitions and restructuring & reorganization advisory businesses, as well as its fund placement operation, Park Hill, while the capital markets business will remain with the parent. The shares are expected to trade on the New York Stock Exchange (NYSE) under the ticker “PJT”. Paul Taubman, PJT’s founder and a veteran investment banker, will lead the newly formed PJT Partners Inc., while Blackstone’s current senior management team will remain in place. Initially, Blackstone shareholders will own 65% of the new company, with the remaining 35% ownership going to the former employees of PJT Capital and BX’s advisory business. The transaction is expected to be completed in 2H 2015.

The simple logic for the transaction is to improve the growth and valuation profile of the financial advisory business, which is often overlooked being embedded within Blackstone. First, the separation could eliminate perceived conflicts of interest between BX’s asset management and advisory services businesses, which could boost growth by expanding PJT’s addressable market, particularly among BX’s asset management and financial sponsor competitors. As well, the subsequent merger offers PJT, which is essentially a start-up, immediate scale while endeavoring to infuse an entrepreneurial spirit into BX’s well-established advisory business. Second, independent publicly traded advisory firms, such as Moelis (NYSE: MC), Greenhill (NYSE: GHL), and Lazard (NYSE: LAZ) garner multiples that are 50%-70% higher than those awarded BX and its alternative asset manager peers, such as Apollo Global Management (NYSE: APO) and Fortress Investment Group (NYSE: FIG).

Blackstone, the world’s largest publicly traded alternative asset manager, with some $338 billion in assets under management (AUM), reports in five segments: (1) private equity (36% of revenue in F2014); (2) real estate (40%); (3) credit (10%); (4) hedge fund solutions (9%); and (5) financial advisory (5%). As such, BX’s core asset management business comprised about 94% of revenue in F2014. The fundamental backdrop for alternative asset managers has been quite favorable over the last several years, as investors have increasingly sought high (and non-correlated) investment returns, while at the same time competition from the large banks, such as Goldman Sachs (NYSE: GS) and J.P. Morgan (NYSE: JPM), has declined due to regulatory pressures (e.g., Basel III and Dodd-Frank). As well, low interest rates, tight credit spreads, a rising equity market, and healthy IPO and M&A activity have aided BX’s investment performance, which has consistently (and widely) outpaced relevant indexes (and peers). Consequently, BX has increased assets under management (AUM) by 60% to $338 billion and about doubled economic net income (ENI) since 2012, over which time the stock price has experienced an almost three-fold increase. To be sure, recent success has fueled concern among some investors that results at alternative asset managers, as a group, are peaking, with real estate prices, private equity purchase multiples, and LBO leverage having rebounded and interest rates potentially set to rise. These concerns notwithstanding, BX appears well positioned to further grow its AUM base and continue posting above-market investment returns. BX’s robust fundraising efforts look poised to continue benefiting from what increasingly appears to be a secular (as opposed to cyclical) trend in capital allocation toward alternative investments, which is an industry with high barriers to entry where BX is a dominant player. As well, the diversity and scale of BX’s business model, which allows the company to find market opportunities, both public and private, across a wide range of asset classes, industries, and geographies, should continue to facilitate industry-leading/above-market investment returns. (Near term, BX has highlighted energy and distressed European credit and real estate as potential areas of investment opportunity.) Based on multiples of earnings and cash flow, which are inherently volatile, as well as assets under management, Blackstone’s asset management business can be fairly valued at about $45 per share.

The financial advisory assets to be spun off from BX generated ~$382 million in revenue for the trailing 12 months ended June 2014 (compared with total segment revenue of $401 million and consolidated BX revenue of $8.1 billion over the same time period). PJT Capital was founded in 2014 by Paul J. Taubman, who left Morgan Stanley (NYSE: MS) in late 2012 after a successful 30-year career and has since advised on marquee deals, such as Verizon’s acquisition of Vodafone’s (NASDAQ: VOD) stake in Verizon Wireless (NYSE: VZ) as well as Comcast’s (NASDAQ: CMCSA) attempted takeover of Time Warner Cable (NYSE: TWC), which has helped him remain among the industry’s top investment bankers. That said, for all intents and purposes, PJT Capital is a fledgling venture (or start-up). Pro forma for the spin-off and merger, PJT Partners Inc. had $401 million of revenue and adjusted net income of about $88 million in F2014.
In valuing PJT, it is important to consider what the business’s potential revenue base and margin profile could be as a standalone entity, as well as the appropriate valuation multiple. Assuming modest fee revenue growth of about 5% per annum, which could be conservative given the potential for increased market penetration in a robust environment for global M&A activity, as well as a margin profile and payout ratio in-line with independent advisory peers, PJT could be fairly valued at $1 per share based on multiples of earnings, equity, and assets as well as a projected dividend yield.

On a pre-spin sum-of-the-parts basis, accounting for Blackstone’s 65% stake in PJT, Blackstone Group can be valued at almost $46 per share, which implies more than 20% of potential upside from the share price at the time of this writing and could be considered an attractive investment opportunity. An alternative way to think about the transaction/potential investment could be that given the relative size of the spin entity compared to the parent’s roughly $45 billion market capitalization, it is logical to presume that the valuation of PJT, whatever it might be, is currently not reflected in the share price of BX and has little impact on the stock. As such, if the price of BX remained constant, which is not likely to be the case, one could assert that shareholders will receive, at least, a value-added dividend of a company with some real value (as well as upside optionality from potential future growth). While the relative size disparity between the spin and the parent entity suggests the possibility that PJT could experience a degree of initial selling pressure, the risk is likely somewhat mitigated by BX’s lack of inclusion in any index (due to its status as a publicly traded partnership).

On October 6, 2014, Hewlett-Packard Company (NYSE: HPQ) announced a plan to spin off the company’s Enterprise business from the PC and printing business via a tax-free distribution of shares. Hewlett Packard Enterprise, the spinco, will operate what is currently the enterprise segment, while the post-spin parent, to be named HP Inc., will control the Personal Systems and Printing businesses. Both post-spin entities are expected to trade on the NYSE: HP Inc. as ticker “HPQ” and HP Enterprise as “HPE”. The two entities commenced separate operations on August 1, 2015; the transaction is expected to be completed by November 1, 2015 (Oct FY end) and is subject to the required regulatory approvals. Meg Whitman, current Chief Executive Officer of Hewlett-Packard, will be President and Chief Executive Officer of Hewlett Packard Enterprise. Dion Weisler, currently Executive Vice President of HP’s Printing and Personal Systems, will be President and Chief Executive Officer of HP Inc. Both companies are expected to continue to have investment-grade ratings and will pay dividends (that sum to a consideration at least equal to the current consolidated dividend). HP expects dis-synergies in the amount of $400-$450 million annually, which are to be evenly split between the two companies. HP believes that it can offset more than half of these dis-synergy costs in F2016, and fully offset them by F2017.

The separation will result in an approximate 50/50 split of revenue, operating profit, and free cash flow. The Enterprise segment achieved 2014 revenue of $54.1 billion, operating income of $4.5 billion, and an operating margin of 8.2%. The product line includes servers, storage, networking, services, and software. HP Inc., which achieved 2014 revenue of $57.3 billion, operating income of $5.4 billion, and an operating margin of 9.5%, is essentially the legacy side of the business, consisting of personal computers (PCs) and printing (59% and 41% of sales, respectively). Notably, the separation of these businesses is an idea that Carly Fiorina fought against a decade ago, Leo Apotheker recommended before being ousted, and Meg Whitman initially reversed, arguing HP was “better together,” but now makes sense—particularly given the long-term challenges in managing a company the size of HP, the negative, long-term secular trends in the PC market, and the need to increasingly steer the company toward growth.

Ultimately, the goal is for the separate companies to improve resource allocation and flexibility while attracting different investors. HP Inc. will largely be a capital return story; a mature, cash-generating vehicle with stable margins, high return on invested capital (ROIC), and dividends from recurring revenue from ink and toner supplies. HP Enterprise hopes to be more dynamic, acquisitive, and growth-oriented, although the business will require continued investment and product development amidst intense competitive challenges. The separation could also provide flexibility for the sale of one or both businesses. Recent media reports have suggested that HP and EMC (NYSE: EMC) may have been in discussions to merge; although it might have been difficult for EMC shareholders to accept and integrate a PC and printer business.

On the enterprise side, HP has, in recent years, reinvigorated its product pipeline with an emphasis on such growth areas as data center infrastructure, security, managed services, and cloud computing—culminating most recently in the acquisition of enterprise mobility leader Aruba Networks (NASDAQ: ARUN). However, there is considerable product and sales development and go-to-market realignment work necessary in order to remain competitive. Recent balance sheet improvement may give Enterprise more flexibility to recapitalize as well as pursue acquisitions in key areas such as cloud, security, and mobility. However, HP Enterprise will generate over 40% of its revenue from services that are undergoing a multi-year transition at the company. Among other products, storage and networking are showing reasonable results, while other segments have posted lackluster performance. We expect challenges to persist. HP Enterprise’s ability to respond to competition will come under pressure, as the business will require greater capital. Over time, we expect the ability to continue paying dividends to be pressured as well, as investment needs consume capital. We believe that HP Enterprise must embark on transformative mergers and acquisitions (at a reasonable price), but the implications of such transactions will likely represent an overhang to near-term valuation.

For HP Inc., the challenging operational and market dynamics of the PC and printing business will generate lower revenue growth, but the post-spin company should produce significant cash. It is reasonable to expect management to return most of the FCF in either dividends or buybacks, with limited M&A. However, over time, we believe competition from Asian vendors will make it difficult to offer margin leverage, while secular headwinds combined with competitive pressure could even result in margin degradation.

Applying comparable-company multiples of sales and EBITDA for both the parent and spin entity, and examining dividend and free cash flow yield for post-spin HP, one can derive a pre-spin sum-of-the-parts fair value estimate of $28 for HP, comprising $10 and $18 for HP Inc. and HP Enterprise, respectively. The pre-spin fair value estimate is equivalent to 4.5x F2016E EV/EBITDA on a combined basis. For Enterprise, the fair value estimate represents an EV/EBITDA multiple of 5x, a discount to peers, which is appropriate, in our view, given evidence of potential erosion in the company’s market share position and long-term growth prospects. With the pre-spin sum-of-the-parts fair value estimate approximating HPQ’s share price at the time of this writing ($28), we do not see meaningful incremental value in the split. Moreover, we see the potential for execution risk, coupled with a muted IT spending environment to pose downside risk to both companies over the next year. The shares appear range-bound at current levels– owing to sizable dis-synergy and separation costs, potential channel disruptions as the company switches IT systems, unpredictable currency fluctuations (approximately 35% EMEA exposure), and mixed industry fundamentals across PCs and storage. Importantly, a key caveat to this sum-of-the-parts analysis is that much of HP’s value and competitive advantage, ironically, comes from the interconnection and leverage of its parts. Specifically, HP Inc. revenue could be at risk from loss of cross-selling and channel leverage, while HP Enterprise could lose several percentage points of margin without the benefits of PC leverage. While we expect 80% or more of HP Inc.’s FCF to be sustainably returnable to shareholders, we would anticipate that for HP Enterprise this percentage will be no more than 50%, due to its need to continue to make acquisitions and restructure the business.

On April 6, 2015, Ventas Inc. (NYSE: VTR) announced that the company’s Board of Directors had unanimously approved the spin-off of a portfolio of post-acute/skilled nursing (SNF) facilities into a publicly traded real estate investment trust (REIT). Separately, VTR announced that it intended to acquire Ardent Health, a privately held for-profit U.S. hospital provider, for $1.75 billion. The spin company will adopt the corporate moniker Care Capital Properties Inc.

VTR’s Board of Directors has unanimously approved the spin-off, and the separation is scheduled to be completed on August 17, 2015, after the market close. Shareholders of record as of August 10, 2015, will receive one share of Care Capital Properties Inc. for every four shares of VTR owned. Shares of Care Capital Properties Inc. will trade on the NYSE under the symbol “CCP”, with regular-way trading expected to begin on August 18, 2015.

CCP will own 355 triple-net leased skilled nursing facilities (SNF) operated by 44 private regional and local healthcare providers in 37 states. VTR thinks that this market is largely neglected by the large-cap healthcare providers and that CCP will have the opportunity to be an active consolidator in a fragmented market with strong demographic tailwinds.

At the core of both companies’ operations, owned properties are leased out on a triple-net basis, resulting in very high-margin sales where EBITDA is almost equal to revenue, as most—though not all—of the expenses are assumed by the entities that lease the properties. In the case of CCP, there was $295 million of revenue and $259 million of EBITDA in 2014.

CCP’s leases are typically 10 years for the initial term, with annual rent escalators approximating between 2.0% and 2.5% per annum. That is the limit the business can grow unless the company can expand its property portfolio. The customary manner of increasing business is by acquisition, which VTR has embraced. In principle, Ventas, which already trades at a very high valuation, could continue to use its low-cost capital and expand the SNF business. However, if it undertook the expansion within the context of a nearly $22 billion market capitalization, that spending probably would not have as meaningful an impact upon valuation as it would in spin-off mode.

The object of the spin-off is not valuation multiple enhancement per se. It is growth, and as a function of that growth, valuation enhancement. To reiterate, it is difficult to increase a $22 billion market capitalization by acquisition. Ventas could buy individual properties, but that takes a long time. It is possible to grow by buying other REITs, but almost all the REITs are at least as expensive as Ventas. Therefore, the company would need to complete acquisitions in a multibillion-dollar range, and it seems unlikely that Ventas could accomplish this on an accretive basis, as it would certainly have to pay a necessary control premium.

On the other hand, the skilled nursing facilities industry is still very fragmented. The company asserts that 75% of the SNF operators in this country own fewer than 25 properties. It is possible that the Care Capital Properties Inc. spin-off will make acquisitions among these operators by using its presumably low cost of equity capital and, as long as it lasts, its low cost of debt capital.

To allow for the use of low-cost capital, the spin-off is relatively unleveraged. After the spinoff, on a pro forma basis, it will have $1.4 billion of equity and $1.3 billion of debt. It should have the ability to use debt financing in future acquisitions. It is even more likely that the company will combine debt and equity issuance, at least as long as the relatively benign interest rate environment lasts. It should be able to expand at a robust rate in spin-off mode. The risk is an end to the benign capital markets environment, and investors should realize that.

Separate from the long-term demographic and fragmented-market supports for long-term expansion for health facility consolidators, a related systemic risk is the adverse relationship of rising inflation (as might be associated with a rising interest environment) on a triple-net lease real estate business. Whereas a conventional real estate business model typically benefits from rising inflation, through increased lease rates, the triple-net lease business model uses long-term leases with a fixed (and modest) rent escalation schedule. To the degree that interest rates and inflation rise, that real estate portfolio takes on the characteristic – and risk – of a long-term bond, since it cannot raise its lease rates.

Based on asset value, income generation, and potential dividend payouts, post-spin fair value estimates of $57 per share of VTR and $35 per share of CCP are derived. On a sum-of-the-parts basis, pre-spin VTR can be valued at $66 per share ($57 for post-spin VTR and $9 for CCP, to account for the one-for-four share distribution ratio), roughly in line with the current share price. The absence of material upside to the fair value estimate should not be surprising, given that the goal of the spin-off is more to spur growth at the spin company and less to be a value-unlocking transaction in itself.

America Móvil, S.A.B. de C.V., one of the world’s largest telecommunication companies by number of subscribers, announced on April 1, 2015 its intention to spin off its passive cellular infrastructure in Mexico, mainly comprising wireless towers. The company was added to The Global Spin-Off Radar in August 2014 due to the July 8, 2014 announcement regarding the company’s intent to separate its cellular sites. The new company will be named Telesites S.A.B. de C.V. The spin-off was approved at the Extraordinary Shareholders’ Meeting held on April 17. America Movil shareholders will receive one Telesites share for each America Móvil share owned. Since America Movil has a fairly active ADS program, it intends to distribute Telesites shares to the ADS depositary . However, there is no guarantee the ADS agent will distribute said shares to ADS holders. It may opt to liquidate the shares in the spin entity and distribute a cash dividend instead. Additionally, while the spin-off is expected to be tax-free for Mexican investors, it will likely comprise a taxable transaction for US tax purposes.  The spin-off, initially expected to be completed by July, will probably take place by September 2015.

Unlike most spin-offs that are typically undertaken for value-enhancing purposes, America Movil is demerging its wireless infrastructure due to regulatory pressure. On March 7, 2014, The Instituto Federal de Telecomunicaciones  (“IFT”), designated the company and its Mexican subsidiaries “preponderant economic agents”. As a result, America Movil is subject to additional, “asymmetric”, regulation that includes, among other requirements, the sharing of passive infrastructure. That being said, the company’s wireless towers can be more valuable as part of an independent company: Telesites will have the opportunity to expand its clientele beyond its former parent, thus increasing the aggregate revenue and profit of the two entities.

As a standalone company, Telesites will be an owner and operator of a portfolio of 10,800 wireless towers in Mexico. America Movil’s wireless operating subsidiary, Telcel, will be the company’s initial client. Telesites’ towers can accommodate more than one client. It is expected that the company will add additional wireless customers, such as AT&T. In fact, the dynamics for the Mexican tower industry appear very favorable. The entrance of AT&T into the market with two acquisitions, pressure on America Movil to cede market share, and a low wireless penetration rate should be precursors of strong wireless infrastructure demand in the years to come. Even more, the nature of the tower industry allows for significant economies of scale when a tower is leased to more than one customer.

On the other hand, the company will be heavily indebted—with an expected MXN 21 billion in debt representing a pro forma debt-to-EBTIDA ratio of 10x. Initially, Telesites’ profitability will be limited. As the company adds new customers, EBITDA should increase materially, lowering leverage. In a similar fashion, valuing the company based on the initial pro forma financials fails to capture the true earnings potential of the firm. Based on normalized EBITDA and free cash flow assumptions, and multiples that are approximately 20% below those of lofty valued peers such as American Tower and Crown Castle International, Telesites could be valued between MXN 0.71 and MXN 0.93 per share. Using peer enterprise value per tower estimates, and based on the company’s initial asset base of 10,800 sites, Telesites could would be valued at MXN 0.79 per share. Given the reasonable assumptions used in the normalized EBITDA and free cash flow projections, the favorable industry dynamics and Telesites’ dominant market position, the purchase of shares at the lower end of our valuation estimates—MXN 0.70 per share—is recommended.

After the spin-off, America Movil will remain one of the world’s largest telecommunications companies, with operations in Mexico, the US, South America and Central-Eastern Europe. It offers fixed and wireless services through a number of brands including Telmex, Telcel and Claro. As of June 30, 2015, the company had 288.8 million wireless subscribers and 78.9 million fixed line accesses.  Mexico accounts for only 25% of the company’s wireless subscribers. America Movil, however, has been long considered a monopoly in its own country. Currently, Telcel has a 60% market share in the Mexican wireless market. Its designation as a preponderant economic agent aims at curbing its market share through regulations and measures including the separation of its wireless towers. On top of that, the company is facing an increasingly competitive domestic environment: AT&T recently completed the acquisitions of the third and fourth largest carriers in Mexico, and will likely be a force to be reckoned with. Further, the Telesites spin-off allows potential and existing competitors to lease towers and quickly ramp up their infrastructure and expand their coverage network.

Despite the competitive environment, the company still operates in a highly cash generative business and has solid profit margins, reasonable leverage and strong free cash flow. Based on 2014 pro forma EBITDA and net income and comparable enterprise value-to-EBITDA and price-to-earnings multiples, America Movil post spin-off could be valued between MXN 13.5 and MXN 13.9 per share. Due to competitive pressure in many of its markets, declining revenue per user and increasing capital expenditure for acquisitions and infrastructure, it is likely that the company’s free cash flow is on a secular decline. In a simple discounted cash flow scenario where free cash flow declines by 1% a year and with an 8% discount rate—due to the company’s very low risk profile—America Movil could be valued at MXN 11.4 per share.

On a pre-spin basis, the company can be valued between MXN 12 and MXN 14.8 per share, with a target price of MXN 14.3. Since America Movil shares trade at a premium to our valuation, they are not recommended for purchase prior to the spin-off. To the contrary, investors are advised to wait until the transaction is completed and focus on Telesites, which may present a better investment opportunity both due to its growth potential and due to a possible sell-off that may offer an attractive entry point.

On February 26, 2015, Barnes & Noble, Inc. (NYSE: BKS) announced a plan to spin off Barnes & Noble Education, which comprises the Barnes & Noble college business, from its Retail and NOOK Digital businesses via a tax-free spin-off. Barnes & Noble will distribute approximately 48.2 million shares of Barnes & Noble Education (approved for listing on the NYSE under the symbol “BNED”), with a record date of July 27, 2015, the record date for the transaction. The distribution represents a ratio of 0.632:1, based on approximately 76.2 million shares of Barnes & Noble common stock outstanding as of the close of business on July 9, 2015 (which total includes the approximately 12.1 million New Barnes & Noble Shares that have been or will be issued by Barnes & Noble prior to the distribution in connection with the conversion of outstanding shares of its senior convertible redeemable Series J preferred stock). When-issued trading began on July 24, 2015 and will continue up to and including the distribution date of August 2, 2015. Regular-way trading will begin on August 3, 2015. Post-spin BKS is expected to pay a $0.60 annual dividend.

Headquartered in Basking Ridge, New Jersey, Barnes & Noble Education (“BNED”) is one of the largest contract operators of bookstores, operating 724 stores on college and university campuses in the U.S. This business generated F2014 (ended May 3) sales of $1,748 million and EBITDA of $106.3 million. For F2015, Barnes and Noble Education generated $1.8 billion in sales and $91 million in EBITDA (5% margin). Max J. Roberts, Chief Executive Officer of Barnes & Noble College, will become CEO of the new company, and Patrick Maloney and Barry Brover will serve as Chief Operating Officer and Chief Financial Officer, respectively.

The parent company, Barnes & Noble, Inc. (“BKS”), will contain Barnes & Noble’s retail and digital interests. Barnes & Noble, Inc. is the nation’s largest bookseller, operating 648 stores in 50 states. The company’s digital interests consist of BN.com and NOOK Digital, the latter of which comprises NOOK® products as well as an expansive collection of digital reading and entertainment content through the NOOK Store®. The Retail segment generates sales of over $4 billion with an 8.4% EBITDA margin, or approximately $340 million EBITDA.

The separation of BKS’s NOOK business has been proposed for some time, but is somewhat complicated by the segment’s lack of profitability as well as by weak growth prospects for the book retailer’s brick-and-mortal operations. The company’s last remaining competitor, Borders Group, Inc., declared bankruptcy and liquidated its operations in 2011. In June 2014, Barnes & Noble disclosed it would separate its NOOK Digital and Retail businesses into standalone companies and more recently targeted a tentative completion date by the end of August 2015. With BKS shares trading at forward multiples of 0.3x EV/sales and 5.3x EV/EBITDA, a discount even to unprofitable turnaround retailers, investor concerns surrounding declining revenue appear to be overshadowing profitability, considerable free cash flow (estimated 12% yield in F2016), and the ability to monetize the education franchise. Underscoring the lack of investor enthusiasm, as of this writing, BKS shares trade at $27, a modest 6% increase from their February 25 close, the day of the spin-off announcement.

Barnes & Noble’s Retail business was in critical condition a few years ago, with the most significant depressant to earnings being the company’s disastrous foray into tablet hardware via a partnership with Microsoft (NASDAQ: MSFT). With the brick-and-mortal bookstore business in a state of secular decline, it was believed that cash flow from the college bookstores would finance the company’s digital (NOOK) operations until the segment could turn a profit. As a result, BKS invested heavily in developing the technology to compete with the Amazon.com Inc. (NASDAQ: AMZN) Kindle and the Apple Inc. (NASDAQ: AAPL) iPad to expand in the e-reading market. However, the company has failed to establish the NOOK as a viable competitor thus far. Rather than proving truly disruptive in a manner similar to the iPod versus CDs, e-books have simply become another format, like paperback or hardback. While NOOK will remain with the retail business, investment has been ratcheting back significantly—capital expenditures and operating expense have already been reduced by $200 million since F2013 and should decline by an additional $100 million by the end of F2017—maneuvers which should halt the decline in the segment’s EBITDA going forward.

At the same time, the retail stores’ attractiveness as a place to visit and browse books, combined with the convenience of picking them up after ordering online, is a key point of differentiation from Amazon. With the worst declines likely behind it, BKS now has a clearer path to improving profitability. Revenues appear to be bottoming as trends in physical books have stabilized and as the company focuses on having a deep catalog of books, related gifts, and cafes in its stores. Further, without the distraction of the college business, management will be free to focus on driving traffic to its traditional retail locations while closing locations that do not make economic sense.

The Education business has been stagnant over the last five to six years, and faces looming threats of online competition, a shift into textbook rentals, and potentially risky investments in digital ventures. Recent investor disappointment centers around flattish revenue trends and low EBITDA margins (4.7% estimated in F2015), due to the shift from selling textbooks (high ticket, low margin) to renting textbooks (lower ticket, higher margin) and the company’s substantial investment in Yuzu, its new digital platform which allows students to organize and manage their digital texts in one location. Yuzu-related investment increased by $12 million in F2015. Longer term, this industry shift toward a rental model should ultimately be accretive to margins, and the company’s investment in Yuzu should abate and begin to bear fruit. Whereas the NOOK tablet failed because BKS had no competitive advantage relative to Amazon or Apple, Yuzu appears uniquely positioned to become a leader in the digital textbook market due to its long-standing relationships with textbook publishers (a more fragmented landscape than fiction, for example) and exclusive access to students on campus, and because of its nature as a software application as opposed to a hardware device.

Moreover, BNED’s 717 stores enjoy an exclusive and seemingly high-barrier-to-entry position selling and renting textbooks and other merchandise on college campuses. The company appears well-positioned to grow organically, both from the industry shift toward a rental model and also by securing an increasing number of college operations. While an estimated 53% of institutions currently run independent bookstores (versus 69% in 2009), an increasing proportion are expected to outsource their operations owing to the considerable cost savings. As a standalone publicly traded company, management will have the flexibility to pursue a growth strategy by expanding its store count (to its goal of 1,000 stores), making acquisitions, and using its stock as currency to raise new capital (presumably at a higher multiple than BKS’s current valuation).

Because of its failed effort to become a hardware-manufacturing company, Barnes & Noble is generally owned by special-situation investors. However, this categorization has the potential to change. By spinning out Education and merging the NOOK division into BKS Retail, both stories become cleaner, allowing pure-play retail and education investors to participate in the respective entities. The return of BKS to its roots as a pure-play retailer should allow a broader base of traditional investors to return to the stock over time. With a steady-state double-digit free cash flow yield and a healthy dividend, the standalone core retail business also has the opportunity to buy back shares (no net debt), and potentially increase its dividend, actions that could also persuade more traditional investors to return to the stock.

Recently issued management guidance of positive 1% same-store core comparative sales for F2016 also highlights the strength of the turnaround and emergence of a more attractive pure-play story. The greater uncertainty for BKS is the endgame for NOOK. On the one hand, the company continues to have an implicit commitment to NOOK users that the platform will continue to exist, yet on the other hand, management’s continued emphasis on integration/rationalization of the business begs the question as to whether a sale is the most likely outcome. Importantly, Microsoft and Pearson, as part of the NOOK Media agreement, are entitled to 22.7% of any proceeds from a NOOK sale for up to three years from the closing date. At the same time, recently underwhelming NOOK device trends suggest a diminished likelihood of a sale at a premium valuation. One theory is that BKS could conceivably extract value from the Education spin-off to help ameliorate some of the overhang. Management also appears more focused on growing content without devices—implying that more dramatic steps toward content and away from the tablet business could positively affect NOOK profitability. Finally, the slowdown in e-book growth (which implies a more rapid recovery for Retail) could mean, over time, that investors are more willing to pay a higher multiple for post-spin BKS—especially if NOOK losses are eliminated or further limited. The business could also be a candidate for being taken private.

Applying comparable multiples of sales and EBITDA for both the parent and spin entity, and examining dividend and free cash flow yield for post-spin BKS, one can derive a pre-spin sum-of-the-parts fair value estimate of $32 for BKS, comprising $22 and $9 for BKS (Retail and NOOK) and BNED (Education), respectively. Post-spin, BNED can be fairly valued at $14, assuming a distribution ratio of 0.0632:1. This analysis ascribes zero value to the NOOK. The pre-spin fair value estimate is equivalent to 5.2x F2017E EV/EBITDA on a combined basis, which represents a discount to each of the company’s peer groups. For BNED, the fair value estimate represents an EV/EBITDA multiple of 6x, a meaningful discount to high-end, differentiated retailers at 13x, implying the business is worth less than the initial valuation when BKS first acquired the Education business on August 10, 2009 (9x EV/EBITDA). With the pre-spin sum-of-the-parts fair value estimate suggesting 17% potential upside to BKS’s share price at the time of this writing ($27), the risk/reward appears compelling. Moreover, there is the potential for near-term momentum in the shares given the low volume (304,000 daily) and relatively high short interest (16%).

On November 17, 2014, Exterran Holdings, Inc. (NYSE: EXH), the largest provider of field compression services to the oil and gas industry in the U.S, announced a plan to spin off its international contract manufacturing, global fabrication, and international aftermarket businesses into a separately traded public company, to be named Exterran Corp., in the form of a pro rata distribution to shareholders. The post-spin parent company will change its name to Archrock, Inc. and will be traded on the New York Stock Exchange, under the symbol ”AROC”; the spin entity will trade on the NYSE under the symbol “EXTN.”

Shares of EXTN will be distributed on July 31, 2015, after the market close, to shareholders of record as of July 22, 2015. EXH shareholders of record will receive one share of EXTN for every two shares of EXH owned. When-issued trading is expected to begin on or shortly before the record date, July 22, 2015.

Exterran is the largest provider of field compression services in the U.S., with an extensive fleet of equipment in North America and several international markets. The company also rents compression equipment to oil and gas producers, midstream operators, and others. Exterran also engineers and fabricates units both for its own fleet and for sale to customers. Exterran Corp., the spin entity, will consist of the company’s international contract manufacturing operations, global fabrication, and aftermarket services businesses currently owned by Exterran Holdings. The company could appeal to investors interested in leverage to international infrastructure and fabrication expansion. Exterran Corp. will incur an initial net debt balance of $656 million, distributing proceeds from the debt offering to the parent, so that AROC will be debt free.

AROC, which will consist of the North America Contract Operations and North American Aftermarket Services businesses (approximately 60% of total Aftermarket sales), is the largest independent provider of compression services in the U.S. The post-spin parent company will also hold the sole general partner (GP) interest and a limited partner interest in the master limited partnership (MLP) Exterran Partners L.P. (NASDAQ: EXLP), which together represent a 37% ownership position, as well as all of the incentive distribution rights (IDRs). Consistent with the name change of the post-spin parent company to Archrock, Inc., Exterran Partners, L.P. will change its name to Archrock Partners, L.P. and will be traded on the NASDAQ under the symbol “APLP”.

In terms of reducing the complexity of EXH’s investment proposition and operations, the spin-off of EXTN makes sense. The parent company will turn into a North American-focused compression services company with a major stake in MLP Exterran Partners. Ownership of the GP and IDRs of APLP with a lower cost of capital (owing to a relatively stable fee-based revenue structure) will allow for greater pass-through of dividend payments from the MLP to Archrock shareholders. Over time it is expected that Archrock will continue to drop down compression assets into Archrock Partners. Currently 75% of EXH’s compression fleet is owned by the publicly-traded MLP, EXLP, of which EXH owns 100% of the GP and 37% of the LP. As post-spin Archrock drops down its remaining compression assets (25% of total) into APLP, it will assume a midstream C-Corp structure in which the company will be able to dividend its LP and GP distributions—a structure which the market has clearly rewarded in companies such as The Williams Companies (NYSE: WMB), Targa Resources Corp. (NYSE: TRGP), and Teekay Corp. (NYSE:TK).

Assuming Archrock were to drop down the entirety of its assets owned at the parent level (approximately 850,000 HP) to Archrock Partners an average price of $691.1 per HP (the average of value of drop-downs from 2010 to 2015), the company could generate an incremental $587 million in revenue and $258 million in incremental EBITDA (44% margin), which could generate incremental distributable cash flow of approximately $280 million, or an additional $0.90 on a quarterly basis (versus our current 2016 estimate of $0.96 annualized). Given that the IDRs for EXLP assume that the GP/LP split dividends once the quarterly distribution to all unit holders exceeds $0.525 per share, Archrock’s 23.6 million LP units could generate substantial incremental cash flows. Accordingly, the current consolidated structure of the company appears to obfuscate the value of these GP and LP interests. Shares of Archrock are likely to be attractive to dividend-focused investors and trade based on a distribution yield as the earnings volatility associated with EXTN is removed. Exterran Corp., for its part, will give investors exposure to international energy infrastructure build-out and be valued more on earnings growth potential.

The post-spin parent, Archrock, generates stable fee-based revenue and cash flow despite volatility in short-term commodity prices. Contract terms with upstream customers typically involve flat monthly fees that are independent of specific well-production metrics. Cash flow is primarily generated from distributions received from its general partner interests, including incentive distribution rights, distribution from LP interests in EXLP (APLP post spin), and from the remaining assets that it will own at the parent level. Following the spin-off, Archrock will become a more streamlined entity, comprising the GP, IDRs, and the 37% LP interest of EXLP (APLP). Importantly, the company will have no debt. With limited capital requirements, Archrock can return a significant portion of cash flow to shareholders via a recurring dividend. While a post-spin distribution has not yet been disclosed, the expectation is that it should be well above EXH’s current $0.60 annualized dividend as incremental free cash flow is generated by growing IDRs and the drop-down of assets to APLP. Simply put, Archrock offers investors a pure-play yield investment with exposure to U.S. energy infrastructure development.

Exterran Corp., the spin entity, will consist of International Contract Operations, Aftermarket Repair & Service, and Fabrication. It will similarly enjoy stable cash flows that, with limited capital spending, can be deployed toward investments in internal contract operations projects. The separation will allow the company to expand its fabricated compressor customer base to include U.S.-based businesses, which have previously been competitors of Exterran Holdings. Driven by global energy infrastructure build-out, Exterran Corp. is likely to exhibit greater variability in revenue and earnings, as international projects tend to be delayed and Fabrication bookings can vary from quarter to quarter. Going forward, the company will continue to grow the contract operation business internationally, but this may prove more difficult than in the past due to project delays and variability in bookings in the Fabrication segment. A pullback in commodity prices or exploration and production capital spending could negatively affect the near-term growth outlook. The Aftermarket segment in particular has disappointed, as operators continue to delay maintenance of compression equipment. However, growing demand for compression services for unconventional natural gas sources such as shale plays (which are growing as a percentage of revenue) may improve the valuation of Exterran Corp. over time. Shares of EXTN can be fairly valued at $32 per share based on comparable peers, projected EBITDA and free cash flow, and an estimated value of compression assets. Accounting for the one-for-two distribution ratio, EXTN contributes $16 per share in value to EXH’s pre-spin fair value.

A sum-of-the-parts analysis based on comparable company valuation multiples applied to EBITDA of the core contract and aftermarket operations and to GP- and IDR-related cash flows, as well as the current value of the LP interests, generates a fair value estimate of $19 for Archrock. Based on estimated 2016 free cash flow, post-spin Archrock should generate an annual distribution of $0.96, which at a 4.5% target yield (in line with the current GP MLP peers) implies a fair value estimate of $21.

The pre-spin sum-of-the-parts analysis suggests a fair value estimate of $35 per share for pre-spin EXH. The pre-spin fair value estimate implies 20% upside from current levels. Based on the current share price for EXH ($29 at the time of this writing) and the $16 pre-spin fair value estimate for Exterran Corp., Archrock is implicitly trading at $13 per share, or a 5.6% yield based on the estimated 2015 dividend of $0.73, well above the GP MLP peer average. This discount suggests investors are discounting the GP value of the post-spin parent company, likely due to sluggish fundamentals in other operating segments and general commodity-related overhang. As the corporate structure and cash flow at Archrock are simplified, this valuation gap may begin to narrow.

Given the 20% upside to the stock’s current market value, the fair value represents an opportunity for investors to capture the rerating of the parent company. Archrock shares should receive a dividend yield in line with other MLP GPs, more than offsetting the multiple decline for EXTN to oil & gas service peers. Following the rerating income oriented investors may hold Archrock shares as the potential for distribution growth, primarily from the progressive income participation fee schedule of the IDR’s (currently at 2% of distributable cash flow), which could make an attractive growing dividend story. More risk tolerant investors should maintain a position in EXTN as exposure to international oil and gas infrastructure investment could provide significant upside over the longer term if energy prices increase off the current multi year lows.

• Griffon Corporation (NYSE: GFF) is a “diversified conglomerate” with three distinct businesses: (1) Home & Building Products (HBP), which manufactures garden tools and garage doors; (2) Telephonics, which builds radar and communications systems; and (3) Clopay Plastics Products (CPP), which produces high-performance plastic films.

• GFF’s three disparate businesses each have distinct manufacturing/distribution footprints, offering limited synergies, and the current corporate structure likely results in the dearth of sell-side research coverage, both of which seemingly contribute to the shares trading at a conglomerate discount. GFF trades at 8.8x F2016E EBITDA, which represents a discount to the multiples awarded the peers of each of its three businesses. On average, peers to HBP, GFF’s largest segment, trade at ~10.5x, while Telephonic and Plastics comparables trade at ~9.5x and ~9.0x, respectively. As such, a separation transaction could unlock value.

• In 2006-2007, GFF faced pressure from shareholders to pursue a wide range of actions, including a breakup, which yielded some corporate governance improvements (and a small divestiture) but failed to eliminate the conglomerate operating structure. Today, the company is not under any overt pressure to pursue strategic alternatives, but notably, its largest shareholder is Gabelli Asset Management (GAMCO), which holds a 17% stake. For its part, GFF management, which collectively owns ~12% of the outstanding shares, has anecdotally indicated that it “likes” each of its businesses as well as expressing a willingness to add to the portfolio.

• Based on peer multiples of earnings, one can ascribe value of $21 per share, $13 per share, and $12 per share to the H&B, Telephonics, and Plastics businesses, respectively. Accounting for corporate costs and net debt of ~$25 per share yields a sum-of-the-parts fair value of about $21.

On September 10, 2014, JDS Uniphase, Inc. (NASDAQ: JDSU) announced a plan to spin off its optical components and commercial laser (CCOP) business into a separately traded public company, to be named Lumentum Holdings, Inc., in the form of a pro rata distribution of 80.1% of the outstanding shares. One share of Lumentum common stock will be distributed for every five shares of JDSU held as of July 15, 2015, the record date for the transaction. The distribution date is July 26, 2015. Based on approximately 233.9 million shares of JDSU common stock outstanding as of March 28, 2015, a total of approximately 46.8 million Lumentum shares will be distributed, and approximately 11.6 million shares will be retained by JDSU. “”When issued”” trading is expected on or shortly before the record date. Because July 26, 2015 is a Sunday and not a business day, the shares are expected to be credited to “”street name”” stockholders through the Depository Trust Corporation (DTC) on the first trading day thereafter, Monday, July 27, 2015. Regular-way trading is expected to begin on July 28, 2015. Lumentum has applied for NASDAQ listing under the symbol “”LITE””. Alan Lowe, president of the Optical Components and Commercial Lasers segment, will serve as CEO of Lumentum, while JDSU’s current president and CEO, Tom Wachter, will continue to serve as CEO of the parent company, which is to be renamed Viavi Solutions, Inc. and will trade on the NASDAQ under the symbol “”VIAV””.

JDS Uniphase is a technology company with a focus on products that manipulate light waves for communications, commercial, and industrial applications. Since the heady days of the telecommunications bubble, the company has weathered the downtown and transformed itself through diversification, becoming a broad-based optical components and communications testing supplier. JDS currently operates three business divisions: Optical Components and Commercial Lasers (CCOP), Network and Service Enablement (NSE), and Optical Security and Performance Products (OSP). The spin entity, Lumentum, comprises JDSU’s CCOP division and addresses a $7.4 billion market for optical communications (85% of F2014 sales, estimated 11% four-year annualized growth rate, or CAGR) and a $2.5 billion market for commercial lasers (15% of F2014 sales, estimated 7% four-year CAGR). Lumentum’s products consist primarily of optical components and subsystems, including transceivers, amplifiers, splitters, ROADMs (reconfigurable add-drop multiplexers) for WDM (wave division multiplexing) applications, and passive components. Customers include major telecommunications, mobile, and cable network operators and network equipment manufacturers. The business generated F2014 (June) sales of $794.1 million and an operating margin of 12%.

Viavi, the parent company, will retain JDS’s NSE and OSP segments. The former addresses a $7 billion market for software and services used in the deployment and operation of next-generation Internet protocol (IP) networks, which is growing 6% to 8% annually. The company has one of the largest test instrument portfolios in the industry, spanning network and protocol and service assurance tools for use in laboratory, network, and enterprise environments. The OSP segment addresses a $1.1 billion market for anti-counterfeiting solutions for currency authentication and high-value optical components for security, safety, electronics, and other applications (also generating 6% to 8% growth). The combined NSE and OSP businesses reported F2014 sales of $949 million (1.6% year-over-year growth) and a blended operating margin of 11%.

With both businesses facing near-term challenges, including reduced spending by telecommunications service providers, intensifying competition and margin erosion, elevated research and development costs, and delayed revenue recognition on new products, JDS has suffered a series of disappointing quarterly results. As of this writing, JDSU shares trade at 1.4x EV/sales, a near-trough valuation reflecting bearish investor sentiment. For Viavi, the business remains constrained by an over 30% year-over-year decline in sales from its largest customer (widely reported to be AT&T [NYSE: T]), which has curtailed spending ahead of its merger with DirecTV (NASDAQ: DTV). With sales from this customer expected to decline another 20% next quarter (F4Q15), there is considerable nervousness concerning the near-term outlook.

Earnings leverage remains a second source of investor consternation. JDS has invested heavily in research and development and acquisitions in its service enablement business in anticipation of the shift toward software-defined networks (SDN), an emerging architecture driving more intelligent and programmable network control, which in turn requires more sophisticated analysis tools. Yet, demand has not materialized. Despite these near-term uncertainties, the long-term growth trajectory for Viavi appears very positive. As a pure-play network and service enablement story, post-spin Viavi appears well positioned to capitalize on the sustainable secular trend toward increased data center complexity and adoption of cloud technologies. In addition, Viavi may benefit from further industry consolidation, as traditional test and measurement companies seek to acquire NSE-related technology in order to capture a rapidly growing data center market. Current management has stressed on multiple occasions that there is an opportunity, following the spin-off, to consolidate the network test industry. JDSU’s nearly $9 billion in NOLs (net operating losses) is a source of value in funding potential transactions. Notably, life sciences diagnostics supplier Agilent Technologies (NYSE: A) spun off its test and measurement subsidiary Keysight Technologies in November 2014. Danaher (NYSE: DHR) is also in the process of spinning off its communications test business, which is to be acquired by Netscout Technologies (NASDAQ: NTCT).

For Lumentum, the business outlook for optical communications and commercial lasers is similarly mixed. Within the optical communications business, the best-performing piece of the business is the Datacom sub-segment (14% of F2014 sales), which is experiencing robust demand for optical transceivers required to support higher-speed data center connections. However, this growth has been offset by sluggish sales in the Telecom sub-segment (60.6% of sales), which remains constrained by reduced capital expenditures by telecommunications service providers. Demand for industrial lasers (15% of F2014 sales) has also recently fallen short of expectations, due to a short-term inventory correction. With a combination of demand weakness and margin pressures likely to remain an overhang on the optical component market, industry observers have argued for further industry consolidation, which they contend could improve overall efficiency and pricing control. Accordingly, there has been considerable speculation as to whether JDS will ultimately pursue a spin-off versus an outright sale of the CCOP business (Lumentum), with Finisar (NASDAQ: FNSR) cited as the most logical suitor. While such a combination would likely be accretive and give Finisar and JDS approximately 25% of the total optical components market, it is not without operational and execution risk, as it would increase the combined company’s exposure to the more volatile, lower-margin telecom market (with likely negative gross margin impact) and would require Finisar to raise significant debt and/or issue shares. For the purposes of this report, we assume JDS completes the spin-off as announced.

Applying comparable multiples of sales, EBITDA, EPS and assets for both the parent and spin entity, one can derive a pre-spin sum-of-the-parts fair value estimate of $10 for JDSU, comprising $5.50 and $4.78 for Viavi and Lumentum, respectively. This valuation excludes JDSU’s over $9 billion in NOLs. Post-spin, assuming a one-to-five distribution, this analysis generates an estimated fair value of $19 and $6.45 for Lumentum and Viavi, respectively. With the pre-spin sum-of-the-parts fair value estimate suggesting modest downside to JDSU’s share price at the time of this writing ($11), the risk/reward does not appear favorable at this time.

Importantly, as technology companies in highly competitive and nascent industry segments, both Viavi and Lumentum must continue to spend heavily on research and development in order to stay ahead of cost/performance curve; the former on cloud-oriented performance management solutions, and the latter on driving increasing efficiencies in next-generation 100G equipment. As a benchmark, JDSU (and its closest peer, FNSR) currently spends approximately 16% of revenues on product development while depreciating its property, plant and equipment (PP&E) by approximately 25% annually. Accordingly, a key risk lies in the timing (and magnitude) of upcoming product cycles, and these companies’ ability to capitalize on it fully with differentiated products, while being able to maximize profitability in an intense pricing environment. For JDS, free cash flow as a percentage of sales averaged 4.2% for the 2012-2014 period, compared with negative 0.26% for FNSR for the same period. Incorporating cash paid for acquisitions exacerbates this lackluster cash flow dynamic.

The bull case argument, supported by improving backlog and underlying secular trends, is that end-market softness at both Lumentum and Viavi is temporary and that applied multiples for both companies will expand as they begin to meaningfully participate in their respective demand cycles. For Viavi, the CCOP spin-off should allow for some incremental multiple expansion, as it provides the company with the liquidity to accelerate its M&A strategy. We expect Lumentum to attract more growth-oriented investors, unlike the more value-focused base of JDSU. That said, the value creation associated with the spin-off could take time to materialize, as investors become more comfortable with business trends and long-term profitability. We note that should post-spin Lumentum shares come under pressure in the months following the spin-off, the likelihood of a purchase by Finisar should meaningfully improve.