Loews Corporation (NYSE: L) is a holding company with four primary business lines: (1) commercial property & casualty insurance, owned via a 90% stake in CNA Financial (NYSE: CNA); (2) oil & gas drilling, via a 53% stake in Diamond Offshore Drilling Inc. (NYSE: DO); (3) mid-stream natural gas storage, transportation, gathering and processing, via a 52% stake in Boardwalk Pipeline Partners LP (NYSE: BWP); and (4) hotels & resorts, via a 100% stake in Loews Hotels Holding Corp.

L could consider separating its disparate businesses, which have no operational overlap, via a split or sale, as the stock trades with an obvious conglomerate discount that is significantly below the sum of its parts (as well as book value). Indeed, L trades at an almost 15% discount to the market value of its holdings in publicly traded subsidiaries and net cash, which suggests the market is currently ascribing no value to the non-public hotel subsidiary. Notably, the company has a history of selling assets (i.e., Bulova) or spinning them off (i.e., Lorillard).

Based on peer multiples of earnings as well as cash flow, one can ascribe an about $42 value to L’s stakes in publicly-traded entities and about $4 per share to the Hotel operations. Including corporate costs and net cash at the parent company of about $6 per share yields a sum-of-the-parts fair value of about $52 per share, which implies potential upside of more than 25%.

Despite the shares having underperformed the S&P 500 in the last one-, three-, and five-year periods, L is not currently under any public pressure to explore its strategic options (or improve governance). This is likely due in large part to the significant insider ownership of the Tisch family, who collectively own about 21% of the outstanding shares and dominate L’s executive ranks. That said, L has only one class of voting stock, its un-staggered Board elects directors annually, and L’s institutional shareholder base includes Southeastern Asset Management, which holds about 9% of the outstanding shares

On July 31, 2014, The E.W. Scripps Co. (NYSE: SSP) and Journal Communications Inc. (NYSE: JRN) announced that the companies had agreed to merge their respective broadcasting operations, spin off their respective newspaper businesses, and subsequently merge the newspaper operations into a standalone publicly traded entity. The merged newspaper company will adopt Journal Media Group as a corporate name. JRN Class A and Class B shareholders will receive 0.5176 Class A SSP shares and 0.1950 shares in Journal Media Group. SSP shareholders will receive 0.2500 shares of Journal Media Group for each Class A and common voting share owned. JRN shareholders will own approximately 31% of the merged SSP entity, with the Scripps family retaining control. SSP shareholders will own 59% of Journal Media Group, with JRN shareholders owning the remaining 41%. Scripps shareholders will receive 0.2500 shares of JMG common stock for each Scripps common share held on the record date. Journal shareholders will receive 0.1950 shares of Scripps common stock for each share of Journal common stock held on the record date. Prior to the transactions, SSP shareholders will receive a $60 million special dividend, or $1.06 per share based on the current shares outstanding. The transaction is expected to close in the first half of 2015.

Post-Spin Scripps (“SSP”) is expected to have net leverage (debt to equity) of about 2x, while Journal Media Group (“JMG”) will be capitalized with $10 million of cash and no debt. Timothy Stautberg, current senior vice president of the Scripps Newspapers business, will become CEO of Journal Media Group, while Rich Boehne will remain CEO of SSP. The transactions have been approved by SSP’s and JRN’s boards of directors; however, they still require Scripps common voting and JRN shareholders’ approval. The transactions, which are expected to be tax-free to shareholders, will occur simultaneously. As of the time of this writing, the Federal Communications Commission (FCC) has approved the Scripps-Journal merger, and a shareholders’ meeting is scheduled for March 11, 2015, at which time shareholders will vote on the merger and set a record date. The transaction is expected to close within 30 days or fewer from the record date. There is a termination fee of approximately $15.8 million, plus expenses up to $7.5 million payable by Journal or Scripps.

The new Scripps will become the nation’s fifth largest broadcasting group, following a similar trend of media companies separating their television and digital properties from slower-growth, less profitable publishing assets. In addition to the divergent growth profiles of the two businesses, a motivation for these divestitures is the potential for the resulting entities to make incremental broadcast acquisitions in accordance with FCC regulations, which prohibit the same company from owning television stations and newspapers in certain markets. Against this background, the transformation to pure broadcast and digital media businesses has created several recent spin-offs, including Time Warner Inc. (NYSE: TWX)/Time Inc. (NYSE: TIME); Tribune Media Company (NASDAQ: TRCO)/Tribune Publishing Company (NYSE: TPUB); and News Corp. (NASDAQ: NWSA)/Twenty-First Century Fox Inc. (NASDAQ: FOXA). In August 2014, Gannett Company, Inc. (NYSE: GCI), the largest U.S. newspaper publisher (10% market share), likewise announced the planned spin-off of its newspaper division.

The transaction also comes at a time of rapid consolidation among broadcast TV station owners, driven by a desire for greater leverage in negotiations over retransmission fees, as well as for increased operational efficiency. The combination of scale and access to large television markets allows broadcasters to attract and charge higher rates to both national advertisers and pay-TV providers (for retransmission consent fees), and generally results in more bargaining power with the major networks. Notably, Media General acquired Lin Media for $1.6 billion in March 2014. Gannett, which owns USA Today, acquired Belo Corp. for $2.2 billion in December 2013. Sinclair Broadcast Group acquired eight TV stations from the Allbritton family, including an ABC affiliate in Washington, DC, for $985 million in August 2014. Tribune Co. acquired Local TV Holdings for $2.73 billion in December 2013, enlarging its portfolio to 39 television stations.

Post-spin Journal Media Group will publish daily newspapers in 14 markets, with Sunday circulation exceeding one million subscribers, as well as controlling associated digital assets. The company had revenue of $537.5 million in 2013 and $384.1 million for the nine months ended September 30, 2014. While the continued separation of print and broadcast assets has created a potentially investable newspaper industry, there are considerable structural challenges that threaten the long-term viability of these businesses. Most important is the ubiquity of the Internet, which has caused a two-fold revenue erosion in the print publishing industry: first, from significant declines in readership (as subscribers turn toward digital media) and, second, from loss of advertising (as advertisers seek to attract more eyeballs from social and mobile formats). Exacerbating these trends is an uncertain economy. Traditionally, advertising and marketing spending is viewed as discretionary, and these budgets are often cut to align expenses during economic slowdowns. With unemployment little changed since October 2014 at 5.7%, limited credit availability and a cautious consumer spending environment are likely to keep prospects for a robust economic recovery relatively low for now. While publishers have attempted to stem the impact of subscriber loss with such tactics as increased subscription prices and bundled digital subscriptions, the resulting incremental revenue growth appears to have been short-lived, leaving the industry to struggle with a long-term strategy for sustainably monetizing digital versions of traditional print publications.

Potential investors may also question of the long-term viability of the local publishing industry. Companies such as Gannett (which owns USA Today), News Corp. (The Wall Street Journal, Barron’s), and The New York Times Company (NYSE: NYT) have, in theory, a global potential addressable market for their brands if they can find the right commercial formula. Scripps, on the other hand, as a local publisher, is squarely positioned in an industry which continues to be displaced. While many small-town papers may generate enough subscriber revenue to sustain profitability, it is uncertain how many of the company’s local publishing markets will remain viable over the long term.

This difficult macro backdrop has accelerated the pace of consolidation in the print publishing industry. American Consolidated Media, a publisher of 100 daily and weekly newspapers, divested the last of its publications in 2014. More recently, Digital First Media, operator of The Denver Post and 13 other Colorado publications, announced that it is exploring an asset sale. Yet, seemingly counterintuitive acquisitions such as that of The Washington Post by Jeff Bezos (October 2013) suggest that publishers’ subscriber footprint and the potential for operational turnaround may be underappreciated by investors. Since its spin-off into an independent publishing company, Tribune has pursued an aggressive acquisition strategy, deepening its regional presence by acquiring 38 publications from the Chicago Sun-Times in October 2014; similarly, Gatehouse Media and Postmedia have made substantial local newspaper acquisitions. With competition escalating and print advertising expenditures expected to continue their decline, the newspaper industry is likely to consolidate further, potentially making post-spin JMG an attractive asset—particularly if the company can stabilize the business by improving margins and cash flow. In the near term, however, JMG appears more of a structural and operational improvement story.

Post-spin, shares of Journal Media Group are likely to remain under pressure, as existing holders most likely will gravitate toward the improving operational performance and healthier demand drivers of the broadcast parent while positioning JMG as a value/contrarian investment story. Despite JMG’s debt-free balance sheet and a focused management team, the overall secular challenges facing the newspaper publishing industry (advertising and circulation) will likely remain an overhang on the sector, as evidenced by the relative underperformance of recent publishing spin-offs. The company is likely to continue ceding share to digital media alternatives, resulting in estimated year-over-year revenue declines in the 2%-5% range beginning in 2015, with EBITDA margins essentially flat in the 10% range.

From a strategic perspective, management’s top priorities will likely center around (1) increasing operational efficiency (stabilizing and improving margins), and (2) accelerating the transformation from print to digital. The outlook for margin improvement is modestly positive, as the newspaper publishing industry is very early in the process of streamlining its operations relative to broadcasting peers. An orderly cost reduction program may maintain or potentially expand cash flow. However, with respect to the potential for a digital transformation, we believe a more cautious stance is warranted. While JMG certainly has the flexibility to allocate capital and shift internal resources accordingly, rapid changes in technology and consumer behavior are key secular concerns that create uncertainty for the company’s long-term growth profile. Facebook, Inc. (NASDAQ: FB), for example, has established a revenue base in six years that took print companies such as The New York Times Company over 150 years to build. Gannett is also likely to become an increasing competitive threat, as the company’s soon-to-be-spun-off publishing assets consist of more established newspaper franchises in small local markets, coupled with one of the strongest newspaper brands (USA Today) and a more developed new media product strategy. Key risks include the company’s ability to achieve greater digital subscriber scale, coupled with the ability to maintain subscriber growth, as circulation forms the foundation for advertising sales. Moreover, given the pace of consolidation and the importance of scale, it is likely that acquisitions will become an important component of increasing shareholder value—creating an additional risk factor for the new company. Net-net, it remains to be seen whether traditional publishers—and in particular, local publishers– can thrive in a digital age. That said, the opportunity to drive margin expansion, reduce costs, maintain (and potentially) expand cash flow, coupled with a low valuation and potential acquisition “halo” may make the shares attractive for patient, turnaround-oriented investors. Importantly, Journal Media Group is one of only a handful of publicly traded local publishers in the United States. If the company can profitably scale the business amidst these secular challenges – this would represent a massive transformative change that could result in meaningful potential upside for early investors. Based on an analysis of comparable peer multiples of revenue, EBITDA, cash flow, assets, revenue, and EPS, pre-spin Scripps and Journal Media Group can be fairly valued at $21 and $5, respectively, resulting in a combined pre-spin fair value of $26. The pre-spin valuation, which represents 29% upside from the current SSP share price at the time of this writing, suggests that the spin-off should unlock incremental value for shareholders. Following the transactions, Scripps and post-spin Journal Media Group can be valued at $18 and $19, respectively.

From a simple value-unlocking perspective, Scripps shares are recommended for purchase ahead of the transaction. The separation should lift the shares’ historical conglomerate discount relative to broadcast peers and enable each business to pursue tailored capital allocation strategies. In addition, the separation of the lower-multiple broadcast business should create a more highly valued stock currency and more flexibility around M&A, which is currently hampered by SSP’s newspaper exposure. With a combined company’s market share at 18% of U.S. households [well below peers such as Sinclair Broadcasting Group, Inc. (NASDAQ: SBGI) and Gannett at 39% and 31%, respectively], Scripps is one of the few broadcast companies with the cash flow and penetration potential to expand. Moreover, at current levels, SSP trades at a discount to pure-play broadcast comparables, as well as below its 10-year historical average on most metrics. In our view, the valuation should expand as investors come to realize the accretive nature of this transaction, the above-average growth prospects of the company, and the financial flexibility for both internal product development and acquisition-related growth. Moreover, there are several fundamental catalysts for the post-spin parent company that could provide incremental upside beyond this fair value estimate. Scripps, as one of the last remaining broadcasters to renew retransmission rates from below-market to current rates, appears uniquely positioned to experience above-industry growth through 2016.

Comcast and Time Warner collectively provide cable television service to 5.5 million subscribers, or about one-third of the households in Scripps’s markets (Scripps broadcasts to 2.5 million and 3 million Comcast and Time Warner subscribers, respectively). The timing of Scripps’s renegotiation of its retransmission contract with Charter Communications, Inc. (NASDAQ: CHTR) has been accelerated by the proposed merger of Time Warner Cable, Inc. (NYSE: TWC) and Comcast (NASDAQ: CMCSK). Simply put, the planned merger pushes forward renegotiations (which would otherwise have occurred in 2019) relating to approximately 5.5 million subscribers (one-third of Scripps’s markets). As a result, Scripps’s retransmission revenue is expected to increase from an estimated $55 million in 2014 to over $100 million in 2015. The year 2016 appears likely to be a banner year, with Scripps well-positioned for over 20% year-over-year revenue and EBITDA growth—well above normalized growth in the 5% range for 2015. With management forecasting at least $165 million in retransmission revenue on a run-rate basis for the combined company post the Comcast/Time Warner and Charter transactions, it is feasible that this number could expand to an estimated $200 million in annual retransmission revenue once Comcast is paying market rates as its contract is negotiated in 2019. At the same time, the business should benefit from low- to mid-single-digit advertising rate growth, as well as a rebound in political advertising, which should accelerate into the 2016 election season, with post-spin Scripps having a significantly larger national broadcast footprint and affiliations with all of the big four networks (CBS, ABC, NBC, FOX) and better-positioned in eight so-called “swing states” pivotal in the presidential election. The potential for incremental retransmission upside, an advertising rebound associated with the 2016 election season, synergies from the integration of Journal, and further accretive M&A activity in the TV broadcast space should provide a positive bias to consensus revenue and earnings estimates over the next several quarters.

Given the difficult competitive environment, coupled with the significant strategic changes required to right-size the business for long-term sustainability, JMG shares are not recommended for purchase at this time. As the company validates stability in the financial model, investors may come to appreciate the potential for free cash flow and the likelihood of further industry consolidation, which may support an expansion in trading multiples.

On April 28, 2014, Comcast Corp. (NASDAQ: CMCSA, CMCSK; OTC: CMCSB), an operator of cable television systems, announced a series of transactions that would result in the company divesting a net 3.9 million subscribers. One of the transactions will be a spin-off of 2.5 million subscribers via a tax-free distribution of shares to CMCSA shareholders. The new entity will be known as GreatLand Connections, and the subscriber base will be primarily located in the Midwest and Southeast.

The rationale for the divestiture transactions, which also include a sale of and exchange of subscribers with Charter Communications Inc. (NASDAQ: CHTR), differs from the trend of recent corporate spin-offs in that it is not an attempt to separate what management (or shareholders) view as an undervalued business within a conglomerate structure, or designed to jettison an underperforming business. Instead, the divestiture of 3.9 million net subscribers is an attempt to head off regulatory opposition to the proposed mega merger between CMCSA and Time Warner Cable Inc. (NYSE: TWC). The proposed merger (announced in February 2014) would create the largest cable company operator, with 33.4 million video and 33.7 million high-speed internet subscribers.

While there is no legal limit to the actual number of video subscribers, or percentage market share, that would preclude the transaction, it is thought by Comcast management that keeping the total percentage of video market share below the previous ownership limit of 30% would help meet antitrust regulators’ concerns. To date the company has met with what could be described as expected pushback from a variety of interests, including regulators, competitors, industry groups, and customers. The divestiture transactions, including the spin-off of GreatLand Connections, are predicated on the completion of the CMCSA/TWC merger. For the purpose of this report it is assumed that this merger will be completed, and that all planned subsequent transactions occur as previously contemplated. However, given recent regulatory pushback, especially in light of FCC Chairman Wheeler’s recent proposal concerning net neutrality (in which broadband would be reclassified as a telecommunications service, which would result in increased regulation), the possibility exists that additional concessions would have to be made to complete the merger. Given that most arguments against the merger are rooted in the fact that the combined entity would control approximately 35% of the wired broadband market in the U.S., additional purging of subscribers would be the most likely remedy. Assuming the TWC merger is completed, investors in CMCSA, including former TWC shareholders, will receive shares of GreatLand Connections and shares of Charter Communications (due to a second merger between GreatLand and a subsidiary of CHTR discussed within this report).

Major players in the cable industry have been vocal about the need for consolidation, given the current competitive threats from over-the-top providers (services delivered via the internet), such as Netflix Inc. (NASDAQ: NFLX) and Google Inc. (NASDAQ: GOOG). AT&T Inc. (NYSE: T) and satellite TV provider DirecTV (NASDAQ: DTV) are also in the process of merging, creating a sizable competitor to CMCSA, with 26 million video subscribers. The need for scale is largely due to the continued rising costs of content that cable operators are forced to pay, with recent disputes between cable operators and content providers resulting in temporary or permanent dropping of channels from cable lineups. Smaller competitors cannot effectively bargain with larger competitors and will probably have to consolidate or risk losing customers as content selection is curbed.

Following the spin-off, GreatLand shareholders will receive shares approximating 5% of CHTR in exchange for approximately 33% of GLCI. GreatLand and CHTR will also enter into a services agreement whereby CHTR will provide certain services in exchange for 4.25% of gross revenue. Given managements’ desire to see consolidation, it would not come as a surprise if GreatLand’s life as a standalone entity were to be a short one.

Applying EV to EBITDA and subscriber count comparable multiples, and accounting for estimated synergies from the TWC merger and the planned $10 billion increase in the company’s share repurchase plan, a fair value estimate of $68 per share can be derived for post-spin CMCSA. Applying similar metrics, GreatLand Connections can be assigned a post-spin fair value estimate of $0.89 per share. GreatLand shareholders will also receive $907 million, or $0.18 per share, in CHTR shares, resulting in a pre-spin CMCSA fair value estimate of $70 per share.

Given industry fundamentals, CMCSA’s market leadership position (content purchasing power), exposure to content creation through NBC Universal, and the likelihood of GreatLands playing a role in the industry’s consolidation (either being consolidated or being a consolidator), coupled with the share price appreciation potential from current levels, shares of Comcast Corp. are recommended for purchase prior to the transaction.

Israel Corporation (ILCO IT) is Israel’s largest holding company, controlled by billionaire Idan Ofer. Its largest holdings comprise privately held IC Power, Oil Refineries Ltd (ORL IT) and Israel Chemicals Ltd (ICL IT). In light of persistent losses in Zim Integrated Shipping Services, due to the condition of the shipping industry, as well as the bankruptcy of Better Place (in which ILCO held a significant stake), the Board of Directors announced on June 26, 2013 that it was considering a spin-off of the company’s holdings. The original time horizon for such a move was 6-12 months, but the spin-off was deferred, probably due to Zim’s restructuring. The approval of the shipping company’s reorganization plan hinted that a spin-off decision was approaching.

On October 13, 2014, the company announced that its Board of Directors approved the separation of several of its subsidiaries into a Singapore incorporated entity, Kenon Holdings Ltd (KEN IT, KEN US), that will subsequently be distributed to the company’s existing shareholders on a seven to one basis. The spin-off, which is taxable, was officially completed on January 7, 2015, with shares of Kenon Holdings distributed to shareholders on January 11. Israel Corporation started trading ex-distribution on the same date. Due to the taxable nature of the transaction, Israel Corporation declared a USD 200 million dividend that it withheld in order to pay Israeli withholding taxes. Furthermore, ICLO planned on retaining a portion of the dividend-in-kind, i.e., shares of Kenon Holdings, with the intention of selling them in the market to raise additional cash were the USD 200 million not sufficient to pay the tax. Shares of Kenon Holdings are also expected to be considered a taxable distribution for US Federal Tax purposes.

Given Israel Corporation’s complex conglomerate structure that includes a series of wholly and partially owned private and publically traded enterprises, any attempt to simplify and streamline its holdings appears value enhancing. Indeed, post spin-off, Israel Corporation will be invested in only two companies, both public, thus making any valuation exercise easier and potentially reducing any holding company discount. Additionally, the spin-off allows the parent company to focus on its two Israeli corporations, while demerging the remaining subsidiaries that conduct most of their operations abroad.

Kenon Holdings was assigned ILCO’s stakes in IC Power, Qoros, Zim and Tower Semiconductor Ltd (TSEM IT, TSEM US). Additionally, the spinco will initially have USD 35 million in cash and no corporate level debt. ILCO will also extend a USD 200 million credit line, which is expected to be draw in the near future, with the proceeds used to fund Qoros’ operations. Among Kenon Holdings’ strategic priorities are a strict capital allocation policy that does not allow cross-investing (that is, investing in one subsidiary by using income earned by another), with the potential exception of Qoros, as well as the monetization of Kenon’s holdings, either through a sale (ZIM) or IPO (IC Power, Qoros). IC Power, a wholly-owned power generation company, is responsible for more than half of the spin entity’s value. It operates in South America, primarily in Peru, as well as in Israel. While IC Power’s balance sheet has a lot of debt, the company can handle a lot of leverage, care of its utility status. Even more, IC Power’s focus is on markets that have low consumption of electricity per capita and rapidly increasing energy demand, thus allowing the company to grow at a rate far above that of the average utility company. Based on its current stock price, Kenon Holdings appears significantly undervalued; a sum-of-the-parts analysis that approaches the value of IC Power and ZIM conservatively and assigns no value to Qoros results in a target price of ILs 7,300 per share, allowing for a double digit upside. The base case scenario leads to a valuation of 12,700 per share. At the same time, were ZIM to reap substantial benefits from lower bunker fuel costs, Kenon Holdings could be valued at ILs 21,900 per share.

It should be noted that the conglomerate’s diverse set of businesses—with each one operating in a different sector and being at a different life cycle stage—could lead to a material holding company discount that will persist absent any value unlocking catalysts, such as a material improvement in ZIM’s financial results (in the short-term), IC Power’s public listing (in the medium- to long-term) and Qoros’ switch to profitability (in the medium- to ling-term). Consequently, shares of Kenon Holdings are recommended for purchase for investors with a multi-year time horizon.

Israel Corporation will comprise a 37% interest in Oil Refineries, which has a market capitalization of ILS 3,670 million and is an associated company, and a 46% stake in Israel Chemicals, a ILS 36,200 million corporation whose results are fully consolidated. In addition, ILCO has retained all corporate level debt. At the holding company level, its pro forma net debt is estimated between USD 1,600 million and USD 1,800 million—not including the USD 200 million loan to Kenon Holdings. Israel Chemicals, one of Israel’s largest corporations, produces fertilizers as well as performance and industrial products and materials. It is, in fact, the world’s sixth largest potash producer, mainly due to its vast Dead Sea reserves. The company has a geographically diverse asset base—with mines, for example, in Spain and the UK—and derives most of its revenues from outside of Israel. Oil Refineries owns and operates Israel’s largest refinery, located in Haifa, as well as a petrochemical producer, Carmel Olefins Ltd. The company has been plagued by poor performance in recent years, while, at the same time, it faces a very high debt burden. The recent decline in the price of crude oil could prove a tailwind for Oil Refineries, supporting its refining margins and increasing fuel demand. A sale of one or even both companies cannot be ruled out. However, an outright distribution of shares to ILCO’s shareholders in essentially impossible due to the material liabilities at the holding company level. Based on the current market value of its two subsidiaries, Israel Corporation could be valued between ILs 141,200 per share and ILs 148,800 per share. Still, while a sum-of-the-parts approach may show that ILCO’s stock could be undervalued, investors should take into account that neither of the two subsidiaries can be monetized without significant tax liabilities—either due to a sale or a dividend-in-specie.

On June 9, 2014, PPL Corporation (NYSE: PPL), the utility owner formerly known as Pennsylvania Power & light, announced the spin-off of its U.S. competitive energy business and the merger of that business with the power generation portfolio of private equity firm Riverstone Holdings Ltd. (RSTON). Under the terms of the tax-free Reverse Morris Trust transaction, PPL shareholders will own 65% of the spin-off company, to be called Talen Energy Corp., upon completion of the merger, while Riverstone will hold the remaining 35% interest. The transaction is subject to regulatory approvals from the Federal Energy Regulatory Commission (FERC), the Federal Trade Commission, the U.S. Department of Justice, the Nuclear Regulatory Commission (NRC), and the Pennsylvania Public Utility Commission (PUC), with completion of the transaction expected in the first half of 2015. PPL Corporation will have no continuing interest in Talen Energy, and the transaction is not subject to PPL shareholder approval.

Talen Energy Corp. will be an independent power producer (IPP)[1] operating 15,320 megawatts of capacity. Talen’s generation assets are primarily located in two of the nation’s largest and most attractive wholesale power markets: PJM Interconnection (83% of capacity)[2], and ERCOT (12% of capacity)[3]. The regions of both organizations are characterized by above-average demand growth and pricing. In particular, PJM’s capacity market, whereby bidders procure capacity three years in advance through a competitive auction, provides Talen with a relatively stable, predictable source of earnings and cash flow. The company operates a diverse production portfolio, albeit coal-weighted (40% coal, 40% gas, 15% nuclear energy, 3% oil, and 2% renewable). Given the monopoly-like control of regulated markets, scale is integral to the ongoing success of independent suppliers, and notably, the combination with Riverstone results in the third largest publicly traded U.S. independent power producer, after NRG Energy (NYSE: NRG) and Calpine Corp. (NYSE: CPN). The company will have significant scale and a competitive cost structure with the financial flexibility to pursue growth.

For PPL, the transaction, which has been well telegraphed and anticipated by investors, is the culmination of the company’s steady strategic efforts to focus on its regulated, as opposed to merchant, business. Declining natural gas costs have caused electricity prices in many markets to fall, creating volatile returns in the merchant market. Accordingly, many large utilities have begun to steadily withdraw from the merchant generation business in order to bolster earnings growth, acquire more profitable regulated assets, or invest in solar and other renewable generation with more predictable returns. Duke Energy Corp. (NASDAQ: DUK), the largest U.S. utility, sold its non-regulated Midwest Commercial Generation business for $2.8 billion to Dynegy in August 2014. American Electric Power Co. (NYSE: AEP), the country’s largest coal-based operator, has similarly announced a potential divestiture of its Midwest non-regulated facilities (approximately 11,000 MW generating capacity), which have exhibited volatile earnings results with fluctuating power prices. While PPL has weathered the downturn in the power markets better than most of the other integrated utilities by virtue of its revenue mix (85% of 2013 earnings were generated by the company’s regulated businesses) as well as by a significantly expanded regulated presence through the acquisitions of utilities in Kentucky and the U.K., the spin-off should further stabilize and accelerate earnings growth and support the company’s attractive dividend profile.

With the spin-off of its merchant business and transformation into a fully regulated utility, PPL should be in an improved position operationally to capitalize on its regulated asset base, which represented over 85% of 2013 earnings and should achieve very healthy rate base growth (6.3% projected five-year CAGR). This high rate of growth is largely due to substantial investments in new transmission facilities ($16 billion over the next five years). At the same time, PPL has a solid track record of returning cash to shareholders, having steadily increased its annual dividend 12 times from 2002 to 2013—resulting in one of the highest yields in the sector at 4.2% (peers currently yield an average of 3.8%). A targeted minimum of 4% compound annual earnings growth associated with a fully regulated business model, coupled with a projected decline in capital expenditures (from $4.19 billion in 2014 to $3.8 billion in 2018), should afford PPL increased operational flexibility to accelerate dividend expansion. The trailing 12 months’ EBITDA margin is the highest in the regulated peer group (38% versus 30% for peers), and the company generates substantially higher return on equity (ROE of 11.8%, versus 9.6% for peers).

Throughout 2014, the utility sector benefited from a favorable macro environment characterized by low U.S. Treasury yields and global growth, currency, and deflationary concerns—which together have caused investor preference to shift toward defensive, income-generating equities. Accordingly, PPL shares exhibited strong 2014 performance, gaining 23% for the year, versus 12% for the S&P 500 index over the same period. Although the shares historically have traded at an approximate 8% discount to large-capitalization regulated peers, owing to the company’s regulated versus merchant mix, this gap has closed in recent months. This valuation expansion suggests investors over-weighted PPL based on an expected transaction for the Supply business, potentially resulting in shareholder churn following the planned spin-off.

Based on an analysis of comparable EPS, revenue, EBITDA, and asset-based multiples, PPL and pre-spin Talen can be valued at $33 and $4, respectively (the latter reflecting 65% ownership by PPL shareholders and assuming $3.1 billion net debt), resulting in a pre-spin combined fair value of $37. Post-spin, Talen can be fairly valued at $7. The pre-spin fair value estimate suggests the shares are fairly valued at current levels. The lack of near-term upside can be attributed to several factors. Despite the positive operational benefits of the company’s transformation to a fully regulated business and the potential earnings leverage associated with U.S. rate base growth, post-spin PPL will exhibit only average sector earnings growth of 4%, owing to meaningful earnings deceleration associated with its U.K. operations (which comprise approximately 55% of consolidated EBITDA). The combined effect of currency risk (owing to a strong U.S. dollar relative to the British pound) and loss of incremental incentive revenue[4] will likely act as a drag on earnings in F2015 and F2016. This awkward geographic mix, with 60% of revenue generated in the U.K. (the highest foreign exposure in the sector), may also prove a concern around issues of cash repatriation, particularly as the company seeks to grow its dividend. That said, over the longer term, an industry-leading yield and more consistent earnings growth may partially offset earnings erosion, making the shares a suitable holding for income-oriented, defensive investors seeking modest capital appreciation. With an improved currency situation and resumed incentive revenue in the U.K., PPL should begin to accelerate earnings growth, potentially expanding the valuation over time.

The current sum-of-the-parts analysis does not appear to point to an unlocking of substantial incremental value. While downside may appear limited on a relative valuation basis, (the shares are trading essentially in line with integrated peers), it is worth considering whether the sector’s premium valuation is sustainable amidst shifting industry fundamentals. Utilities are currently trading at a premium valuation to the S&P 500 Index of 17x forward earnings, compared to 16x for the broader market. Over the past 20 years, utilities have traded largely in line with the broader market, on average at 14x earnings; therefore, the sector is currently trading at a significant premium to historical levels. Meaningful industry risks to be considered include increasing industry de-regulation, more stringent emissions regulations, the potential for reduced load growth (owing to demand displacement from wind and solar) and a general slowdown in capital expenditures (which in turn results in slower rate base growth), the latter of which would be accelerated by rising interest rates and an ensuing rise in cost of capital. These industry shifts could force a sector-wide reduction in the regulated asset base, which would in turn impact dividend maintenance and expansion over time. Arguably, with coal still generating over 40% of the world’s electricity,[5] the disruption from renewable energy is still in early stages, affording regulated utilities the ability to raise prices to consumers and retain profit margins, at least in the near term. Moreover, PPL may be more insulated from these industry risks than its peers, given the company’s considerable exposure to the U.K. market. The U.K.’s performance-based rate structure, coupled with longer price controls (eight years, versus three years for the U.S.) reduces the motivation (characteristic of U.S. utilities) to overinvest in fixed assets in order to drive rate base increases. Ultimately, this U.K. exposure may help stabilize the company’s Return on Equity (ROE), which has declined from 12.8% in 2008 to 10.7% in 2014.

A longer term bull case for PPL clearly rests with the potential for improving revenue and earnings growth in its U.K. business, coupled with company-specific catalysts (notably, a potential rate increase in Kentucky and new PJM construction opportunity). Assuming PPL shares could expand to the level of the mid-cycle 2007 peak multiple (10x), a post-spin fair value of $38 could be derived (15% potential upside to our fair value estimate). Of course, this multiple expansion may be unlikely given broader industry fundamentals. Net-net, an in-line relative valuation, coupled with broader industry risks, do not warrant a purchase recommendation for PPL shares at this time.

For post-spin Talen, despite being an industry-leading IPP with a diverse and growing asset base, the shares may initially trade at a modest discount to our fair value estimate, given a relatively weaker free cash flow and EBITDA profile relative to peers, a weak overall commodity pricing environment, unpredictable weather trends, and lack of significant demand growth—factors which may adversely affect broader sector valuations. Longer term, the previously-mentioned industry risks apply to Talen as a merchant supplier. Moreover, without regulatory insulation, the combined impacts of reduced demand growth and demand displacement would be exacerbated– requiring that Talen become a consolidator in order to maintain efficiencies of scale. In addition, the potential sale of Duke Energy’s PJM generation portfolio could also pressure valuations. Coupled with a potential guidance reset and turnover in the shareholder base, we would be more constructive on a pullback.

On October 13, 2014, Atlas Energy L.P. (NYSE: ATLS) announced a plan to spin off its non-midstream related assets. The parent company consists of two entities, both of which will be acquired. Atlas’s 6% limited partner (LP) interest in Atlas Pipeline Partners (NYSE: APL), which provides natural gas gathering and processing services in the Anadarko and Permian Basins, will be acquired by Targa Resources Partners LP (NYSE: NGLS). The purchase price of $5.8 billion includes $1.8 billion of debt (a 12x 2015E EBITDA multiple). Atlas Pipeline Partners owns and operates 14 active gas processing plants and 18 gas treating facilities, as well as approximately 11,200 miles of active intrastate gas gathering pipeline in Oklahoma, southern Kansas, Texas, and Tennessee. Accordingly, NGLS will acquire assets in the liquids-rich Woodford/SCOOP, Mississippi Lime, Eagle Ford, and Permian Basins. Each APL common unit holder will receive 0.5846 NGLS units and a one-time cash payment of $1.26 per unit.

In a concurrent transaction, Atlas’s 2% general partner (GP) interest and incentive distribution rights (IDRs) in Atlas Pipeline Partners L.P. (NYSE: APL), will be acquired by Targa Resources Corp. (NYSE: TRGP), for $1.9 billion in cash and shares. This includes 5.8 million APL units and APL IDRs. Based on consensus 2015E EBITDA of $486 million for APL, the purchase price is roughly 16x EV-to-2015E EBITDA, or 37x estimated 2015 cash flow. Each Atlas Energy unit holder will receive roughly 0.1809 TRGP shares and $9.12 in cash per unit. Following the acquisition, Atlas Energy will become a subsidiary of Targa Resources, and Targa will acquire all of Atlas’s APL-related assets. Following the close of the transaction, Targa Resources Corp. (TRGP) will remain a pure-play general partner, with no physical operating assets. The combined transactions are valued at approximately $7.7 billion. Following the distribution, Atlas Energy unit holders as of the record date will receive common units of New Atlas, which will hold all of Atlas’s non-midstream assets, in addition to the merger consideration of 0.1809 of a share of Targa Resources Corp. common stock, par value $0.001 per share, and $9.12 in cash per unit, without interest as a result of the Atlas merger.

The spin-off, “New Atlas,” consists of all of Atlas Energy’s non-midstream assets and is essentially a yield company whose cash-flow-producing assets will be distributed as dividends to investors. New Atlas includes (1) Atlas Energy’s general partner interest, incentive distribution rights, and limited partner interest in Atlas Resource Partners, L.P. (NYSE: ARP), a publicly traded master limited partnership and independent developer and producer of natural gas, crude oil, and natural gas liquids; (2) the general and limited partner interests in its exploration & production development subsidiary, Arc Logistics Partners L.P. (NYSE: ARCX), which currently conducts operations in the mid-continent region of the United States; (3) general and limited partner interests in Lightfoot Capital Partners, a limited partnership investment business; and (4) other natural gas and oil exploration and production assets located in the Arkoma Basin that generate net production of approximately 11.5 million cubic feet per day. New Atlas is expected to produce initial annualized distributions of $1.10 per unit on a pro rata basis. Distribution and record dates for the spin-off, as well as the distribution ratio have not been announced as of this writing; the spin-off and merger transactions are expected to be completed in the first quarter of 2015. Targa has received Hart-Scott-Rodino (HSR) antitrust clearance.

The transaction represents the last remaining publicly traded general partner to separate its production (upstream) and pipeline (midstream) interests. For NGLS, the acquisition underscores the ongoing consolidation of the midstream industry, while clearly improving the partner’s scale. Based on estimated combined NGLS and APL EBITDA of $1.5 billion, NGLS will become one of the largest gathering and processing (G&P) MLPs, having acquired highly complementary assets which should significantly enhance the cash flow stability and credit profile of the partnership. The transaction puts NGLS into a dominant position for gas and NGL processing in the Permian—the second largest position after DCP Midstream Partners LP (NYSE: DPM)—augmented by additional assets in Barnett, Woodford/SCOOP, Mississippian Lime, and Eagle Ford—all of which are liquids-rich basins with robust producer activity. Management now expects a total of approximately $4.2 billion in additional growth projects for the 2015-2018 period for the combined entity, versus expectations of approximately $2.0 billion previously (implying a contribution by APL of approximately $1 billion). Immediately upon the close of the deal, NGLS announced plans to increase distributions by 11%-13% year-over-year in 2015. For TRGP, the continued weakness in crude prices may provide an opportunity for further consolidation in the space, which may be an advantage if its midstream interest in NGLS is used as an acquisition currency.

For current ATLS shareholders, the transaction offers a reprieve given the shares’ 35% decline since January, owing not only to the declining commodity price environment but also to criticism of its largest ownership interest, APL. For long-time E&P investors, the transaction may precipitate feelings of déjà vu. Indeed, the spin-off of Atlas’s E&P assets is highly reminiscent of the 2011 sale of the partner’s predecessor, Atlas Energy Inc., to Chevron (NYSE: CVX) for $4.3 billion. Following the acquisition, Atlas Energy, LP (ATLS) formed Atlas Resource Partners, LP (ARP), having reconfigured the remaining exploration and production operations as an MLP. Once again, ATLS has sold its midstream business, this time to Targa, and is spinning out its E&P and other assets. The question, however, is whether the new Atlas can execute this strategy for a third time. In this case, the remaining E&P assets appear to be significantly undervalued against a challenging commodity backdrop. Backing out a purchase price of $28.49 for the parent company from ATLS’s current share price, the remaining New Atlas (non-midstream assets), is currently implicitly valued at $3.09 per share, or a $160 million market capitalization.

Arriving at a valuation for the post-spin entity is complicated by the diversity of GP and LP interests it holds. As one might expect, the current implied valuation for post-spin Atlas Energy Group is based on its largest publicly traded holding—its limited partner interest in ARP (worth $5.38 per share at current prices). Adjusting for net debt, the value of post-spin Atlas’ LP interest in ARP alone is worth $2.68 per share, or a 13% discount to the shares’ current implied value. While such a valuation may not appear compelling on the surface, it is important to note that it is fundamentally incomplete. A valuation of post-spin Atlas based solely on ARP assigns no value to its natural gas assets, and even more importantly, it fails to consider the post-spin entity’s long-term growth strategy—that is, potentially growing cash flows from its other GP and LP interests. As a first step, assigning some value to the Arkoma Basin natural gas assets (11.5 mmcf/d production), the post-spin entity can be valued at between $3.46 and $3.83 per unit, representing approximately 12% to 24% upside from the current implied value. As noted, the above assessments fail to consider Atlas’s other sources of incremental cash flow growth—mainly, its interests in Lightfoot Capital and its GP and LP interest in its E&P development subsidiary (the latter of which generated approximately $160 million in cash distributions over the trailing 12 months). Moreover, these valuation methodologies assign no value to future growth associated with new limited partner interests and funds.

A more holistic sum-of-the-parts analysis should include Atlas’s LP ARP units, the projected cash flows associated with its ARP-related GP interest and IDRs, the partner’s GP and LP interest in Lightfoot, projected cash flows from its E&P subsidiary, and the partner’s natural gas production. Applying this methodology, coupled with discounted peer multiples on estimated EBITDA and distribution growth, New Atlas can be fairly valued at between $4.88 and $6.78—suggesting between 37% and 54% potential upside to its current implied value.

For post-spin Atlas, the timing of the transaction is undoubtedly burdensome for an upstream E&P, owing to continued commodity market weakness culminating in recently reduced distribution forecasts at ATLS and ARP. Accordingly, the primary investment risk is whether a further eroding commodity environment, potentially exacerbated by seasonal headwinds, depresses production, and in turn, distribution growth. Going forward, new Atlas’s distribution growth will be highly dependent on the underlying performance of ARP, as it owns 100% of the GP and IDRs, and a 27.7% LP interest (every $1 increase in ARP adds approximately 50 cents to ATLS). With ARP shares trading at a 21% yield at the time of this writing (the shares have declined approximately 58% from the November 2012 initial public offering), the valuation appears sufficiently discounted to reflect the underlying risks. Importantly, ARP does enjoy an unusual position as a low-cost, well-hedged producer primarily exposed to natural gas (oil is 9.6% of current production), providing some insulation from potentially worsening crude pricing. There is also reduced cash flow risk given relatively stable drilling partnerships and a high cost of production, which at approximately $2 per mcf is mostly hedged at over $4 per mcf.

Following the spin-off, one would expect the new Atlas to accelerate expansion of its project backlog through acquisitions and new drilling partnerships, thus increasing dropdown and growth visibility at ARP. Specifically, one can reasonably expect Atlas to increasingly leverage its investment in Arc Logistics (ARCX) and its planned new funding vehicle in order to supplement cash flows and dropdown assets to ARP. Management has been quite vocal in its disappointment over the apparent undervaluation of the E&P business, hinting at the possibility of additional transactions to obtain “fair market value.” At the same time, recently revised F2015 distribution targets appear reasonable and suggest 1.0x coverage for the post-spin entity, affording investors a stable dividend as they await improvement in the macro environment.

While it is important not to understate macro and company-specific risks, the implied fair value for post-spin Atlas Energy Group suggests meaningful upside for more speculative, risk-tolerant investors able to navigate the potential near-term volatility and negative sentiment. In the short term, post-spin ATLS shares can initially be viewed as a discounted, lower-risk derivative investment in ARP. Longer term, ATLS offers an option on incremental growth from the partner’s other LP and GP interests and funds (which are currently being assigned no value). Arbitrage-oriented investors may also consider hedging the transaction risk in the short term.

On July 29, 2014, Windstream Holdings Inc. (NASDAQ: WIN) announced plans to spin off certain telecommunications network assets into a standalone publicly traded company via a tax-free distribution of shares. The new company, to be called Communications Sales & Leasing (“CS&L”), will be structured as a real estate investment trust (REIT). WIN will maintain a 19.9% ownership stake in CS&L for up to 12 months. Management expects that post-separation WIN’s annual dividend will be equivalent to $0.10 per share on a pre-spin share count, while the REIT will have an annual payout equivalent to $0.60 per share based on the pre-spin share count. The company has received a private letter ruling from the IRS regarding the tax-free nature of the spin-off and stating that the assets to be transferred qualify for inclusion in a REIT. The spin-off still requires final Board approval, an effectiveness declaration of a Form 10 filing, and certain regulatory approvals. The transaction is expected to be completed in 1Q 2015. In addition, the transaction requires WIN shareholder approval of a one for six reverse stock split and conversion of Windstream Corp. into a limited liability company (LLC). The change to an LLC is required to maintain the tax-free nature of the spin-off.

WIN is a provider of residential and business telecommunications services, primarily to rural customers. The company operates a fiber network of approximately 118,000 miles, and 26 data centers in 48 states and the District of Columbia. Over the past several years, Windstream has been transforming its core business from a residential competitive local exchange carrier (CLEC) to offer a more robust set of services, including high-speed broadband, cloud computing, and Internet protocol (IP) based services. The transformation was aided by several recent acquisitions, including the $2.2 billion acquisition of PAETEC Holding Corp. in 2011, which increased the company’s exposure to medium and large-sized business customers. WIN now generates in excess of 70% of revenue from broadband-related services.

The assets to be transferred into the REIT will primarily include fiber and copper distribution systems, as well as some real estate and other fixed assets, representing less than 25% of WIN’s total asset base. Data-center assets will remain with WIN following the spin-off. The spin entity will also receive WIN’s residential competitive local exchange carrier (CLEC) business. The REIT will incur approximately $3.6 billion in new debt, the proceeds of which will be used to retire $2.2 billion in current WIN debt and fund a cash distribution of $1.2 billion to WIN. Assets transferred to the REIT entity will be leased back to WIN on a triple-net basis and are expected to generate initial annual rental income of $650 million.

The planned spin-off of fiber and copper distribution assets into a REIT has been met with a high degree of skepticism in the market and has elicited an unfavorable stock price reaction. WIN’s business continues to decline, as the loss of consumer and small business accounts has more than offset increases in enterprise business accounts and cost cuts. Despite WIN’s receipt of a private letter ruling from the IRS stating that the assets qualify as real property, general market sentiment suggests doubts that the transaction will take place, and if it does, uncertainty as to how much value would be unlocked.

Compounding WIN’s issues, in December 2014 WIN CEO Jeff Gardener stepped down from the role he has held since the company was formed in 2006. CFO Tony Thomas replaced Gardener as CEO, effective immediately. The CEO shuffle was unexpected, as Thomas was slated to assume the CEO role at CS&L following the spin-off. WIN has begun a search for a new CEO to lead CS&L. The management change could, at minimum, result in a delay of the transaction, while declining business trends and negative feedback regarding the change in corporate structure could lead management to rethink the plan altogether.

If the spin-off does occur, the transaction appears to be potentially transformative for the telecommunications industry. Moving forward, the REIT could become an industry consolidator, given an expected lower cost of capital and the advantages of being the first to implement a REIT structure with these kinds of assets. CS&L could prove to be an attractive source of financing for other owners of fiber and copper distribution systems looking to accelerate network investments.

The pre-spin fair value assumes that the current corporate structure remains intact and that the spin-off of Communications Sales & Leasing does not occur. The pre-spin fair value should be used by investors until there is significantly more clarity on the timing of the spin-off, given the concerns noted above, and until management exhibits an ability to stabilize the underlying businesses. Based on 2015 consensus EBITDA and direct peer comparables, pre-spin WIN shares can be valued at $6.92 per share, with downside to $4.81 per share on a continued decline in business trends.

If the transaction does occur, it appears that value could be unlocked if the REIT is valued anywhere near other triple-net lease operators. The post-spin fair value estimates assume that shares of CS&L are distributed on a one for five basis, WIN retains 19.9% ownership of CS&L, and WIN conducts a one for six reverse stock split following the spin-off. Based on projected EBITDA, funds from operations, and dividend yield, Communications Sales & Leasing Inc.’s fair value is $29 per share. Post-spin WIN’s fair value of $25 per share is derived based on projected EBITDA and free cash flow, assuming a 10% decline in earnings. If the transaction ultimately proceeds, the pre-spin value of the combined post-spin entities represents 19% price appreciation potential from current levels (consisting of $7.12 per share for WIN and $2.75 per share from CS&L based on post-spin valuations and current shares outstanding); however, the shares are not recommended for purchase prior to finalization of details surrounding the spin-off, including senior management, capital structure, and distribution dates, as a possible failure to complete the transaction or further declines in WIN’s business present risks that outweigh potential gains at this point in time. The recommendation will be revisited if and when clarity increases around the noted concerns.

As a final aside, it can be noted that WIN is certainly not the first company to exit the local and regional carrier business in favor of shifting investments towards mobile and digital networks and spectrum. WIN’s choice of placing copper and fiber distribution assets into a REIT is unique; however, the spin-off accomplishes much of the same goals that larger carriers, such as Verizon and AT&T, accomplished via a variety of asset sales and spin-offs. The exit of what is arguably a dying business, has freed up capital for investments in more technologically advanced product offerings based on fiber networks and wireless spectrum. The legacy copper-based businesses have struggled to compete with the likes of “triple play” offerings from cable companies that provide faster internet speeds and arguably better value and service. Further, as demand continues to shift towards mobile dominated phone service, it begs the question of how long carriers can support the infrastructure investments needed to maintain these legacy networks as investments made into these assets, in the form of maintenance and acquisitions, appear to be having diminishing or negative returns in the form of revenue and earnings.

Reckitt Benckiser Group Plc (RB/ LN) is a British-based global consumer products company, with a portfolio of household names including Air Wick and Dettol. On July 28, 2014, the company announced the demerger of its pharmaceutical business through a separate listing on the London Stock Exchange. The spin-off was approved at the shareholders meeting held on December 11. The last day of trading for Reckitt Benckiser shares cum-distribution is December 22. The spin entity, which will be named Indivior Plc, will start trading the following day—December 23. On the same date, an ADR facility will be established and holders of Reckitt Benckiser ADRs will receive Indivior ADSs.

The two post demerger companies have very disparate business models: one is a consumer staples company with a relatively stable stream of revenues and a global presence. The other is a specialty pharmaceutical company which can experience sharp revenue changes, and whose future is highly dependent on the success of its drug pipeline and its patent protection. The timing of the spin-off is not incidental. Indivior is currently at an inflection point, where on one hand it faces increasing generic competition in the US and, on the other hand, it is ramping up research and development spending as it prepares numerous drug launches until 2020.

However, investors could question the demerger on the basis of its value enhancing benefits. It is common in spin-offs to observe valuation multiple expansion for either the spin entity or the parent, leading to a sum-of-the-parts price that is higher than the pre-spin valuation. That is attributable to one segment deserving a higher multiple than the rest of the company, something that is recognized only after it becomes a separate corporation. In the case of Reckitt Benckiser though, the opposite is true: as a consumer staples company with a solid portfolio of brands, Reckitt Benckiser trades—deservingly, perhaps—at high multiples. Indivior, though, faces numerous challenges and should be reasonably expected to trade at lower multiples. Ergo, the sum is worth less than the whole. As a counterargument, Reckitt Benckiser’s management could be pursuing the spin-off at this very moment to avoid having RB Pharmaceuticals’ negative results—declining sales and profitability—affecting its consolidated financials.

Following the spin-off, Reckitt Benckiser will be a pure-play consumer goods company focusing in the areas of Health, Hygiene and Home as well as the non-core category of Foods. As a company comparable to Procter & Gamble Co (PG US), Unilever NV (UNIA NA), Colgate-Palmolive Co (CL US) and Clorox Co (CLX US), it has a high return on equity and a relatively stable stream of sales. Consequently it is expected to continue trading at a P/E multiple above 20x. The company’s future is not without challenges though. The markets of developed nations are mature, while growth in emerging markets can be disrupted by various geopolitical and macroeconomic factors, such as currency fluctuations. Post spin-off, the company’s shares could be valued between GBp 3,844 and GBp 4,092. Given the strong performance of consumer staples companies, that many times is not accompanied by similarly strong sales growth rates, one may be concerned about their valuation levels. Reckitt Benckiser’s valuation is, indeed, on an EV/EBITDA basis, in the top third of its ten-year valuation range. Were the company to be valued at the median EV/EBITDA multiple of the last decade, it should be worth GBp 3,583 per share.

Indivior Plc will comprise Reckitt Benckiser’s former RB Pharmaceuticals segment. It is a specialty pharmaceutical business focusing on the treatment of opioid dependence. The vast majority of its revenues are generated from three drugs sold in 44 countries: Suboxone Film, Suboxone Tablet and Subutex Tablet. Aiming on capitalizing on its expertise in the field of addiction, Indivior has a drug pipeline of six products, all of which are in Phase II or Phase III trials and are expected to be launched from 2015 through 2020. Two drugs are extension candidates of its existing Suboxone and Subutex products, with the rest focusing on the treatment of opioid overdose, cocaine intoxication, alcohol dependence and schizophrenia.

At the same time, the company is facing an ever increasing threat from generic competition. The Subutex Tablet was withdrawn from the US market, the company’s most important, with 78% of 2013 sales, in September 2011, while the Subutex Tablet was withdrawn from the same market in March 2013—just as several generic products became available. More importantly, the company is facing the potential threat of generic competition to its main source of revenue, the Suboxone Film. It is expected to lose 25-30% of its US revenue next year due to generic tablet competition. Moreover, Indivior is currently suing four companies for patent infringement of its Suboxone Film with the goal of postponing their entrance to the market. Were its legal efforts to fail, its revenues would be crippled in a relatively short time frame.

Taking into account the uncertainties regarding the success of its pipeline of new products, the fact that some of the new drugs will mostly cannibalize sales of its existing drugs rather than generate new sources of revenue, the expected toll from current generic competition in the US, and the threat to its main product—the Suboxone Film—which depends on judicial proceedings, Indivior must offer a very high rate of return in order to represent an attractive risk/return investment. Valued on a discounted cash flow basis, Indivior shares are worth GBp 165 and GBp 254 using an equity discount rate of 20% and 15%, respectively. Thus, investors may wish to purchase Indivior stock at a price below fair value that would suggest the possibility of realizing high double digit rates of return. However, such a price does not necessarily offer an adequate margin of safety. What if Indivior’s new drugs are not successful, they are launched later than expected, or sales of Suboxone Film decline more than expected due to direct generic competition? To address such a scenario, one may wish to value the Indivior on a “terminal value” basis, assuming 2015 free cash flow to equity will decline indefinitely by 10%. With a discount rate between 10% and 15%, Indivior shares should be valued between GBp 56 and GBp 70. By investing at such a price, one would be able to realize a double digit rate of return even if Indivior’s sales continue to decline, while at the same time getting the company’s drug pipeline for free.

Reckitt Benckiser, prior to the spin-off, is valued between GBp 3,640 and GBp 4,330 per share, with a target price of GBp 4,010 per share. The sum-of-the-parts valuation is significantly below the company’s current stock price. One potential explanation is the fact that Indivior’s earning’s stream should be valued at a significantly lower multiples compared to a consumer staples company. By keeping the pharmaceutical division in-house, Reckitt Benckiser was the beneficiary of having approximately 16% of its operating income valued at a higher multiple than would normally have been the case. After the spin-off, one-sixth of the company’s pre-spin operating income could potentially experience a multiple contraction. Given the material contribution of RB Pharmaceuticals to Reckitt Benckiser’s bottom-line, investors may wish to short the company prior to the spin-off in order to benefit from a lower sum-of-the-parts value of the two stocks shortly after the demerger.

Forestar Group Inc. (NYSE: FOR) is a real estate and natural resource company operating two primary segments: (1) real estate; and (2) oil & gas.

FOR is likely considering separating its real estate and oil & gas businesses, via a split or sale. The disparate segments have minimal synergies, and the complex asset portfolio likely contributes to the dearth of sell-side research coverage and the stock’s significant discount to estimated net asset value. As well, a separation would remove the self-funding real estate business from the capital-consuming oil & gas segment while reducing its exposure to the volatility associated with fluctuations in the energy markets.

Since its spin-off from Temple-Inland in late 2007, FOR’s stock has significantly underperformed on both a relative and absolute basis; indeed, the stock is down roughly 40% as a standalone entity. Not surprisingly, in our view, the company came under pressure from shareholders via a 13D filed in November 2014 to review strategic alternatives for the oil & gas business as well as improve its capital allocation and corporate governance policies, which prompted the retention of Goldman Sachs as an advisor in December 2014. Nevertheless, FOR’s stock continues to trade near a 52-week low (and at a discount to tangible book value).

Based on asset values, one can ascribe a $21 per share value to FOR’s real estate segment and $3 per share to the oil & gas segment. Accounting for net debt of $4, a sum-of-the-parts valuation of $20, implying share price appreciation potential of nearly 40%, can be derived.

Future potential catalysts include a separation of FOR’s businesses, asset sales, and/or share repurchases, as well as strengthening in the energy and/or housing markets. Potential risks include the continuation of the current operating structure, a lack of management execution, commodity price fluctuations, and/or a recession.

PORR AG is Austria’s oldest engineering and construction company. It offers services in building construction, civil engineering, infrastructure construction and real estate development. The company is active primarily in Austria, Germany and Switzerland, while it also operates in Eastern Europe and undertakes infrastructure projects in the Middle East. On August 31, PORR announced its intention to spin off its real estate development business into a separate listed entity that will be renamed PIAG Immobilien AG. The new company will comprise PORR’s interest in two subsidiaries, Strauss and Partner Group (S&P) and publically-listed UBM Realitätenentwicklung AG (UBS AV), as well as non-operational real estate. The transaction was approved by the company’s shareholders on October 27, 2014. While no official announcement with regard to the spin-off date has been made, it is expected that PORR will trade ex-distribution from December 10.

The primary rational for the spin-off is to improve PORR’s balance sheet and lead to value creation by allowing investors to better understand the construction company’s operations. Real estate development is capital intensive, requiring both significant debt and working capital. Both weigh on PORR’s balance sheet, showing a heavily indebted company with a restricted return on equity. Additionally, just a few months prior to the August spin-off decision the company became aware of the opportunity to purchase the 59% of UBM shares it did not already own—due to the willingness of another large shareholder to dispose of his stake—thus allowing its real estate development division to gain material scale and be able to operate on a stand-alone basis.

Besides the management’s published intentions with regard to the spin-off, one may consider that the underperforming real estate division, already leveraged, may be used to offload a considerable amount of debt. Firstly, in the initial spin-off announcement, PORR mentioned that its goal was to create a “net debt-free pure-play ‘Constructor’ ”. On a pro forma basis, PORR still has net debt of EUR 275 million. However, PIAG Immobilien’s pro forma net debt, as of June 30, 2014, stood at EUR 768 million. To understand our assertion that PIAG will be used to free PORR of its debt, one can simply look at the structure of the spin-off; while PORR owns approximately 100% of S&P[1], it will only transfer to PIAG 40%. The remaining 60% interest will be sold to PIAG for EUR 66 million. That amount therefore will not be considered a transfer of equity—as usually happens with spin-offs—but rather will be an equity-neutral transaction with PIAG increasing its assets but also increasing its debt by the same amount, in order to fund the acquisition.

PORR AG, following the spin-off, will be a pure-play construction and engineering company. Since its 2011 turnaround, the company has seen an increase in profitability and an order backlog that has almost doubled. As of June 30, 2014, backlog stood at EUR 4,708 million. Production output[2] for the past twelve months is estimated[3] to be EUR 3,408 million. As a direct consequence of its improving performance, the company has reduced its net debt substantially. That trend continues with the spin-off, as net debt will decrease by more than EUR 100 million. Therefore, the lower debt burden as well as an improved working capital cycle could assist PORR in weathering the cyclical nature of the construction industry. The economic environment in Europe remains challenging, with muted spending, especially on infrastructure projects. However, with a stronger balance sheet, high order book and its ability to generate profit even in the recent challenging years, the company appears poised to benefit when macroeconomic conditions improve. Additionally, PORR is owner-operated, with an investor syndicate controlled by its CEO and its Vice Chairman controlling 55% of the shares. Post spin-off, the company’s valuation is estimated between EUR 43.2 and EUR 50.4 per share, with a target price of EUR 48.9 per share.

The newly created entity, PIAG Immobilien AG, will focus on real estate development. Its operating model relies on the construction of real estate properties—residential, office, retail and hotels—their short-term management and eventual sale. Thus, PIAG will not rely on an income stream from rents. Rather, it will constantly replenish its asset base, building new properties while disposing of older ones. The spin-off involves transferring 40% of PORR’s stake in Strauss and Partner to PIAG, with the spin entity purchasing the remaining 60%. Additionally, PIAG will take over PORR’s 41% interest in UBM as well as its options and commitments to acquire more UBM shares. As of June 30, 2014, PIAG had pro forma net debt of EUR 768 million, five times its shareholders’ equity. That fact, combined with the real estate segment’s weak profitability, cast doubt into the company’s ability to survive. In fact, were it not for PORR/PIAG pursuing the UBM acquisition, one could reasonably believe that is the purpose of the spin-off. On a net asset value basis, PIAG Immobilien could be valued between EUR 4.1 and EUR 4.7 per share. However, a downside scenario with a price target of zero should be taken into account.

Prior to the spin-off, PORR’s sum-of-the-parts valuation is estimated at EUR 53.1 per share, with a low case valuation of EUR 43.2 per share and a high case of EUR 55.1 per share. The mid- and high-case scenarios do provide for a return of 7% and 11%, respectively, while the low-case scenario, which assumes no value for PIAG, allows for a 13% downside. Due to the limited upside, along with a potential stock price collapse for PIAG shortly after the spin-off—perhaps justifiably, according to the analysis presented herein—investors are advised to purchase PORR stock only after the spin-off, at a price that would lead to an attractive return even in the low case scenario, while completely avoiding PIAG Immobilien, regardless of its stock price.