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.

Somfy SA (SO FP) is a French company that specializes in the manufacturing and selling of motors and controls for awnings, blinds, shutters and garage doors through Somfy Activities. Additionally, through its subsidiary, Somfy Participations, it invests in companies that mainly operate outside the company’s core activities. On August 28, 2014, Somfy announced that its Supervisory Board approved in principal the demerger of its investment subsidiary, Somfy Participations. The standalone company will be floated on the Euro MRF market of the Luxembourg Stock Exchange and will be renamed Edify SA. There will be 5,060,620 shares issued, implying a distribution ratio of approximately 0.68 Edify shares for each Somfy share. Shareholders will have the discretion to elect a distribution either in cash—EUR 50 per Edify share—or in shares of the new company. Therefore it is likely that Somfy will end up holding a stake in the spin entity. The controlling Despature family, which owns 74% of the shares, has announced that it will receive its consideration in shares of the new company. The spin-off was approved by Somfy’s shareholders on November 27, 2014. The parent company is expected to trade without the right to Edify shares, or the cash consideration, from December 2, 2014. The period during which eligible shareholders can elect to receive their consideration in cash or shares will last until December 12. Edify shares are expected to start trading between December 19 and December 22.

The spin-off will lead to the creation of two pure-play companies that will also better cater to individual shareholders preferences. Given that the new entity will have shareholders’ equity of approximately EUR 250 million, its float-adjusted market capitalization is expected to be very small—given that the Despature family will own 74% of the shares outstanding and Somfy will own the shares of investors electing the cash payment. Consequently, one cannot rule out that the controlling family may not seek a full privatization of Edify. Such a transaction can be consummated with a minor cash outlay. The caveat is that, while strategically reasonable, a buyout shortly after the spin-off may conflict with French laws regarding preferential tax treatment for spin-offs.

Post spin-off, Somfy will be a pure operating entity in the home improvement industry. Besides the assets attributed to Somfy Activities, the parent company will retain the 34% interest in Faac SpA that is currently considered one of Somfy Participations’ holdings—due to the similarity in their operations. Its products include motors, remote controls, sensors and other automation solutions and technologies for shutters, awnings, windows, blinds, gates and garage doors. Following the spin-off, Somfy’s valuation range is estimated between EUR 174.6 and EUR 190.7 per share.

Edify SA will be a Luxembourg entity that will comprise Somfy’s Somfy Participations subsidiary. It will be an investment holding company that focuses on companies undergoing change or transaction. Its investment horizon is long term and its approach is similar to that of private equity companies. Its portfolio includes investment in eight companies. Pro forma shareholders’ equity stands at EUR 256 million. Based on peer NAV multiples of 0.6x to 1.4x, Edify could be valued at EUR 48.2 per share. Based on earnings power, Edify’s shares are valued at EUR 32.6 per share. Thus, holders of Somfy SA should consider opting for the cash consideration instead of shares.

The sum-of-the-parts valuation for Somfy, prior to the spin-off, ranges from EUR 196.8 to EUR 224.7 per share, with a target price of EUR 214.6 per share. The upper end of the range assumes that shareholders elect the cash consideration of EUR 50 per Edify share.

However, investors should take note of two additional scenarios that could potentially lead to short or long term gains. The first one takes into account that the current Somfy shareholders who believe that Edify is worth less than EUR 50 per share will elect the cash consideration. The same applies for investors not wishing to hold Edify—for various reasons that usually lead to the outperformance of recently spun off companies. Thus, forced selling after the demerger is unlikely to take place. Moreover, informed shareholders who assigned a sub-EUR 50 value to Edify shares will also have exited. Consequently, it is highly unlikely that in the first days of trading there will be many sellers below the EUR 50 mark—with the possibility of pushing the Edify stock price above that level.

The second scenario takes into account the owner operator nature of the company. The Despature family controls approximately 74% of the shares, valued at EUR 1.25 billion. Thus, the decision to allow shareholders to receive EUR 50 per Edify share implies that they place the intrinsic value higher than that. Such a high valuation is not justified by Somfy Participations recent earnings power. However, no one should underestimate the actions of successful shareholders with insider knowledge and control. It may very well be that after a short period of softness, Edify’s earnings increase substantially, to justify the EUR 50 book value per share. If not, the owner operator can take other actions to unlock shareholder value, such as selling some of the portfolio holdings. Regardless of the path, long term shareholders could profit by following the insiders.

On June 10, 2014, B/E Aerospace, Inc. (NASDAQ: BEAV) announced plans to spin off its Consumables Management Segment, consisting of the company’s aerospace division and energy services, business into a new company, to be named KLX, Inc., through a tax-free distribution of shares to BEAV shareholders. The parent company, which achieved revenue of approximately $3.5 billion in F2013 (13% year-over-year growth) and is expected to achieve revenue of approximately $4.3 billion in F2014 (23% year-over-year growth), has grown through over two dozen acquisitions to become one of the largest manufacturers of aircraft seating and cabin interiors—an estimated $12 billion market by 2016 growing at a 4.6% CAGR by 2020. BEAV is the established leader in each of its product categories, holding over 50% share of the aircraft seating market.

The aircraft manufacturing industry, which has contracted and expanded considerably over the past ten years, is currently experiencing a period of renewed growth. Demand for air travel, which was significantly reduced during the recession (as was purchasing from airlines), has rebounded since 2010, aided by a recovering global economy and continued GDP growth (3.6% average to 2019). Global air traffic increased 5.2% in 2013, following increases of 5.1% and 6.0% in 2012 and 2011, respectively. 2014 forecasts call for a global passenger traffic increase of approximately 5.5% and capacity growth of approximately 5.4%. Load factors (capacity utilization) of 79.5% are at near-record levels, and yields (revenue per mile) have increased 0.2% compared with 2012. Commercial air carrier domestic revenue passenger miles (RPMs) are expected to increase 0.9% in 2014 and grow at an average of 2.2% annually through 2034. Moreover, industry economics have vastly improved, with an expected $19.7 billion in 2014 global airline profits (52% year-over-year growth), marking the fifth consecutive year of profitability.

Growing passenger volumes have accelerated demand for new commercial aircraft, with reported backlog at Airbus SAS and The Boeing Company currently at record levels of $11,396, or approximately 52% of the global fleet, through October (an approximately eight-year backlog). Aircraft production from these two suppliers alone is expected to require over 3.4 million seats from 2014 to 2020.[7] Yet, production is not the only growth lever for BEAV’s aircraft manufacturing and services business. Equally important is the delayed replacement of aging aircraft over the 2008-2011 period, which has created an extensive, multi-year retrofit cycle. With an active fleet of approximately 23,000 commercial jetliners competing for passengers (particularly high-margin business travelers), the aircraft interior has become a strategic battleground, resulting in continued replacement of interior components as well as retrofit and refurbishment to improve customization and brand positioning. Ultimately, the motivation for airline operators is to maximize profitability, energy-efficiency, and use of space. Aircraft interior design changes can greatly influence passenger appeal, create incremental seating, and remove excess weight (decreasing fuel consumption and carbon dioxide emissions)—significantly improving airline economics and creating value well in excess of design and development costs.

For BEAV, the industry’s intensifying competitive dynamics and strong secular trends, coupled with an ongoing recovery in the consumables market and sticky customer relationships, have generated exceptional (and consistent) financial performance and stable operating metrics. The company’s sales growth has averaged 20% over the past three years—more than double the growth rate of leading aerospace carriers Boeing (NYSE: BA) and Airbus (NYSE: AIR), which have averaged 9% over the comparable period. BEAV’s growth rate is also more than double rate of industry growth (approximately 8% CAGR from 2011 to 2016), underscoring the company’s adept product development and market share gains. Moreover, while the capital intensity of the airline industry may limit long-term earnings growth to the single digits, BEAV has the advantage of being the supplier for a product that we believe is typically sole-sourced, resulting in enduring customer relationships and more attractive operating margin (approximately 18%, versus 14% for its closest competitor, Zodiac Aerospace [ZC.FP]). The company is among the top earnings growers in the aerospace sector (24% and 20% EPS and EBITDA margin growth, respectively, in F2013), and is characterized by an extremely high level of production visibility, owing to $8.9 billion in total backlog (almost double estimated F2015 revenue). When coupled with the company’s over $9.0 billion installed base of products within the global aircraft fleet, BEAV has substantial potential revenue streams that should continue to generate above-average industry growth. Post-spin, BEAV should be able to sustain a low-teens organic growth rate—owing to a market-leading position, a mix shift toward wide-body aircraft (which require as much as $10 million of product versus under $1.5 million for a typical narrow body aircraft), a strong position in business and first-class interiors (which are growing as a portion of the overall seating market), and the discretionary portion of roughly 40% of the company’s business (a positive when airlines are highly profitable).

The spin-off entity, KLX, comprises BEAV’s Consumables Management Segment (CMS) and focuses on distribution, logistics, and technical services for the aerospace and energy services markets. The Aerospace Solutions Group (ATG), 80% of CMS sales, is the largest distributor of aircraft fasteners (nuts, bolts, screws, etc.), consumable products (e.g., spare aircraft seat parts) and supply chain services—a $4.7 billion addressable market in 2013. Energy Technical Services (ETS), 20% of sales, provides wireline and retrieval services, rental equipment, and other related components to oil and gas drillers—an estimated $15 billion addressable market. The total CMS business has grown at a 13% CAGR (including acquisitions) since 2009 and generated 2013 revenue of approximately $1.3 billion. Like the post-spin parent company, KLX should continue to generate low-teens annual revenue growth, with potential upside stemming from its energy services business, which addresses a market 2x to 3x larger than the aerospace consumables industry and is growing at a double-digit growth rate. Operating margins for the services business are slightly higher than for manufacturing, averaging 19% over the past four years, and are well above peers, at 11%. EBITDA margins are also well above peers, having averaged 21% over the same period, compared to a peer average of 12%. In addition, energy services acquisitions have been highly accretive, resulting in the company’s recent upward revision to earnings guidance.

The timing of the proposed spin-off appears opportune considering that aircraft manufacturers are consolidating their supply chains as they reduce costs and accelerate production. With components representing more than two-thirds of overall aircraft manufacturing costs, Boeing, for example, is seeking to compensate with its Partnering for Success (PFS) supply chain policy, which seeks pricing discounts (reportedly between 15% and 25%) from suppliers in exchange for purchase volume. Considerable M&A speculation has surrounded BEAV since a May 2014 announcement that the company was exploring strategic alternatives. Fueling this speculation is public commentary from German aircraft seating manufacturer RECARO Aircraft Seating GmbH & Co. (privately held), which noted its interest in purchasing BEAV assets. RECARO, the market leader for economy seats, is making a strategic push into the more profitable premium seating market. Ultimately BEAV’s potential takeout valuation—which would have to consider a robust backlog and ramping retrofit cycle—coupled with the potential lack of synergy associated with the energy services business makes a spinoff a more viable strategy versus an outright sale or divestiture of the distribution business. By separating the interiors business from distribution, both entities appear more attractive as acquisition targets for a large commercial aircraft manufacturer or broad-based industrial distributor, given their profitability, stability, and continued industry consolidation. Regardless, the separation should lead to incremental cost synergies and increased operational flexibility for both entities. In addition, management will be able to focus increasingly on efficient capital allocation, free cash flow distribution policy, and growth initiatives.

Also worth noting is that senior management, en masse, are going to KLX; executive leadership for post-spin BEAV is likely to be announced at the company’s upcoming investor day on December 1st. BEAV has a 50% share of its market; so in the intermediate- to longer-term time frame, the acquisition-based component of its historical growth rate will dissipate. With KLX, not only will management be able to stay with a longer-growth-trajectory vehicle, but they might well secure better stock options and stock award packages, since KLX has a greater likelihood of trading at low initial valuation multiples. This may be a reason for management, which has intensive experience with a roll-up strategy, to potentially jump to a smaller vehicle with the same future possibilities as the parent company enjoyed.

While both companies are strategically well-positioned, an important investor concern centers around the long-term health of the aero cycle and the potential for an aircraft production bubble—particularly given BEAV’s 40% revenue exposure to original equipment manufacturers (OEMs), which is in turn linked to a civil aircraft delivery cycle that is expected to decelerate beginning in 2016. That said, BEAV appears able to sustainably outgrow the market and maintain double-digit revenue and earnings growth, owing to two trends. First, a continued mix shift toward wide-body aircraft should increase BEAV’s average revenue per seat (given more business class and food service solutions) and in turn drive incremental revenue growth. Second, BEAV should be able to grow its penetration within the cabin interior with its successful next-gen lavatory retrofit product.

The recent decline in fuel prices is also worth noting as a potential risk factor for both businesses should aircraft operators decide they can more profitably operate their existing fleets at the expense of new aircraft (fuel represents approximately 35% of airline operating costs). While oil, at approximately $75 per barrel, has indeed declined precipitously over the last six months, prices still appear too high to offset other fixed costs that would result in any meaningful production changes by aircraft operators. Also alleviating production concerns is the rate of global air traffic growth, which continues to outrun capacity, and robust utilization rates, with high load factors coupled with net delivery growth being measured at 2% to 3% per year. Moreover, the useful life of an aircraft has decreased from 28 to 21 years since 1999 given very poor economics on the fuel consumption of older aircraft, resulting in a spike in replacement demand.

While constructive on the long-term outlook for both companies, we believe the shares are likely to experience volatility leading into and following the spin-off. BEAV’s initial F2015 earnings guidance, pro forma for the spin (expected on December 1) may be moderately below consensus expectations—owing to higher interest expense associated with recent debt issuance, and incremental recurring expenses and a higher tax rate associated with KLX as an independent company. Another headwind is the potential for shareholder turnover given market capitalization and investment profile disparity between the companies. Post-spin KLX is likely to generate a market capitalization below $3 billion, which may cause large-cap, growth investors currently invested in BEAV to sell KLX on the spin-off. BEAV is currently present as a top-10 holding in three ETFs, which have an aggregate Assets Under Management (AUM) in excess of $5 billion. These ETFs track S&P mid-cap growth indexes, increasing the likelihood that KLX does not get pulled into another set of indexes or ETFs with significant amounts of AUM. Post-spin BEAV is a well-understood, more structural aerospace manufacturing story tied to OEM production and cabin retrofit. Expansion into lavatory retrofits, full galleys, and lighting systems also creates the potential for incremental earnings leverage. KLX, by contrast, faces negative headwinds associated with valuation multiple contraction in the energy sector, coupled with unfavorable comparable valuations. Ultimately, KLX’s energy services business will be valued against the Thomas Tools division of Schlumberger (NYSE: SLB), whose sale is expected to generate a valuation in the 6x to 7x EBITDA range. Longer term, however, the company appears competitively better positioned than peers and should benefit from a recovering aftermarket, coupled with the potential to accelerate both revenue and earnings growth from its expansion into a highly fragmented energy services market growing 20% annually.

Based on an analysis of projected EBITDA, sales, and assets, as well as potential acquisition multiples and dividend associated with the post-spin parent, one can arrive at post-spin fair value estimates of $55 for BEAV and $26 for KLX (based on a 1:1 exchange ratio). KLX will likely be accorded a lower multiple than BEAV, owing to a lower growth rate and visibility associated with the aftermarket and risk associated with the expansion into energy services. The spin-off should allow each entity to determine its own capital structure, cash allocation, and growth strategy, while making one or both more attractive as acquisition targets. Yet, with a sum-of-the-parts analysis suggesting a fair value of $81 per share, the transaction does not appear to offer enough potential price appreciation to warrant a purchase recommendation at this time. Coupled with a potential guidance reset and turnover in the shareholder base, we would recommend waiting for a better entry point on KLX below $22. While the current sum-of-the-parts analysis does not appear to unlock substantial incremental value, a look at BEAV’s historical performance may prove useful for longer-term investors, particularly given the strategic value of these assets and the potential for a renewed aerospace manufacturing growth cycle. Assuming KLX’s energy services business can demonstrate evidence of accelerating revenue and earnings growth, improving industry fundamentals and more favorable investor sentiment, it is reasonable to assume the business can expand into a 7x multiple (the high end of the comparable range). Similarly, should aerospace aftermarket demand continue its recovery, this segment of the business could expand into a 12.0x multiple (BEAV’s 10-year historical average), suggesting a valuation for post-spin KLX of $32 (23% upside to our fair value estimate). Similarly, it is feasible that BEAV’s manufacturing business may be able to expand from a 10.0x multiple today to 12.0x (its 10-year historical average) with incremental evidence of re-accelerating F2016 growth, suggesting a fair value of $64 (16% upside to our fair value estimate)