ALERT: ARMK to Spin-Off Uniform Services Business

On May 10, 2022, before the market open, Aramark (NYSE: ARMK) announced that the company plans to separate Aramark Uniform Services (AUS) into a separately traded public company. The separation is expected to be completed via a tax-free spin-off of shares in AUS to ARMK shareholders of record as of a yet to be disclosed record date. Management currently expects to complete the transaction by the end of F2023 (September year-end), and is subject to customary conditions including final Board approval, and receipt of a favorable tax status opinion from the IRS.

In conjunction with the spin-off, AUS will raise a yet to be determined debt, which will be used to fund a one-time cash dividend that will be paid to ARMK. ARMK will use the debt proceeds to reduce its outstanding debt. Both companies are expected to have targeted leverage ratios below 3.5x.

Aramark is a provider of food, facilities, and uniform services to education, healthcare, business & industry, and sports, leisure & corrections clients. The company is currently comprised of three business segments: (1) Food Service & Support (FSS) United States as well as (2) FSS International, which accounted for a combined 80% of consolidated sales and 70.5% of EBITDA in F2021 and are focused on providing outsourced cafeteria and concession services as well as facility services (e.g., maintenance, custodial, and landscaping) to the education, healthcare, corporate, sports, and corrections markets; and (3) Uniform (20% of sales and 29.5% of EBITDA in F2021), which provides a full range of employee uniform solutions, including design, manufacturing, and maintenance/cleaning.

In conjunction with the spin-off announcement, ARMK announced 2Q F2022 earnings, which included year-over-year revenue increase of 37%, of which 35% was deemed organic growth. Notably, 2Q F2022 total company revenue was at 95% compared to pre-COVID 2Q F2019. Additionally, ARMK updated its F2022 guidance to include organic revenue growth of ~27% (previously 23% – 27%), annualized net new business of $650 – $750 million (previously $550 – $650 million), adjusted operating margin of ~5% (previously 5.0% – 5.5%), and free cash flow of $300 – $350 million (previously $300 – $400 million).

PRELIMINARY VALUATION

In F2021, sales at the combined FSS business, including both the domestic and international segments, declined roughly 6% to $9.7 billion, with EBITDA of $606.8 million (or margin of 6.3%). Revenue and profitability of the FSS segments have been negatively impacted by COVID related shutdowns and changes in end user behavior, and revenue remains below pre-COVID F2018 revenue of $13.8 billion. (EBITDA margins were 9.4% in F2018). Based on current trends and guidance, which includes the impacts of the current inflationary environment and the lagging nature of the company’s ability to take price on contracts, the FSS business could be reasonably projected to post combined F2023E sales of $13.8 billion, with EBITDA of $1.3 billion. Public comparisons to FSS could include Compass Group (CPG LN), Sodexo (SW FP), Elior Group (ELIOR FP), and SSP Group (SSPG LN), which trade at roughly 7.5x 2020E EV/EBITDA on average, albeit in a wide range. We note that we view CPG LN as the most appropriate peer comp and the company trades at 11.7x 2023 EBITDA estimates. Applying a multiple of 11.5x, to FSS F2023E EBITDA implies segment value of almost $15.1 billion.

In F2021, the Uniform segment posted sales decline of 3.8% to $2.4 billion with EBITDA of $254 million (or margin of 10.5%). Based on current trends and guidance, the Uniform segment could be projected to generate F2023E sales of more than $2.7 billion, with EBITDA of $374 million, respectively. Public peers could include Cintas Corp. (NASDAQ: CTAS), UniFirst (NYSE: UNF), and Superior Group (NASDAQ: SGC), which trade at ~11x 2023E EV/EBITDA. Notably, in March 2017, CTS acquired competitor G&K Services for $2.14 billion, or ~13.5x consensus forward EBITDA. Applying a discount multiple of 9x to F2023E EBITDA implies segment value of almost $3.4 billion. We view a discounted multiple as warranted given AUS’s margin profile.

Accounting for corporate costs, capitalized at the weighted average of applied segment earnings, as well as net debt of $7.4 billion, implies a preliminary sum-of-the-parts fair value of $9.8 billion, or $38 per share (based on a diluted share count of 258.7 million).

IDT postpones Net2phone spin-off due to “current market conditions” but will look to “monetize the business at an opportune time”

• Last night, after the market close, IDT disclosed that its Board had decided to postpone the spin-off of its Net2phone cloud communications (UCaaS) business, which it had been working to complete on or before the end of its July-ending fiscal year, in light of “current market conditions”.
• That said, the company will continue to execute on its growth strategy (while striving to make the business “bottom line accretive”) and to “monetize the business at an opportune time”.
• All things considered, this delay is not likely all that surprising to investors as it seems evident that the spin-off of what would be a relatively small (albeit rapidly growing), unprofitable (for the moment) UCaaS business was not likely to be received with great enthusiasm by the market in the current environment.  (As well, we have always viewed the potential/eventual separation of the company’s National Retail Solutions or NRS business as a significantly more meaningful catalyst.)
• For context, in 2021 IDT’s Net2phone business posted 38% top-line growth to $44 million with operating and EBITDA losses of $14.3 million and $9.3 million, respectively.  In 1H 2022, the business generated sales growth of 28% to ~$26.5 million with operating and EBITDA losses narrowing modestly to $7.1 million and $4.8 million, respectively.  In our estimation, Net2phone is likely to post compound annual top-line growth in the mid-to-high 20%’s through F2023E when it would approach EBITDA breakeven (although management’s commentary suggests an increased focus on profitability that could pull forward our perceived timetable on the profitability front).
• Simply as a reminder, we note IDT ended 2Q F2021 no debt and $148.3 million in net cash (or roughly $5.80 per share).
• Our base case fair value estimate is ~$60 per share, which values IDT’s Traditional Communications segment at 5.0x F2023E EBITDA, applies sales multiples of 2.5x and 8.0x to the company’s Net2Phone and Fintech businesses, respectively, and accounts for ~$215 million of projected net cash (see Exhibit #1 on page 2).

ALERT: VSTO to Spin-Off Outdoor Products Business

On May 5, 2022, before the market open, Vista Outdoor Inc. (NYSE: VSTO) announced that its Board of Directors has approved a plan to spin-off its Outdoor Products segment into a separate, independent, publicly traded company. The spin-off is expected to be tax-free to shareholders and is currently targeted to be completed in calendar year 2023, subject to customary closing conditions including an effectiveness declaration of a Form 10 filing with the SEC, and final Board approval.

In its current form, VSTO operates under two reportable segments: Sporting Products (aka Shooting Sports) (57% of revenue), and Outdoor Products (43% of revenue). The Sporting Products segment is primarily focused on sales of ammunition used in sporting rifles, handguns, and personal protection. In addition to ammunition used in training and recreational target shooting, the segment also sells reloading components for self-loading ammunition, optics (binoculars, telescopes, etc.), and accessories including clay targets, holsters, game calls, and decoys, amongst others. In F2022 (March year-end), Sporting products generated $1.7 billion in revenue and $626 million in EBITDA. F2022 revenue increased 55% versus the prior year driven by acquisitions, improved pricing, and strong demand for the company’s ammunition products. EBITDA margins widened to 36% from 22% in the F2021 as higher gross margin on products was only partially offset by increased SG&A costs from acquisitions

Outdoor Products sells a variety of outdoor sports accessories, including helmets, and goggles for cycling, action sports, and power sports, golf laser rangefinders, hydration packs, water bottles, and outdoor cooking equipment. The Outdoor Products segment generated $1.3 billion in revenue in F2022, representing a 18% year-over-year increase as the company saw increased demand across its product categories and benefited from acquisitions over the prior year period. Outdoor Products EBITDA margin of 16% was approximately flat versus the prior year as the increased sales and gross margins were offset by increased SG&A expenses due to acquisitions and investments made in sales and marketing efforts.

On a consolidated basis, the company has issued F2023 guidance that includes revenue of $3.15 billion to $3.25 billion, adjusted EBITDA margins of 20.5% to 21.5%, adjusted EPS of $7.00 to $7.75, and free cash flow of $300 million to $350 million. Imbedded in the F2023 guidance, management expects Sporting Products sales growth in the mid-single digit range, and Outdoor Products sales growth in the high-single digit range.

PRELIMINARY VALUATION

Following the separation, it can be expected that despite the faster growth, higher margin, and repeatable sales nature of its consumables business, the Sporting Products as a standalone company will continue to be awarded a relatively low valuation multiple given the discount valuation the firearm’s related industry has historically been awarded. Conversely, the Outdoor Products business, without the stigma of the firearms focus would be rerated higher. We compare the Sporting Products business to Strum Ruger & Co. Inc. (NYSE: RGR) and Smith & Wesson Brands Inc. (NASDAQ: SWBI), which currently trade at 5.5x and 2.0x their respective 2022 consensus EBITDA estimates. We compare the Outdoor Products business to a basket of companies involved in outdoor sporting goods including Callaway Golf (ELY), Yeti Holdings Inc. (YETI), and Brunswick Corp. (BC), amongst others, which on average trade at approximately 8x the consensus 2022 EBITDA estimates. Notably, VSTO currently trades at 3.9x the 2022 consensus EBITDA estimate.

We forecast that as standalone companies, the Outdoor Products business would increase revenue by 8% and operate with a 16.0% EBITDA margin, inline with F2022, resulting in F2023 revenue and EBITDA of $1.4 billion and $226 million, respectively.  Valuing the Outdoor business at 8.0x our EBITDA estimate implies an enterprise value of $1.8 billion. The Sporting business is forecast to increase revenue by 5.0% and operate with a 28% EBITDA margin resulting in F2023 revenue of $1.8 billion and EBITDA of $511 million. Valuing the Sporting business at 4.0x implies an enterprise value of $2.0 billion.  We note that the Sporting business EBITDA margin assumption is below that of F2022 levels but inline with historic operating performance of the segment.

Incorporating current net debt of $644 million and 56.1 million shares outstanding, on a preliminary, pre-spin, sum-of-the-parts basis shares of VSTO are fairly valued at $57 per share.

ALERT: FBHS to Spin-Off Cabinets Business

On April 28, 2022, after the market close, Fortune Brands Home & Security Inc. (NYSE: FBHS) announced that its Board of Directors has authorized the company to pursue a tax-free spin-off of its Cabinets business. If completed, it is posited that the separation would be completed in approximately 12 months from the announcement, implying a 2Q 2023 distribution to shareholders. The separation is subject to customary closing conditions including an effectiveness declaration of a Form 10 filing with the SEC, and final Board approval.

As the company stands today, FBHS operates under three reporting segments: Plumbing (36% of sales), Outdoors & Security (27% of sales), and Cabinets (37% of sales).

• Plumbing manufactures and sells a variety of faucets, kitchen sinks, waste disposals, and accessories under well known brand names such as Moen, ROHL, Riobel, and Victoria+Albert, amongst others. Plumbing generated $2.8 billion in revenue and $630 million in operating income. Major customers include The Home Depot and Lowe’s, which account for 21% of segment sales.
• Outdoors & Security manufactures and sells fiberglass and steel entry door systems, storm, screen and security doors, composite decking, railing, and cladding, as well as urethane millwork under a variety of brand names. Additionally, the segment sells locks, safety, and security devices under the Master Lock and American Lock brand names, as well as a portfolio of fire resistant safes and security containers. The Home Depot and Lowe’s account for 30% of segment sales. The segment generated $2.0 billion in revenue and $292 million in operating income in 2021.
• Cabinets manufacturers stock, semi-custom and custom cabinetry, and vanities for kitchens and bathrooms. The Cabinets segment generated $2.9 billion in revenue and $279 million in operating income in 2021. The Home Depot and Lowe’s were responsible for 39% of segment sales in 2021

Following the separation, as a pure-play Cabinet company, the spin will give investors exposure to the leading cabinet company in North America which exhibits a lower growth profile than the current corporate rate, while the parent company’s Plumbing, and Doors & Security segments top line growth will improve as the company capitalizes on current housing market trends, which includes limited existing homes available for sale and an increasing rate of homeownership.

PRELIMINARY VALUATION

On a pro-forma basis, the Cabinets business would have generated $2.9 billion in sales and approximately $300 million in operating income, representing a 10.1% margin, in 2021. Recent revenue growth, 3.3% in 2020 and 15.6% in 2022, has benefited from increased demand across the product portfolio and price increases taken to mitigate commodity and transportation cost increases. Additionally, segment sales volume was impacted by COVID-19 in 2020, creating a favorable comparison in 2021. Management has highlighted that it expects to continue a trend of “above-market performance in the most attractive segments” and expects to reach a mid-teens operating margin while generating significant free cash flow.

For its part, the pro-forma parent company would have generated $4.8 billion in revenue and approximately $900 million in operating income, representing a 19.5% margin, in 2021. Revenue growth has been strong across the company’s two segments, with Outdoors revenue generating a 19.9% CAGR since 2018, while Plumbing generated a 13.6% CAGR over the same period. Post-separation the company looks to accelerate its growth profile, which may be supplemented by potential M&A.

We conservatively estimate that the Cabinets business can increase at 5% annually, while the parent company will continue to experience low-double digit revenue growth of 12% annually. If the Cabinets business operates with a 12% EBITDA margin, inline with pro-forma 2021 results, the company would generate $378 million in EBITDA, while the parent company would generate $1.3 billion in EBITDA if it were to maintain its 22% EBITDA margins. In terms of valuation multiples, the Cabinets business is most directly comparable to American Woodmark Corp. (NASDAQ: AMWD), which currently trades at 6.3x the consensus 2023 EBITDA estimate. The parent company would likely see multiple expansion to reflect the improved growth and margin profile post-spin and could be compared to other composite deck manufacturers such as Trex Company Inc. (NYSE: TREX) and The AZEK Company Inc. (NYSE: AZEK), which on average trade at 12.3x 2023 EBITDA estimates, and building supply companies such as MASCO Corp. (NYSE: MAS), TOTO ltd. (5332 JP), and Armstrong World Industries Inc. (NYSE: AWI), which on average trade at 9.2x the 2023 consensus EBIDA estimate. FBHS currently trades at 8.4x the 2023 consensus EBITDA estimate.

Applying a 6.5x multiple to the cabinets business and a 10.0x multiple to the parent company results in respective enterprise values for the post-separation companies of $2.5 billion and $13.2 billion. Incorporating approximately $3.0 billion in net debt and 132.3 million shares outstanding, on a preliminary pre-spin sum-of-the-parts basis, shares of FBHS would be fairly valued at $96 per share.

GTX reduces full-year 2022 guidance on lower global auto production and FX headwinds; leverage profile/capital structure profile continues to improve/simplify; fair value adjusted to $11 per share (from $12)

• This morning, GTX posted 1Q 2022 a net sales decline of ~10% (or 6% on a constant currency basis) to $901 million, on a ~10.5% decline in unit volume to 3.4 million, with a ~17% decline in adjusted EBITDA to $146 million, reflecting a 150-basis point deterioration in the margin to 16.2%. Free cash flow (FCF) was $38 million (versus $140 million in the prior year period).
• The company ended 1Q 2022 with a net leverage ratio, including Series B Preferred stock, of 1.88x (versus 1.95x at the end of 2021, 2.55x at the end of 3Q 2021 and 2.73x at the end of 2Q 2021), reflecting the prepayment of $191 million in the Series B stock during the quarter. In our view, GTX continues to make solid progress toward the de-leveraging and simplification of its balance sheet and capital structure (i.e., into just debt and equity), which is a process that we expect will be completed, at the latest, by April 2023. As well, the company has ~$79 million on the $100 million buyback program that was authorized in November 2021.
• Given current market conditions, which continue to be impacted by the on-going chip shortage/supply chain disruptions as well as increased currency fluctuation headwinds, management lowered its full-year 2022E guidance, which now calls for net sales of $3.5-$3.7 billion (previously $3.7-$4.0 billion) with adjusted EBITDA of $530-$590 million (previously $590-$650 million) and GAAP net income of $250-$295 million (previously $295-$340 million). Adjusted free cash flow is expected to be $330-$430 million (previously $$400-$500 million; see Exhibit #1 on page 2). Notably, GTX’s revised guidance assumes global light vehicle production is roughly flat at ~77 million units (compared with its prior guide, which forecasted 7% growth to ~80.1 million units).
• Our fair value estimate is revised to $11 per share (from $12), which reflects a constant 8.0x multiple on our 2023E adjusted net income forecast of $428 million (previously $470 million) and a diluted share count of ~325 million. For context, on an EV/EBITDA basis, our valuation implies a ~6.0x multiple (see Exhibit #2 on page 2).

EHC posts a modest beat in 1Q 2022 and maintains full-year 2022 sales, adj. EBITDA and EPS guidance (with an increase in its FCF expectation); tax-free spin-off its Home Health & Hospice business, Enhabit, expected to be effectuated July 1^st

• Last night, after the market close, EHC reported 1Q 2022 consolidated sales up 8.4% to ~$1.334 billion (vs. consensus of $1.326 billion) with declines of 2.3% and ~7.5% in adjusted EBITDA and EPS to $245 million and $0.97, respectively (vs. consensus of $243.5 million and $0.91).  Adj. free cash flow improved 54.5% to ~$166 million.
• By segment, Inpatient Rehabilitation sales increased ~10.4% to $1.059 billion with an ~4% decline in adjusted EBITDA to $226.2 million while Home Health & Hospice revenue improved 1.4% at ~$274.3 million with a ~1.5% decline in adj. EBITDA to $50.1 million.
• The company ended 1Q 2022 2021 with net debt of ~$3.17 billion, including cash of $94 million and debt of $3.264 billion, and a leverage ratio, by our calculation, of 3.1x (compared with 3.1x and 3.6x at the end of 2021 and 2020, respectively, and its covenant of 4.25x). 
• In terms of guidance, management maintained its initial full year 2022E forecasts (see Exhibit #1 on page 2), which called for consolidated sales $5.38-$5.5 billion (vs. current consensus of $5.461, adjusted EBITDA of $1.015-$1.065 billion (vs. consensus of $1.045 billion) and adj. EPS of $3.83-$4.19 (vs. the consensus estimate of $4.10).  The company increased its free cash flow (FCF) guidance to $405-$555 million (from $365-$510 million).
• As well, EHC maintained its long-term growth targets (i.e., 2022-2026) for both IR and HH&H, which call for discharge and admissions growth of 6%-18% and 10%-15%, respectively (see Exhibit #2 on page 2).
• The company disclosed that the previously announced spin-off of its Home Health & Hospice business, which will be rebranded Enhabit Home Health & Hospice, is expected to be effectuated on July 1, 2022. As well, management indicated that it expects to provide separate guidance for both entities (i.e., EHC and Enhabit) in 1H 2022.
• Our fair value remains $81.50 per share, reflecting a blended multiple of ~9.5x on 2023E adj. EBITDA of $1.2 billion along with projected net debt, including minority interest, of ~$3.3785 billion (see Exhibit #3 on page 2).
• EHC will hold a conference call this morning at 10 a.m. (ET); call-in at (866) 342-8591 with the passcode EHC1Q22.

Drop Coverage of CNH Industrial N.V. and Iveco Group N.V. Effective Immediately

• On December 30, 2021, CNH Industrial N.V. (NYSE: CNHI, CNHI IM) completed the spin-off of its “on-highway” business, which adopted the corporate moniker Iveco Group N.V. Shares of Iveco trade on Borsa Italiana under the ticker “IVG”.
• Given the transactions have now passed our coverage mandate of 90 days post-spin, we DROP coverage of CNH Industrial N.V. and Iveco Group N.V. effective immediately.
• Our prior estimates and fair values for CNHI, and IVG IM should no longer be relied on.

Drop Coverage of Bread Financial Holdings Inc. and Loyalty Ventures Inc. Effective Immediately

• On November 5, 2021, after the market close, Alliance Data Systems Inc. (previously traded on the NYSE under the ticker “ADS”) completed the spin-off of Loyalty Ventures Inc. (NASDAQ: LYLT). Subsequent to the spin-off, ADS changed its corporate moniker to Bread Financial Holdings Inc., and now trades on the NYSE under the ticker “BFH”.
• Given the transactions have now passed our coverage mandate of 90 days post-spin, we DROP coverage of Bread Financial Holdings Inc. and Loyalty Ventures Inc. effective immediately.
• Our prior estimates and fair values for BFH, and LYLT should no longer be relied on.

AT&T Completes Spin-Off of WarnerMedia, RMT with Warner Brothers Discovery (formerly Discovery Inc.); Adjust T FVE to $21 per Share, Maintain NEUTRAL Rating; Maintain $35 FVE and BUY Rating on Warner Brothers Discovery

• On April 8, 2022, after the market close, AT&T Inc. (NYSE: T) completed the spin-off of its WarnerMedia business, which immediately merged with Discovery Inc. in a Reverse Morris Trust (“RMT”) transaction.
• Following the merger, Discovery changed its corporate moniker to Warner Brothers Discovery Inc. and will begin trading on the NYSE under the ticker “WBD” on April 10, 2022.
• At the end of the transactions, T shareholders of record received 0.24 shares of WBD for each share of T stock owned, resulting in AT&T shareholders owning 71% of Warner Brothers Discovery, with former Discovery shareholders controlling the remaining 29% of WBD.
• Following the spin-off of WarnerMedia, AT&T will be a more focused company that will look to increase its 5G wireless coverage and fiber reach. Within Mobility, the company will accelerate investments to support next-generation network services, with an eye to achieving profitable market share gains.
• It can be expected that upon completion of the merger, WBD’s multiple is likely to expand over time to better reflect the company’s significantly larger streaming subscriber base and could come to approximate the multiples of diversified media peers with sizeable streaming exposure.
• Applying a 10.5x multiple to our 2023 WBD EBITDA estimate, we fairly value shares of Warner Brothers Discovery Inc. at $35 per share. Given the implied upside from the current share price, we rate shares of WBD at BUY.
• We adjust our AT&T fair value estimate to reflect the distribution of WBD shares to T shareholders. We now fairly value shares of AT&T at $21 per share (previously $29 per share), which is derived by taking the average of applying a 7.0x multiple on our 2023 EBITDA estimate and a 6.0% dividend yield on T’s current annual dividend of $1.11 per share.
• In the context of this transaction we favor the risk-reward scenario for shares of WBD versus the risk-reward for T, and as such we rate shares of AT&T at NEUTRAL. We would revisit our recommendation on AT&T if the shares were to sell off beyond a reasonable level following the separation of WarnerMedia.
• For more details, please refer to The Spin Off Report dated March 30, 2022.

Enovis Corp. (formerly Colfax Corp.)Completes Separation of ESAB Corp.; Rate ENOV at NEUTRAL with $73 FVE; Rate ESAB at BUY with $70 FVE

• On April 4, 2022, after the market Close, the company formerly known as Colfax Corp. completed the separation of its fabrication technology business into a separate publicly traded company that adopted the corporate moniker ESAB Corp. ESAB now trades on the NYSE under the ticker “ESAB”.
• In connection with the separation, Colfax rebranded its corporate name to Enovis Corp., and now trades on the NYSE under the ticker symbol “ENOV”.
• Colfax shareholders of record as of March 22, 2022, received one share of ESAB for every share of Colfax owned.
• Following the spin-off, ENOV completed its previously announced one-for-three reverse stock split.
• ENOV retained a 10% stake in ESAB, which the company intends to divest within 12 months of the spin-off in a “tax-efficient exchange for its outstanding debt”.
• We value shares of ESAB at $70 per share, which is based on a 12x multiple of our 2023 EBITDA estimate of $446 million. For reference 2022 EBITDA guidance calls for $400 – $420 million and our valuation multiple is near the low end of the peer group, in line with peer Lincoln Electric Holdings Inc. (NASDAQ: LECO).
• We note that there was limited interest in either company’s when-issued shares, with only ESAB trading 500 shares at $50 per share. Given the implied upside to our $70 fair value estimate, we rate shares of ESAB at BUY.
• We fairly value shares of Enovis at $73 per share, which is based on a 13x multiple of our 2023 EBITDA estimate of $306 million, and includes approximately $8 per share in value attributable to the 10% ownership position in ESAB (valued at our fair value). In pre-market trading this morning, shares of ENOV indicated a previous close of $67.18. Given limited upside to our fair value estimate, we rate shares of ENOV at NEUTRAL.
• For more details, please refer to The Spin Off Report dated November 15, 2021, and UPDATE dated March 15, 2022.