On August 13, 2012, Elan Corporation plc (NYSE: ELN, DUBLIN: ELN) announced it would spin off its biotechnology drug discovery sciences businesses to shareholders. The spin company will be named Prothena Corporation plc and will be listed on the NASDAQ under the symbol ‘PRTA’. The separation has received approval from shareholders and still requires approval from regulatory agencies. Elan will retain an 18% minority ownership position in Prothena through a total contribution of $125 million in start-up capital. The company has declared the effective date for the transaction to be December 14, 2012, and the spin-off is scheduled to be completed by year-end 2012.

Prothena will focus on early discovery and development of pathology-biology-based molecules to be used in treatment of degenerative diseases. The transaction will separate most of the riskier biotech drug discovery business, with its longer development timeline, from the more commercial, profitable, and cash flow positive operations that will remain with Elan.

Prothena appears to have a long road ahead of it in terms of any monetization of its drug programs, given the early development stages of the drugs in its portfolio. Given a lack of revenue and the high likelihood that the company will need to raise additional funds to remain in operation, investors will likely seek a significant margin of safety prior to investing in this speculative company. As seen in prior spin-off transactions of drug development companies, initial trading may experience significant volatility. A fair value estimate of $5.64 per share can be derived for Prothena, taking account of the 1-to-41 share distribution.

Following the separation, Elan will immediately become profitable and will have opportunities to increase sales and return cash flow to investors through any combination of dividends, share repurchase, and/or debt retirement. The removal of Prothena’s operating losses from within Elan is clearly an attempt to maximize shareholder value. The turn to profitability will foster a positive return on equity, book value growth and likely lower the company’s overall cost of capital. However, investors are likely to focus on the fact that Elan is dependent on one product, Tysabri, its drug for the treatment of multiple sclerosis. With Elan’s development pipeline having seen recent setbacks, the near-term risk of competing products and patent expirations beginning in 2020 may weigh on valuations. A fair value estimate of $10 per share can be derived using a variety of valuation metrics.

On a sum-of-the-parts basis, a fair value estimate of $10 per share for pre-spin ELN can be derived. Given ELN currently trades slightly above this fair value estimate, shares are not recommended for purchase prior to the transaction.

On July 19, 2012, PPG Industries Inc. (NYSE: PPG) announced plans to separate its Commodity Chemicals business in a spin-off and immediately merge it with chemicals and building products manufacturer Georgia Gulf Corp. (NYSE: GGC). The separation, which is expected to be tax-free, will require an affirmative IRS ruling, Georgia Gulf shareholder approval, a declaration of effectiveness by the SEC, and any additional regulatory approvals. The merger will be structured as a Reverse Morris Trust transaction, which will maintain the tax-free status of the separation. Following the transaction, PPG shareholders will control approximately 50.5% of the newly merged company, while Paul Carrico of Georgia Gulf will be the CEO. The deal is valued at $2.4 billion based on the current share price of GGC, a $900 million cash distribution paid to PPG, and $182 million in assumed debt and minority interest. The merger is expected to occur in late 2012 or early 2013.

After the separation, PPG Industries will focus on building out its higher-growth coatings and specialty materials businesses, while the merger will afford New Georgia Gulf increased scale in the more commoditized and cyclical business. New GGC will have annual revenue of approximately $5 billion, making it the third largest chlor-alkali producer and fourth largest polyvinyl chloride (PVC) producer in North America.

Unlike a traditional spin-off, there is no wait for ‘price discovery’ in a Reverse Morris Trust transaction. Investors have already weighed the risks and rewards of the spin-off and merger with respect to both PPG and GGC. The stocks, therefore, should already reflect the near-term earnings opportunities of both companies. While this report will consider comparable and historical multiples, management guidance, and transaction costs/synergies, it should not come as a great surprise that no mispricing was uncovered, and neither stock is recommended for a short-term holder prior to the transaction. Based on a study of Reverse Morris Trust transactions over the last decade, it is possible to observe a clear history of selling in the first weeks of existence for newly merged companies. This history also may dissuade investors from considering accumulating shares prior to the transaction.

For long-term investors, however, an opportunity may arise from a potential recovery in the housing market, which should generate growth in sales for both PPG and New GGC, and ongoing soft natural gas prices, which could restrain cost increases. The benefit should accrue to a greater degree to New GGC, simply because PPG’s margins tend to be more stable, as the company has an easier time passing along swings in input costs. Recovery in housing demand is likely a multiyear process and, as a result, it may require more patience from investors in New GGC. Natural gas is the largest input cost in the creation of caustic soda and chlorine. Given the development of burgeoning natural gas shale plays, gas prices should not revert to pre-recession levels. As a result, New GGC should generate significantly better margins, through lower gas costs and synergies from the merger, than it generated in the previous housing boom. A patient investor could benefit from these developments.

On November 17, 2011, MeadWestvaco Corporation (NYSE: MWV) announced plans to separate its consumer and office products business (C&OP) and immediately merge it with office supplies manufacturer ACCO Brands (NYSE: ABD). MWV shareholders will receive approximately one share of ACCO Brands for every three shares of MWV held as of the record date, while MWV will receive $460 million in cash. Following the transaction, MWV shareholders will own approximately 50.5% of ACCO. MWV’s office products segment includes the Mead, FiveStar, and Trapper Keeper brands. ACCO expects the transaction to be immediately accretive, generating $20 million in annual cost synergies by 2014. After the separation, MWV will focus on its core packaging businesses. The transactions are expected to be completed in 1H 2012. The deal still requires ACCO shareholder approval, while MWV’s separation of the C&OP business is contingent on an affirmative IRS ruling. ACCO management will run the merged company. MWV intends to maintain its current quarterly dividend of $0.25 per share.

On the surface, the transaction appears rooted in MWV management’s goal of focusing its operations on the packaging side of the business through the spin-off of the non-core C&OP business. While the C&OP business has higher margins and is a significant contributor to MeadWestvaco’s profit, it appears likely that the packaging business, especially in emerging markets, may enjoy more robust growth opportunities. ACCO’s merger with the spinco should result in increased market share, greater diversity of customer mix, and a wider geographic footprint, while improving its balance sheet. The increased scale and resulting synergies could improve ACCO’s competitive positioning moving forward, however industry consolidation by peers presents challenges to profitable market share growth.

MWV shares currently trade either in line with or at a slight premium to peers in the packaging space. This would appear to leave little opportunity for unlocking value through this transaction. However, the resultant loss of EBITDA from the spin-off of the C&OP business, $166 million, versus the $460 million cash proceeds provide a favorable valuation shift. MWV shares upon spin-off will likely trade at a wider discount to peers than warranted and should increase in value beyond today’s market capitalization. If applying an in-line EV/EBITDA multiple to post-spin MWV, one arrives at a fair value estimate of $39 per share. Thus, shares of MWV are recommended for purchase.

On the other hand, ABD’s recent share price appreciation means that the effective price ACCO is paying for the C&OP business is at the high end of what has been paid by competitors in similar recent transactions. The low growth profile of the consumer and office products business, increased competitive pressure from industry consolidation, and a rising cost environment make this a less favorable investment opportunity than MWV. Considering the earnings growth potential for post-merger ABD, a fair value estimate of $11 can be derived. Accordingly, ABD shares are not recommended for purchase at this time.

Autogrill’s current stock price is EUR 11.88, which compares to our mid case valuation of EUR 13.95. However, given the downside risks to the Food & Beverage business, investors should be advised to wait until the spin-off has been completed, rather than trying to benefit from a combined valuation of the two separate companies that appears to be above Autogrill’s current stock price. Currently, the mid case upside is 18%, as opposed to a potential downside of 27% for the low case. As a result, investors who wish to purchase AGL’s stock prior to the spin-off, could do so if its price declines to a point that offers better downside protection.

After the spin-off, Autogrill could be valued at EUR 5.2 per share. Investors should be wary of the shrinking EBITDA margins of the Food & Beverage business, which have declined to 7% in 2012 from 11.6% in 2008. An equally important cause of concern is the probability that the revenue decline in motorways as well as in Italy proves more secular than short-term. Another important issue is the higher capital expenditure requirements of the Food & Beverage division, which hinders free cash flow and profitability, especially combined with lackluster growth. Thus, even though a post spin-off Autogrill could be worth EUR 7 per share, investors should exercise caution and accumulate shares if the price is closer to the low end of the valuation range detailed in this report—EUR 3.5.

World Duty Free has managed to increase both its sales and EBITDA over the past few years. More importantly, WDF’s EBITDA margin has improved substantially, and, based on similar public companies’ profitability, could improve even further. Therefore, while a base case valuation is EUR 8.8 per share, one should not exclude the possibility of WDF trading at EUR 10.4 in a medium to long-term horizon. Consequently, shares of World Duty Free are recommended for purchase at a price below EUR 8.8.

On January 24, 2011, The Global Spin-Off Report issued a report covering the spin-off of Aperam from ArcelorMittal. Aperam is a stainless and specialty steel producer headquartered in Luxembourg. Ordinary shares are mainly traded on the Euronext Amsterdam and on the Luxemburg Stock Exchange, while registry depository receipts are traded over-the-counter in the United States. Aperam is the largest producer of stainless and specialty steel in South America and the second largest in Europe. Its production sites are located in Belgium, France and Brazil and have a total capacity of 2.5 million tonnes per annum.

Aperam appears to be undervalued, and could very well prove to be a good, albeit decidedly riskier, long-term investment. While the steel industry is distressed, steel production has been transformed into a margin business (i.e. the price of steel is expected to adjust to the price of its feedstock). Steel prices adjust for the input costs, such as iron ore, coking coal and scrap steel. In the case of stainless steel, which requires the addition of other metals such as chromium and nickel, the price is broken down into the so called base price and the alloy surcharge, which is incurred by the client. Therefore, in a more stable environment with reduced overcapacity, stainless steel production will be a less risky activity than it was in the past. 

Aperam has been posting consecutive losses since it was spun off from ArcelorMittal. While that would be a reason for the stock to be ignored by many investors, the company has consistently generated positive EBITDA and FCF, demonstrating its ability to operate profitably and benefit significantly from a recovery in the stainless steel market. Aperam currently trades at EUR 10.58, a price that does not appear to reflect the potential strong results it can achieve from such a recovery. In a stable market, Aperam’s stock price could be worth EUR 29 by 2015, allowing for an annualized return of 67%. Assuming declining demand and price for stainless steel, Aperam could generate EBITDA in excess of USD 300 million and command a price of EUR 22 per share. Even on a liquidation scenario, it is reasonable to expect Aperam to have a value equal to its tangible equity, or EUR 17 per share.

At the final stages of preparing this report, OCI NV rose in value by almost 20%. Thus, the initial purchase recommendation is held in abeyance. Nonetheless, this reports should be used as a guide to OCI NV’s business and intrinsic value. While the near-term appreciation is likely related to the June 28th transaction that effectively shifts the exchange listing from Egypt to the Netherlands, the spin-off date is, nevertheless, a year or more away, a sufficiently long period as to perhaps offer additional buying opportunities.
 
With OCI trading at USD 34.50, 13% below our target price and 31% above our low case scenario, investors are advised to wait for an entry point that suits their risk tolerance and preferred gain/loss ratio. Given that the sum-of-the-parts analysis indicates that the fertilizer business is responsible for approximately 80% of OCI NV’s valuation, the price of OCI’s stock is expected to fluctuate in concert with other commodities businesses.
 
Still, investors who wish to capitalize on the expected increase in trading once all 208.9 million shares start trading in Amsterdam-from July 29, 2013-could purchase OCI NV shares at or close to that date, since the recent increase in OCI’s stock price has been accompanied by very low volume. Additionally, since OCI NV derives most of its value from the fertilizer business, it could be a suitable long-term investment for someone who would desirous of a suitable vehicle on the favorable dynamics of the fertilizer and agricultural commodities markets.

YIT Oyj (YIT) is a building systems and construction company with roots dating back to 1912 and the Swedish consulting engineering company AIB. It is comprised of four groups, Building Services Northern Europe, Building Services Central Europe, Construction Services Finland and International Construction Services. The spun-off company will be named Caverion Oyj (Caverion) and will receive the assets and liabilities that belong to YIT’s Building Services Central Europe and Building Services Northern Europe. The other two business will remain with YIT. YIT shareholders will receive one share of Caverion for each share of YIT they own. Thus Caverion’s shares outstanding will equal those of YIT minus its treasury shares. The implementation day of the demerger is June 30, and Caverion’s shares will start trading on the NASDAQ OMX Helsinki on July 1. It should be noted that the last day of trading for the pre spin-off YIT stock is June 28.
 
The rationale behind the spin-off is that the two separate businesses-Construction and Building Services-are large and profitable enough to operate independently, while they follow very different operating models. Construction Services (YIT) is a capital intensive business that is growing rapidly and derives the vast majority of its revenues from Finland and Russia. On the other hand, Building Services operates in a very competitive environment, is struggling with declining margins and focusing on gaining market share in Central European countries. The separation of YIT would also allow both management teams to operate more efficiently, focusing on each company’s competitive advantages and different methods to unlock shareholder value.
 
YIT currently trades at EUR 13.35, at 10 times trailing 12 month earnings. The very depressed valuation compared to other Finnish companies[1] can be attributed to the declining profitability of Building Services. However, YIT’s Construction Services division appears to have significant growth opportunities, and a post spin-off YIT could be valued at EUR 13.94, 4% higher than the market capitalization of the pre-spin-off entity, even if the company achieves limited revenue growth and margin expansion. It appears that the market is taking a sufficiently negative view of the Building Systems unit, at least as expressed in the parent company share price, that it is being valued at zero. Clearly, though, the division is worth more than zero, especially if the management achieves to increase its operating margins. Consequently, shares of YIT before the spin-off are recommended for purchase.
 
Besides the opportunity that is presented by the sum-of-the-parts valuation and the purchase of YIT stock before the spin-off takes place, the two separate companies, post spin-off YIT and Caverion have different business models, competitive advantages and targets, and at the right price could represent good investment opportunities for investors with different investment styles.

On Wednesday, April 17, 2013, the Board of Directors of Paris-listed Kering approved the distribution of the company’s mass-market entertainment and leisure products business known as Groupe Fnac. The proposed distribution of Groupe Fnac was approved at the annual shareholders’ meeting held this week on Tuesday, June 18th. As a result, shareholders will receive one Groupe Fnac share for every eight Kering shares. The company is expected to distribute a maximum of 15,764,588 Groupe Fnac shares, representing slightly less than 95 percent of Groupe Fnac’s total share capital.

Notably, the distribution of Groupe Fnac shares will be treated as a taxable distribution to Kering shareholders. Nonresidents of France will be subject to a withholding tax of between 15 percent and 75 percent depending on one’s country of residence so please consult the tax disclosures found in the listing prospectus. Following shareholder approval on June 18th, Kering shares will trade ex-entitlement beginning on June 20th, with the listing of Groupe Fnac shares on the NYSE Euronext Paris expected the same day.

Formerly known as PPR (Pinault-Printemps-Redoute), Kering is a family-controlled business increasingly focused on apparel and accessories across two divisions: Luxury and Sport & Lifestyle. The company’s Luxury division includes several iconic brands such as Gucci, Bottega Veneta, Saint Laurent, Alexander McQueen, Balenciaga, Brioni, Christopher Kane, Stella McCartney, Sergio Rossi, Boucheron, Girard-Perregaux, JEANRICHARD and Qeelin. The Sport & Lifestyle division includes the brands Puma, Volcom, Cobra, Electric and Tretorn.

During 2012, the Luxury and Sport & Lifestyle divisions generated revenue and EBITDA of €9,736 million and €2,067 million, respectively, or an EBITDA margin of 21.2 percent. In contrast, Groupe Fnac’s mass-market entertainment and leisure products business generated revenue and EBITDA of €4,061 million and €144 million, respectively, or a meaningfully lower EBITDA margin of 3.5 percent.

With respect to valuation, one must first recognize that Groupe Fnac is in the midst of a restructuring. The company’s mass-market entertainment and leisure products business—which is to say the business of retailing consumer electronics as well as various media such as books, music, movies and video games—continues to be under competitive pressure from e-commerce concerns such as Amazon.com.

Since such competitive threats may very well prove to be increasingly problematic with the passing of time, it is hardly surprising that Kering has chosen to proceed with a spin-off, the most expeditious of business separation solutions. Not only does such a transaction expedite the separation of the ‘good’ business from the ‘bad’ business, but when viewed in the context of Kering’s below-market valuation multiple, such a separation is likely to take on immediate financial significance for the parent company.

In other words, when one observes the current valuations of luxury goods companies such as LVMH Moet Hennessy Louis Vuitton, Burberry Group, Christian Dior, Hermes International, Cie Financiere Richemont, Prada and Tod’s, for example, one might reasonably conclude that rather than trading at a valuation of approximately 15 times current earnings, a figure between 18 and 20 times would arguably be more suitable for a luxury goods focused company (i.e., a per share valuation of between €190 and €210). That is to say, it is quite possible that the depressed multiple at which the company currently trades is simply due to the presence of a disparate business focused on the increasingly competitive sale of commoditized consumer goods.

It is worth observing that since the company’s Board of Directors announced the potential for a separation of the two businesses in October 2012, Kering’s shares have appreciated by nearly 30 percent. And though one could make the case for further appreciation following the separation (as many sell side firms have already done), our position is that the more interesting, albeit decidedly riskier, investment opportunity is likely to be found in the shares of Groupe Fnac. Not only is the company faced with a considerably more challenged, more analytically opaque financial situation, but certain technical factors associated with the spin-off are quite likely to result in a significantly depressed valuation following the completion of the transaction.

Specifically, the disparate nature of the respective business as well as the divergent dividend policies and market capitalizations of the parent and spin-off are likely to result in significant turnover of the shareholder base following the completion of the transaction. As well, since the market capitalization of Groupe Fnac is expected to be 98 percent smaller than that of Kering and since the Pinault family holds nearly 40 percent of total shares outstanding—thereby significantly limiting the free float—the immediate impact of indiscriminate selling via programmed investment mechanisms such as indexes and exchange-traded funds is likely to exaggerate the transaction’s short-term impact on the share price. And though a distressed valuation is likely warranted given the current operational challenges faced by Groupe Fnac, the immediate post-demerger share price may very well excessively discount such risks as a result of these technical factors.

Given the distressed nature of the investment, our preference is to await a more asymmetric risk-reward opportunity. And though one is able to arrive at fair values approximating €37 per share in the longer-term, more optimistic scenarios wherein management is able to successfully navigate the increasingly competitive e-commerce environment and meet the stated 2015 restructuring targets, our position is that the desired risk-reward asymmetry only begins to present itself at prices below €20 per share. Ergo, shares of Groupe Fnac are commended to our readers’ attention and recommended for purchase should the technical factors associated with the distribution result in an artificially—and, ideally, temporarily—depressed share price. This is a business we would otherwise not be inclined to purchase; however, the potential for an abnormally depressed valuation following the spin-off warrants some attention.

SM-SAAM is a company with a relatively stable set of businesses, a high degree of recurring revenue and excellent long-term expansion prospects. At a price below CLP 53, the shares are recommended for purchase.

If the company does not make significant changes to its capital structure, an appropriate base-level valuation range for the stock is roughly CLP 49.45 to CLP 70.86. Due to the conservative nature of its chosen business segments within the shipping industry and the company’s low leverage, a further decline in price would appear to be less likely. On the other hand, should SM-SAAM’s management decide to expand its operating asset portfolio and aggressively expand by issuing debt – and recent joint venture activity is suggestive of this strategic direction – returns could be even higher. Our target price for 2016, under such a scenario, ranges from CLP 79.83 to CLP 89.06. Combined with dividends, which are expected to represent 30% of the company’s net income, annualized returns could surpass 17.5% over the four-year period. Lastly, there is additional optionality. SM-SAAM is a good strategic fit for Royal Boskalis Westminster, the company that has completed two similar acquisitions since 2009. With a potential acquisition price of CLP 67.04 to CLP 96.07, such an option could be the fastest way to monetize an investment in SM-SAAM.

On May 23, 2013, Dean Foods distributed the majority of its interest in WhiteWave Foods to shareholders. This ongoing separation was first initiated through a carve-out of a 13.3% interest in WhiteWave in October 2012. This latest transaction involved Dean Foods distributing 115.6 million shares of WhiteWave, which will leave the company with 34.4 million shares of WhiteWave, or just under 20% of the total shares outstanding.
 
The motive of the separation was twofold. WhiteWave is a manufacturer of organic milk products, and its premium brands are both growing at a higher rate than the core Dean Foods dairy business and generate noticeably higher profit margins. WhiteWave was worth more to Dean Foods shareholders as a standalone entity than remaining to exist within the lower margin non-organic dairy business.
 
Secondly, after years of debt-financed acquisitions, and a leveraged recapitalization that was used to repurchase shares, Dean Foods was left a highly leveraged company. By placing debt with WhiteWave, in addition to selling its wholesale food products company known as Morningstar, Dean Foods now has a far more reasonably arranged balance sheet. Thus, the separation of WhiteWave served two important purposes.
 
At the time of original publication in December 2012, the Dean Foods stub was trading at $4.50 per share. This seemed egregiously low, relative to possible earnings under a normal margin scenario of at least $1 per share. Dean Foods now trades at $10.52 per share, including the $3.39 per share value of its remaining interest in WhiteWave. The stub therefore is currently priced at $7.13, representing an increase on this basis of 58%. More traditionally, or assuming one purchased Dean Foods and subsequently received the WhiteWave shares, the return would have been as follows:
 
Table 1: Theoretical Dean Foods Return Since December 2012
 
DF Price, 12/14/12 $16.44

DF Price, 5/28/13 10.52
Plus: 0.255 WWAV shares @ $18.49 4.72
Plus: 0.364 WWAV-B shares @ $17.81 6.48
Spin-Off Adj. DF Price $21.72

Cumulative Return 32.1%
S&P 500 Return, including dividends 18.2%
 

Of course, equity prices have also risen substantially during this time, so one’s good fortune cannot be attributed exclusively to the market’s recognition of value in Dean Foods. Nevertheless, despite an increase in the company’s share price, it still appears quite undervalued. At a stub price of $7.13, Dean Foods trades at under 5x normalized earnings. Currently, the company estimates that its 2013 earnings per share, excluding WhiteWave, will be $0.50. Therefore, investors have placed a 14x multiple on these earnings, which is not inconsistent with the valuations of other low margin, food commodity-based companies. However, this earnings estimate is based on the company’s current operating margin of only 3.2%, far below historic levels of 6%-8%. There has been a sustained increase in raw milk prices over the last few years, which has dramatically compressed the Dean Foods margin, as it has been unable to pass this increase onto its customers.
 
If this ultimately is a permanent departure from historical industry pricing dynamics, then Dean Foods is more fairly valued. However, if raw milk commodity prices were to decline to normal historical levels, and Dean Foods regains its historical pricing power, its earnings per share could be two or three times the current $0.50. Yet, since most cannot forecast when or if this will occur, the company trades at more visible, nearer-term profit measures.
 
Aside from this margin-based optionality, Dean Foods has indicated that the final separation of WhiteWave could include a debt-for-equity exchange. This possibility is explored later in this report, and it seems that the removal of debt, on a dollar-for-dollar basis, would be accretive by some 34% to the company’s per share earnings. For instance, even at the current 3.2% operating margin, if Dean Foods exchanges its WhiteWave shares (currently worth $636 million) for a like amount of its debt to be placed at WhiteWave, it might generate $0.67 per share of net profit. This is 34% higher than the current company estimate, which excludes any impact of a possible debt-for-equity exchange, of $0.50 per share.
 
Given these outcomes, which provide, as estimated later in this report, as high as an 80% return, Dean Foods still seems attractively priced. Therefore, it is again considered for purchase.