In July 2010, Haldex AB (‘Haldex’), a Swedish vehicle parts manufacturer, initially announced its intention to disaggregate its three business segments into separately traded companies. At that time, the company began a more comprehensive study of the potential transaction. On October 21, 2010, the company announced its intention to proceed with a demerger of the Hydraulic Systems Division and Traction Systems Division, with the Commercial Vehicle Systems Division continuing as part of the parent company.
On January 31, 2011, however, as opposed to proceeding with the demerger, the company completed the sale of the Traction Systems Division to BorgWarner, Inc. for a total purchase price consideration of SEK 1,425 million (i.e., USD 221 million). Notably, the purchase price represented approximately 12.1 times 2010 divisional operating income.
As a means to distributing such proceeds to company shareholders, the Haldex Board of Directors has proposed a share split, whereby each Haldex share shall be divided into two shares, one of which will be a redemption share. The redemption shares will be automatically redeemed by Haldex for SEK 30 each. The ex-date for entitlement to such redemption shares is Thursday, June 30, 2011. Further, the redemption share will be listed on the Nasdaq OMX during the period from July 6 to July 20. The payment of SEK 30 per share for each such redemption share will be made by the company on July 28, 2011.
The demerger of the Hydraulic Systems Division will proceed as planned, with the last trading date in Haldex shares with entitlement to participate in the demerger scheduled for Wednesday, June 8, 2011. The new company will begin trading on a when-issued basis on Thursday, June 9, 2011 as Concentric AB (‘Concentric’), with regular-way trading scheduled to begin on Thursday, June 16, 2011.

At the current level of operating profitability, the combined businesses of New Haldex and Concentric—considered in conjunction with the upcoming ordinary and extraordinary dividends—do not appear to support the current share price of SEK 115.50; however, the potential for acquisitive activity post-demerger, in conjunction with the longer-term potential for a normalization of revenues and margins, suggests fair value share prices in excess of the current price. Should revenues and operating income of New Haldex and Concentric revert to peak levels established in 2006 and 2007, respectively, the combined fair value market capitalization would be SEK 5,477 million, or SEK 123.86 per share, a 7.2 percent premium to the current price.

Alternatively, the potential for larger competitors to acquire the respective businesses and, thereby, exploit economies of scale suggests that one might wish to assign potential fair value estimates on the basis of margins somewhat higher than the company’s current margins. That is, if either company were subject to an acquisition offer, one might reasonably argue that the purchase price should be consistent with the margins that would otherwise be realized in the absence of such an offer. Since managements’ targeted margins are considerably lower than those of the competition, such a transaction would still prove accretive for the higher margin acquirer. The current operating margin targets suggest that at the current level of revenues, a combined fair value market capitalization is SEK 5,926 million, or SEK 134.03 per share, a 16.0 premium to the current price.

Should management succeed in meeting revenue growth and operating margin targets over the subsequent one year, for example, the combined fair value market capitalization would be SEK 6,275 million, or SEK 141.92 per share, a 22.9 percent premium to the current price; meeting more ambitious targets would result in returns of 41 percent and 65 percent.

Though the company trades at a significant premium to a fair value based on the current level of operating profitability, there appears to be ample evidence supporting a case for higher share prices. The historical results clearly illustrate the significantly higher earnings potential of both divisions; moreover, should the shares trade at a discount subsequent to the demerger, the gains to a potential acquirer appear compelling enough such that a prolonged, long-term discount (i.e., impairment of capital) seems unlikely. In the event that both companies meet management targets, the longer-term earnings power appears sufficient to provide one with a good, though not excessive, rate of return. Finally, the embedded optionality associated with the possibility of meeting more ambitious targets has the potential to provide one with a very nice rate of return.

Given the low risk-to-reward tradeoff, the shares appear attractive on a pre-demerger basis; however, the low level of current profitability and the possibility that many investors hold the shares in anticipation of the extraordinary dividend may very well result in superior rates of return subsequent to the distribution. Ergo, our preference is to await a more asymmetric post-demerger return opportunity.

On October 18, 2010, the Australian gaming company Tabcorp Holdings Limited (‘Tabcorp’) announced its decision to pursue the demerger of the casino and hotel franchise from the diversified gaming business. Upon demerger, Tabcorp shareholders will each receive one share of Echo Entertainment Group Limited (‘Echo’) for each Tabcorp share held as of the last trading day on Friday, June 3. Both companies will be listed on the Australian Stock Exchange beginning on Monday, June 6, with regular-way trading beginning on Tuesday, June 21.1 Following the demerger, each of New Tabcorp and Echo are expected to be included in the S&P/ASX 200 index
The newly created casino company will contain the four hotel casinos currently located in Australia, namely the Star City Casino in Sydney, Jupiters Hotel & Casino on the Gold Coast, Treasury Casino & Hotel in Brisbane, and Jupiters Townsville Casino. The company’s casinos are either currently or about to be involved in expansion projects that will upgrade and refine the overall gaming experience through the development of additional gaming space, restaurants, and nightlife attractions.
Of course, casino expansion requires substantial upfront capital investment, which appears to be the primary motive behind the demerger transaction. With two separate capital structures, one entity may operate on a more leveraged basis without affecting the valuation characteristics of the other. As well, apart from merely providing shareholders with a differentiated choice of investments, management has positioned the demerger as a mechanism that will enable each company’s participation “in any consolidation or corporate activity in their respective industries.”
The New Tabcorp business will continue to operate the wagering, gaming, and keno businesses. These will include over 2,000 fixed odds retail betting locations, on-course betting at 264 racecourses, retail gaming operations distributed via television, internet, and telephone, and 3,811 Keno terminals.2

On Tuesday, May 31, 2011, Mondi Limited (‘Mondi’) (MND SJ), a South African international paper and packaging group, announced its decision to proceed with the demerger of Mondi Packaging South Africa Limited, the company’s containers and packaging subsidiary.
The demerged entity will be known as Mpact Limited (‘Mpact’) and will continue to operate as an integrated producer of corrugated products, rigid plastics packaging, and cartonboard. The demerger will be implemented by way of a dividend in specie to Mondi ordinary shareholders on Monday, July 18, 2011 on the basis of one Mpact ordinary share for every one Mondi ordinary share held by each Mondi shareholder as of the last trade date on Friday, July 8, 2011.
Mpact is primarily focused on southern Africa, with most of its operations located throughout South Africa and with plants located in Namibia, Mozambique, and Zimbabwe. According to the company, Mpact’s primary growth opportunities going forward are expected to be in expanding the rigid plastics business. As this focus represents a divergence from Mondi’s primary business focus of paper packaging, the separate listing of Mpact will allow the company to pursue an independent, plastics-focused growth strategy.
Mpact is one of the largest South African packaging businesses, with total revenues of ZAR 6,259 million in 2010, ZAR 5,774 million in 2009, and ZAR 5,711 million in 2008; in 2010, 2009, and 2008, EBITDA amounted to ZAR 805 million, ZAR 714 million, and ZAR 631 million, respectively (1 USD = 6.80 ZAR). The operations of the group are divided into the paper business and the plastics business.

On Tuesday, May 24, 2011, Telecom Corporation of New Zealand Limited (TEL NZ) (‘Telecom’), New Zealand’s leading phone provider, announced plans to split its telecommunications retailing and telecommunications network operations into separate companies by the end of 2011.
The announcement comes after the company was granted the right to build out the country’s government-sponsored broadband network in 24 regions, including the biggest city Auckland and the capital Wellington, the lower North Island, and most of the South Island. The company stated that it expects to begin work towards the end of 2011.
The plan requires that that the company demerge its telecommunications network operations into a separate-listed entity, which will be known as Chorus. Meanwhile, Telecom will continue operations as a telecommunications retailer. The separation, which Telecom had put forward to satisfy competition concerns, still requires a law change and shareholder approval. It is expected that the separation will be accomplished through a court approved demerger scheme, which will leave Telecom shareholders with stakes in the two companies.
Under the agreement, the government’s Crown Fibre Holdings will invest NZD 929 million (1 USD = 1.2241 NZD) in Chorus through a mix of debt and equity as the broadband network is built. The shares will be non-voting and no dividends will be paid before 2025, while the debt will be unsecured and non-interest bearing. The government has promoted the plan to supply fast internet to 75 percent of the country by 2019 through fiber-optic cables as a key policy to boost economic growth. It is investing a total of NZD 1.5 billion to build the network, with the total cost estimated to be as much as NZD 7.5 billion.

On November 8, 2010, Toromont Industries Limited (‘Toromont’) announced that its Board of Directors unanimously approved a proposal to spin off Enerflex Limited (‘Enerflex’), a supplier of natural gas production and processing equipment. Toromont Industries Limited currently operates through two business segments: the Equipment Group and the Compression Group, most of the operations of which will comprise Enerflex.
The Compression Group is a global leader specializing in the design, engineering, fabrication, and installation of compression systems for natural gas, coalbed methane, fuel gas, and carbon dioxide. After the spin-off, Enerflex will continue to operate as a market leader in the gas compression systems business in Western Canada and Australia and as a leading supplier in the United States and the Middle East.
Importantly, the spin-off follows Toromont’s recent acquisition of the compression business of the Enerflex Systems Income Fund (‘ESIF’), which was merged with and into Toromont’s existing natural gas compression business on January 20, 2010.1 And, though the combined businesses reported 2010 revenues of CAD 1,125 million, one must recognize the inherent cyclicality of the natural gas compression business. For example, in 2008, ESIF and the Toromont Compression Group reported revenues of CAD 1,046 million and CAD 827 million, respectively.