Drop Coverage of KAR Auction Services Inc. Effective Immediately

• On June 28, 2019, KAR Auction Services Inc. (NYSE: KAR) completed the spin-off of IAA Inc. (NYSE: IAA).
• Given the transaction has now passed our coverage mandate of 90 days post-spin, we DROP coverage of KAR Auction Services Inc. effective immediately.
• Our prior estimates and fair values for KAR should no longer be relied on.

Revising Cerence Fair Value Estimate to $17 (from $22); Maintain HOLD

• Nuance Communications Inc. (NASDAQ: NUAN) completed the spin-off of Cerence Inc. (NASDAQ: CRNC) on October 1, 2019 in a 1:3 distribution.  Shares of CRNC are essentially flat since the spin off, in line with the S&P 500 over the same period.
• Primary concerns center on cyclicality of the company’s automotive end markets and longer-term competitive pressures within the automotive voice interactivity and intelligence market, which is estimated at $4.5 billion by 2020. We adjust our applied estimates downward to reflect conservatism on the company’s long-term market share position. We value CRNC at 8x EBITDA (from 10x) and 12x EPS (versus 15x). Accordingly, we revise our price target to $17 (versus $22 previously). 
• We see the shares as fairly valued and see limited catalysts in the near-term. We maintain our HOLD recommendation. While we view the market dynamics favorably, competition from larger Internet technology companies remains a concern.
• For more details, please refer to The Spin Off Report dated June 24, 2019 and UPDATE dated September 27, 2019.

Drop Coverage of DuPont Inc. Effective Immediately

• On June 3, 2019, DowDuPont Inc. (formerly NYSE: DWDP) completed the spin-off of Corteva Inc. (NYSE: CTVA), the company’s agriculture sciences business. Following the spin-off, DowDuPont changed its corporate moniker to DuPont Inc. (NYSE: DD).
• Given the transaction has now passed our coverage mandate of 90 days post-spin, we DROP coverage of DuPont Inc. effective immediately.
• Our prior estimates and fair values for DD should no longer be relied on.

Drop Coverage of V.F. Corporation Effective Immediately

• On May 22, 2019, V.F. Corp. (NYSE: VFC) completed the spin-off of Kontoor Brands Inc. Inc. (NYSE: KTB).
• Given shares of VFC are currently trading at approximately our fair value estimate ($93.25 as of this writing versus our prior FVE of $94 per share) and the transaction has now passed our coverage mandate of 90 days post-spin, we DROP coverage of V.F. Corp. effective immediately.
• Our prior estimates and fair values for VFC should no longer be relied on.

Drop Coverage of Eaton Corp. plc Effective Immediately

• On October 16, 2019, before the market open, Easton Corp. plc (NYSE: ETN) announced it had entered into a definitive agreement to sell its Lighting business to Signify N.V. (Euronext: LIGHT).
• The purchase agreement includes a cash purchase price of $1.4 billion, equating to 0.82x 2018 sales.
• As a result of the sale, ETN will not spin-off the Lighting business as previously planned; as such we DROP coverage of ETN effective immediately.
• Our prior estimates and fair values for ETN should no longer be relied on.

Drop Coverage of AECOM Effective Immediately

• On October 14, 2019, before the market open, AECOM (NYSE: ACM) announced it had entered into a definitive agreement to sell its Management Services business to affiliates of American Securities LLC and Lindsay Goldberg.
• The purchase agreement includes a purchase price of $2.405 billion, equating to 11.6x forecasted F2019 adjusted segment EBITDA.
• As a result of the sale, ACM will not spin-off the Management Services business as previously planned; as such we DROP coverage of AECOM effective immediately.
• Our prior estimates and fair values for ACM should no longer be relied on.

LNDC reiterates F2020E adj. EBITDA guidance of $36-$40 million; expects to refinance its current credit agreement within the next 30 days 

• In 1Q F2020, LNDC posted consolidated top-line growth of ~11% to ~$139 million with adjusted EBITDA of $0.3 million (compared with $3.3 million in 1Q F2019) and a net loss of $0.16 per share (versus $0.01 per share in 1Q F2019).
• Importantly, management reiterated full-year F2020E guidance, which calls for consolidated sales growth of 8%-10% with consolidated EPS and EBITDA of $0.28-$0.32 and $36-$40 million, respectively.  As well, the company expects cash flow from operations of $26-$30 million.
• By segment, the company is expecting full-year F2020E sales growth of 8%-10% at Curation Foods with segment adjusted EBITDA of $19-$21 million. Lifecore is projected to post top-line growth of 10%-12% with segment adjusted EBITDA of $21-$23 million.
• For 2Q F2020, LNDC expects consolidated sales of $142-$146 million (versus $125 million in 2Q F2019) with EBITDA of $4-$5 million (compared with $2.7 million in 2Q F2019) and a net loss of $0.04-$0.06 per share (compared with net loss of $0.02 in 2Q F2019).
• At the end of 1Q F2020, LNDC’s leverage and fixed-coverage ratios were 4.4x and 1.9x (compared with covenants of 4.5x and 1.2x), respectively.
• To that end, the company currently has borrowing capacity of ~$10 million but indicates that it is in “late stage” discussions with its lenders (JPMorgan, BMO and City National) to amend its current credit agreement and a favorable resolution (i.e. increased availability, longer duration, less restrictive covenants) is expected within the next 30 days.
• Fair value remains $14 per share although adjustments to our forecasts may be made following this morning’s conference call at 11 a.m. (ET).

Ensign Completes Spin-Off of The Pennant Group; ENSG Rated HOLD; PNTG Rated HOLD; Maintain FVEs

• On October 1, 2019, The Ensign Group Inc. (NASDAQ: ENSG) completed the spin-off of its home health and hospice business via a distribution of shares in The Pennant Group Inc. (NASDAQ: PNTG) to ENSG shareholders of record as of September 19, 2019, received one share of PNTG for every two shares of ENSG owned.
• In initial trading, shares of PNTG have traded up to $15.89 per share; there was no trading volume in the planned when-issued market for Pennant shares and as of this writing approximately 130,000 shares have traded today. Ex-Pennant, shares of Ensign are currently trading at $41.60 per share.
• We maintain our fair value estimates of $47 per share for post-spin ENSG and $15 per share for PNTG; we rate both ENSG and PNTG at HOLD.
• With a limited number of shares outstanding, and given the relative disparity between post-spin entity market capitalizations, we expect shares of PNTG to be volatilize in initial trading as investors focus remains on the larger Ensign business and potentially exit their ownership position in PNTG.
• While the outlook for both businesses appears strong, longer-term our concerns over both businesses ability to fund a growth via acquisition strategy in a rising interest rate environment and reliance on government payment programs keep us cautious on increasing our fair values beyond the current values in light of what we view as expanded multiples that already discount the future earnings growth of the post-spin entities.
• Our fair value estimate of $15 per share is based on a 15x multiple of 2020 EBITDA estimate of $28.4 million, incorporating $25 million in net debt and 26.7 million shares outstanding
• For post-spin ENSG, our $47 per share fair value estimate is based on a 2020 EBITDA estimate of $220 million valued at 12.5x, with post-spin debt of $221.6 million and shares outstanding of 53.4 million.
• For more details, please refer to The Spin Off Report dated September 4, 2019.

Cerence Inc. Begins When-Issued Trading; Revising Post-Spin Fair Value Estimates; Maintain HOLD

• When-issued trading of Cerence Inc. began on the NASDAQ on Monday, September 16, 2019 under the symbol “CRNCV.” The distribution is expected to take place at 5:00 PM EST on October 1, 2019.  Each NUAN shareholder as of the record date of September 17, 2019 will receive one share of Cerence Inc. common stock for every 8 shares of NUAN held. Cerence will be listed under the symbol “CRNC.” Regular way-trading will begin on October 2, 2019.

• With Cerence trading in the when-issued market at approximately $17.50, investor concerns center on cyclicality and longer-term competitive pressures of the automotive business. Accordingly, we adjust our applied estimates for Cerence to 10x EBITDA versus 12x previously. Note that Cerence is expected to incur approximately $425.0 million of debt and make a cash distribution of approximately $309.9 million to Nuance. The pre-spin fair value estimate for NUAN remains $18 per share. Post-spin, NUAN and CRNC can be fairly valued at $15 and $22 (versus $14 and $28 previously), respectively.

• Shares of NUAN have appreciated approximately 20% year to date (approaching a 52-week high of $18), versus 18% for the S&P 500 over the same period. With the pre-spin sum of the parts fair value estimate approximating the current share price, we see the shares as approaching a full valuation and maintain our HOLD recommendation. While we view favorably management’s efforts to streamline the business, accelerate share buybacks, and repay debt, we remain concerned about near-term operational performance. Specifically, near-term revenue growth may be offset by more rapid declines in non-core businesses. In addition, competition from larger technology companies remains a concern. While Nuance’s Healthcare and Enterprise businesses tend to be subject to stricter regulatory requirements, which may provide some insulation from competition, we think that unlocking this value may take time.

• For more details, please refer to The Spin Off Report dated June 24, 2019 and UPDATE dated September 4, 2019.

HDS to Separate Construction & Industrial and Facilities Maintenance Assets via Spin-Off

On September 24, 2019 after the market close, HD Supply Holdings Inc. (NASDAQ: HDS) announced that the company plans to separate its Construction & Industrial from its Facilities Maintenance businesses via a tax-free spin-off. The separation is expected to be completed in the middle of F2020 (roughly mid-year 2020), subject to standard conditions. Joe DeAngelo, Chairman and CEO, HD Supply, is expected to serve as Chairman and CEO, HD Supply Facilities Maintenance; Evan Levitt, currently CFO and Chief Administrative Officer of HD Supply, is expected to serve in the same capacity for HD Supply Facilities Maintenance; and Brad Paulsen, currently President of Facilities Maintenance, is also expected to serve in the same capacity after the separation. Management will hold a conference call today at 8:00 AM EDT.

HDS, with a current market capitalization of $6.3 billion, is a North American industrial distribution company founded in 1974 as Maintenance Warehouse. In 1997, The Home Depot Inc. (NYSE: HD) acquired Maintenance Warehouse for its dedicated delivery trucks and free delivery service and changed its name to HD Supply. In January 2006, Home Depot announced the $3.2 billion acquisition of plumbing supplies wholesaler Hughes Supply and subsequently sold HD Supply in order to raise capital to repurchase Home Depot stock and bolster its sagging stock price. In 2007 the company was purchased by private equity firms Bain Capital LLC; The Carlyle Group; and Clayton, Dublilier & Rice, and continued as HD Supply. On June 27, 2013, HD Supply Holdings, Inc., the indirect parent of HD Supply, Inc., announced an IPO of 53.2 million shares of common stock at $18.00 per share. The company underwent an extensive balance sheet restructuring, and today the majority of the company’s debt repayment has been completed (at the time of the IPO the company was highly leveraged following the acquisition of over 40 businesses).

Following the spin-off, The Construction & Industrial business will become a one-stop shop for concrete accessories and chemicals, tools and equipment, building materials and fasteners, erosion and waterproofing and safety products to professional contractors in non-residential, residential and industrial applications. Sales were approximately $3 billion in F2018, ended February 3, 2019.

The Facilities Maintenance business will continue to focus on providing MRO (Maintenance, Repair, Operations) products, value-add services and custom products to multifamily, hospitality, healthcare and institutional property owners and managers. The business operates a distribution center-based model and sells its products primarily through a professional sales force, e-commerce and print catalogs. The company intends to retain the HD Supply name and ticker symbol. HD Supply Facilities Maintenance generated approximately $3 billion in F2018 sales.

PRELIMINARY VALUATION

As it stands today, HDS competes with a wide mix of both small regional distributors and larger national retailers that operate similarly to its business model. Of note are publicly traded Fastenal Co. (NASDAQ: FAST), W.W. Grainger Inc. (NYSE: GWW), MSC Industrial Direct Co. Inc. (NYSE: MSM), and Watsco Inc. (NYSE: WSO). Additionally, the company competes with subsidiaries of industry behemoths The Home Depot Inc. (NYSE: HD) and Lowes Companies Inc. (NYSE: LOW). On average the distributors trade at 12.5x consensus 2020 EBITDA, with a range of 9.0x – 16.3x. Home Depot and Lowes trade at 15.x and 13.5x 2020 EBITDA estimates, respectively. For its part shares of HDS currently trade at 10.0x the consensus 2020 EBITDA estimate. In general distributors with higher margins, derived from either product mix, purchasing efficiencies, or cost controls, tend to be rewarded with higher valuation multiples. However, it appears that despite HDS’s ability to drive increased margins, repurchase shares, and reduce outstanding debt, the company has not seen a significant benefit in terms of market multiple. In this frame of mind, it can be argued that separating out the higher margin Facilities Maintenance business from the Construction & Industrial business makes sense if the market were to re-rate the Facilities business higher and maintain or slightly re-rate lower the Construction & Industrial business. Given the relative size of the two businesses, which are evenly split on revenue, yet Facilities is almost twice the profit contributor given EBITDA margins of 17.7% versus 11.0% for Construction & Industrial in 2018, even a slight re-rating higher could provide optionality from the proposed separation.

As a preliminary base case for valuation, we project Facilities Maintech business can increase revenue by3.0% in both F2019 and F2020, as a standalone company the business would generate $3.3 billion in sales. We note that Facilities Maintenance revenue increased 3.8% through 1H F2019, however 2Q F2019 revenue growth decelerated to just 1.2%. If the company were to operate with a 17.0% EBITDA margin and expand its valuation multiple to 12.0x based on higher margins, the company would earn $557 million in F2020 and be valued at $6.7 billion on an enterprise basis.

Construction and Industrials has increased revenue through 1H F2019 by 4.8%, however the segment experienced a similar deceleration in revenue growth as Facilities Maintenance business, with an increase of 1.8% year over year in the 2Q F2019. Assuming the slowdown in construction business is more sustained than the current sales pressure on Facilities Maintenance, with revenue increases of 4.0% and 2.0% in F2019 and F2020, a standalone company would generate $3.1 billion in revenue in F2020. Assuming margins of 10.5% and a valuation multiple that contracts to 9.0x, the company would earn $329.8 million in EBITDA and be valued at $3.0 billion on an enterprise basis.

Incorporating current net debt of $2.0 billion, and shares outstanding of 165.9 million, on a preliminary basis, a pre-spin, sum-of-the-parts fair value estimate of $46 per share is derived, which implies that the proposed spin-off could unlock significant shareholder value if the higher margin, more stable Facilities Management business is re-rated sufficiently higher than the current trading multiple. It should be noted that the cyclical nature of HDS’s businesses do pose a risk in the current environment.