General Electric and Westinghouse Air Brake Technologies announce modified merger terms; Post-spin fair value estimate for WAB adjusted to $86 per share

• On January 25, 2019, General Electric Inc. (NYSE: GE) and Westinghouse Air Brake Technologies Corp. (“Wabtec”) (NYSE: WAB) filed updated S-4 and S-1 registration statements disclosing modified terms associated with the merger of WAB and GE’s Transportation business.
• Under the terms of the amended merger agreement, GE will complete the spin-off of GE Transportation to GE shareholders and will immediately merge GE Transportation into a wholly owned subsidiary of Wabtec. Upon closing, Wabtec shareholders will own approximately 50.8% of Wabtec on a fully diluted basis, compared to approximately 49.9% under the previous terms. GE shareholders will directly own approximately 24.9% of Wabtec on a fully diluted basis. In aggregate, Wabtec will issue 3.3 million fewer shares than originally contemplated. Under this modified structure, the spin-off will be considered a taxable dividend for U.S. federal income tax purposes.
• The transaction is expected to close by the end of February 2019. For more details, please refer to The Spin Off Report dated November 29, 2018.
• Our pre-spin sum-of-the parts fair value estimate for GE is unchanged at $9. With the fair value estimate approaching GE’s current share price, pre-spin shares appear fairly valued for the transaction and are not recommended for purchase. Post-spin, GE can be fairly valued at $8. 
• Our fair value estimate for WAB has been adjusted to $86 (versus $114 previously), reflecting recent multiple compression, adjusted merger terms, and balance sheet information as of September 30, 2018. Note that WAB shares have declined over 30% in the past 6 months, versus a 3% decline for the S&P 500 over the same period. With the fair value estimate representing 21% upside to WAB’s current share price, WAB shares are recommended for purchase.

Withdraw recommendation of AJRD with shares trading at a modest premium to our base-case fair value

• AJRD shares have returned ~41.5% since our initial recommendation in March 2018 (versus declines of ~3% and ~6% in the S&P 500 and Russell 2000, respectively).
• That said, with the stock trading at a modest premium to our base case fair value estimate and toward the higher-end of our bull/bear scenarios we prefer to maintain a disciplined approach and withdraw our recommendation, as of today’s close.
• We will continue to monitor AJRD for an opportunity to re-recommend the shares if valuation shifts or if incremental steps toward potential strategic alternatives materialize.

Henry Schein Inc. Revises Distribution Date for Spin-Off of the Company’s Animal Health Business, Merger with Vets First Choice

• On January 16, 2019, before the market open, Henry Schein Inc. (NASDAQ: HSIC) announced that the company has revised the distribution date for the planned spin-off of Henry Schein Animal Health (HSAH) to February 7, 2019 (previously February 4, 2019).
• Following the spin-off, HSAH will merge with Vets First Choice in a Reverse Morris Trust transaction, with the combined entity adopting the corporate moniker Covetrus Inc.
• Shareholders of record as of January 17, 2019, will receive 0.4 shares of Covetrus for every share of HSIC owned.
• Shares of Covetrus Inc. are expected to trade on the NASDAQ under the symbol “CVET”. Covetrus shares are expected to trade on a when-issued basis no later than February 4, 2019, under the symbol “CVETV”. HSIC is also expected to trade when-issued, under the symbol “HSICV”. Following the completion of the transaction, shares of Henry Schein will continue to trade under the symbol “HSIC”.
• On a pre-spin basis, shares of Henry Schein are fairly valued at $76 per share. The pre-spin fair value estimate is comprised of approximately $6 per share in value from the 53.1% ownership of Covetrus and approximately $70 per share in value from post-spin Henry Schein Inc. On a post-spin basis, Covetrus is fairly valued at $14 per share, based on 111 million post-spin, post-merger shares outstanding, while HSIC is fairly valued at $70 per share.
• Following the spin-off, investors may approach both post-spin entities with caution. Risks at HSIC are associated with its ability to improve margins via the current restructuring plan, especially in light of pricing pressure risk from Dental Service Organizations. For Covetrus, we would expect that high-single-digit revenue growth and the potential for significant synergies from the combination of HSAH and Vets First may result in demand for shares of CVET in initial trading, limiting attractive entry points. For Further information please see the Henry Schein Inc. Spin-Off Report dated January 15, 2019.

Twenty-First Century Fox files updated Form-10; Pre-spin, sum-of-the-parts fair value estimate adjusted to $51 per share

• On January 8, 2019, Twenty-First Century Fox Inc. (NASDAQ: FOXA) issued an updated Form-10 with the SEC associated with the spin-off of Fox Corp., which is to be acquired by The Walt Disney Company (NYSE: DIS).
• The spin-off will be taxable to Twenty-First Century Fox, but not to shareholders. New Fox will receive a step-up in its tax basis commensurate with the amount of the corporate tax relating to the spin-off that will generate annual cash tax savings over the next 15 years. Prior to completion of the spin-off, New Fox will pay an $8.5 billion cash dividend to 21st Century Fox, net of the estimated $2 billion to be paid from Disney to FOX, subject to closing adjustments.
• The spin-off is still subject to regulatory approvals and receipt of tax opinions and is expected to be completed in 1H 2019.
• Twenty-First Century Fox’s shareholders will receive one share of common stock in New Fox for each same-class 21st Century Fox share held. Following the separation, New Fox will maintain two classes of common stock: Class A Common and Class B Common Voting Shares. For more details, please refer to The Spin Off Report dated August 2018.
• Our pre-spin sum-of-the parts fair value estimate for FOXA has been adjusted to $51 per share (previously $53). The fair value estimate includes the sale of FOX’s 39% ownership interest stake in Sky plc to Comcast for $15 billion.
• With the fair value estimate approaching FOXA’s current share price, pre-spin shares appear fairly valued for the transaction and are not recommended for purchase. Post-spin, FOX can be fairly valued at $24 (versus $15 previously), which includes approximately $15 billion in cash associated with the Sky asset sale.
• Our fair value estimate for DIS has been adjusted to $120 (versus $132 previously). The fair value estimate is based on an estimated 2.1 billion shares outstanding (includes 607.2 million shares issued to FOX and FOXA shareholders, based on an exchange ratio of 0.1615). With the fair value estimate representing 8% upside to DIS’ current share price, DIS shares appear to be approaching a full valuation and are not recommended for purchase.

BEL to be acquired by LVMH for $25 per share, representing a ~23x multiple and 40% premium to yesterday’s closing price; withdraw recommendation, as of today’s close

• Today, Belmond announced an agreement to be acquired by LVMH (LVMH.PA) for $3.2 billion or $25 per share in cash, which represents an about 23x multiple on trailing-twelve-month EBITDA of ~$140 million (and almost 13.5x the company’s 2020 EBITDA target of $240 million).  On a per-key basis, we estimate the valuation implies a valuation of roughly $1.1. million.
• Reportedly, the bidding attracted broad interest from multiple real estate and lodging companies as well as sovereign wealth funds and private equity concerns, including Ashkenazy Acquisition Corp. (private), Blackstone (NYSE: BX), Hilton (NYSE: H), Hyatt (NYSE: H), KKR (NYSE: KKR) and KSL Capital (private).  To that end, the purchase price represents a ~40% premium to BEL’s latest closing price and more than double where the stock was trading prior to the company’s announcement that it would explore strategic alternatives.  (As well, we would note that the purchase price represents a modest premium to the high-end of our estimated take-out value of $19-$24 per share.)
• Given the apparently robust nature of the bidding process and the deal’s attractive valuation we do not expect additional bids to emerge; as such, we will close coverage of BEL, as of today’s close.

On December 6, 2018, Mallinckrodt plc (NYSE: MNK) announced plans for the separation of its Specialty Generics business in a tax-free spin-off to shareholders. The transaction is expected to be completed in 2H 2019, subject to several conditions, including Form-10 effectiveness. The specialty generics business will retain the Mallinckrodt corporate name, while the parent company will adopt a new, as yet to be determined, corporate moniker. Following the separation, Mallinckrodt will focus on specialty generic products and active pharmaceutical ingredient (API) manufacturing, while the parent company will focus on “innovative specialty pharmaceutical brands” 

MNK’s generics company will include a leading acetaminophen business, the API and generic finished dose forms of controlled substances as well as other drugs. The company will also control the AMITIZA product and other non-promoted assets. Over the past twelve months (ended September 2018), the future generics company reported revenue in excess of $850 million. It should be noted that the generics business had been placed up for sale since late 2016 and had two interested buyers, according to industry media reports, but talks were ultimately unsuccessful.

The parent company is expected to have sales over $2.3 billion (including a $1 billion hospital portfolio and a robust pipeline). Products include INOmax (nitric oxide) gas, for inhalation, the OFIRMEV (acetaminophen) injection and the Therakos immunotherapy platform.  In terms of rationale, considering the company’s previous unsuccessful attempts to sell the unit combined with the its heavy debt load amid industry struggles with increased pricing pressure and reimbursement hurdles, the deal appears to make strategic sense. To that end, the generics entity will likely assume a lot of the company’s current debt load, which should allow for increased flexibility at the specialty parent company. The generics business has been managed for cash and will likely continue to have stable sales and cash flow profile. The parent company’s increased flexibility should allow for increased R&D, and/or provide opportunities for M&A.

In terms of valuation, specialty generic companies trade at a discount to larger pharmaceutical companies. Generic companies currently trade at approximately 3.0x EV to sales, while larger pharma companies currently trade approximately 4.5x. For its part MNK currently trades close to generic peers. Given revenue trends, along with liabilities associated with the company’s opioid practices, we forecast revenue of $672 million and $1.8 billion for the spin and parent companies, respectively. Assuming the generics multiple remains at 3.0x, and the parent company experiences slight multiple expansion to 3.5x, the new Mallinckrodt would have an enterprise value of $2 billion, while the parent company’s enterprise value would total $6.3 billion. Accounting for $5.9 billion in net debt, and 83.3 million shares outstanding, this preliminary sum-of-the-parts valuation suggest a fair value estimate of $29 per share versus the current share price of $21.50. While this preliminary exercise implies that value could potentially be unlocked from the spin-off, concerns over pricing in the generics industry, potential liabilities from opioids, and the high debt levels may warrant discounted multiples, are likely to limit potential share price appreciation.

On November 29, 2018, United Technologies Corp. (NYSE: UTX) announced plans to separate into three independent, publicly traded companies. The separation as it is currently posited will be completed via tax-free spin-offs of the Otis elevator business and Carrier HVAC businesses to share holders of UTX. The completion of the spin-offs is subject to customary conditions, including final Board approval, receipt of a tax opinion from counsel, and the effectiveness of the company’s Form 10 filings with the SEC, and are expected to be completed within 18-24 months from the announcement (mid-to-late 2020). The announcement was made in conjunction with the completion of the acquisition of Rockwell Collins (previously NYSE: COL).

UTX currently operates under three general verticals: Aerospace (UTC Aerospace Systems and Pratt & Whitney), which generated $30.9 billion in revenue in 2017; HVAC (including building automation, fire safety, and security products), which generated sales of $17.8 billion in 2017; and Elevators (including escalators, and moving walkways) with $12.3 billion in sales. The COL acquisition will add ~$8.7 billion to UTX’s Aerospace revenue and will result in the creation of Collins Aerospace, which is the combination of UTC Aerospace Systems and Rockwell Collins. Collins Aerospace Systems is expected to generate in excess of $500 million in run-rate pre-tax cost synergies over the first four years of combined operations.

In terms of rationale, the separation, which had been telegraphed by UTX management at industry conferences and in quarterly conference calls, makes sense given the completion of COL. UTX’s aerospace businesses, including Pratt & Whitney, UTC Aerospace Systems, and COL, have seen revenue growth based on increased aircraft production, while the elevator and HVAC businesses have experienced more muted growth. The HVAC business appears poised to benefit from an improving housing market, while increased demand for elevators in U.S. and Europe are being hindered by pricing pressures from China.

It is expected that prior to the separation the company will at least maintain its current dividend of $0.735 per share per quarter, and it is expected that following the separation, the companies will pay in aggregate dividends at least equal to $0.735 per share per quarter, while noting that management has cited it will not execute significant share buybacks in the interim. Within the spin announcement, management did update the company’s 2018 financial outlook, increasing revenue to $64.5 – $65.0 billion (from $64.0 – $64.5 billion), adjusted EPS of $7.10 – $7.20 (previously $7.20 – $7.30 due to acquisition dilution), and free cash flow of $4.25 – $4.5 billion (previously $4.5 to $5.0 billion).

Following the separation, it could be expected that Carrier would generate 2019 revenue and EBITDA of $19.8 billion and $4.1 billion, respectively, based on revenue growth of 6% and EBITDA margins of 20.6%. Otis revenue growth of 4% would result in sales of $13.3 billion, with EBITDA margins of 17.8% resulting in forecasted EBITDA of $2.4 billion. The parent entity is forecasted to have sales of $46.8 billion and EBITDA of $7.9 billion, not including any run-rate synergies from the COL acquisition.

Aerospace peers could include General Electric (NYSE: GE), Honeywell (NYSE: HON), Rolls-Royce (RR/LN), Safran (SAF FP) and Textron, which trade at ~11.0x 2019E EBITDA. (For context, we note that UTX paid 13.9x 2018E EBITDA for ROL.) Peers to Otis could include Canny Elevator Co. (002367 CH), Thyssenkrupp (TKA GY) and Schindler Holding (SCHP SW), which trade at 11.6x 2019E EBITDA. Peers to Carrier could include AAON Inc. (NASDAQ: AAON), Daikin Industries (6367 JP), Honeywell (NYSE: HON), Johnson Controls (NYSE: JCI) and Lennox International (NYSE: LII), which trade at about 13.1x 2019E EBITDA. Applying respective peer multiples to the expected 2018 EBITDA contributions from Aerospace, Otis and Carrier implies segment values of $87.4 billion, $27.6 billion and $53.5 billion, respectively. Accounting for ~$1 billion of corporate costs as well as projected pro forma net debt of $51 billion yields a sum of the parts value of $106 billion or $121 per share (based on a diluted share count of 872 million), roughly in line with the current share price ($120.12 as of this writing).

NUAN plans to spin-off its Automotive business; sees F2019 EPS and FCF per share of $1.19-$1.27 and $1.06-$1.24, respectively; transfer coverage to our colleagues at The Spin-Off Report

• NUAN announced plans for a tax-free spin-off of its Automotive business, which generated sales of $279 million with a segment margin of 39% in F2018, as a separate publically-traded entity; the transaction is expected to be completed by the end of NUAN’s September-ending F2019.
• This deal, in conjunction with last week’s announcement that NUAN would sell its Imaging business to Kofax Inc. for $~$400 million (or $380 million, net), represents a further narrowing of the company’s focus on its core Healthcare and Enterprise offerings.
• Separately, the company reported full-year F2018 revenue and non-GAAP EPS of $2.069 billion and $1.19 per share, respectively.  As well, the company guided to full-year F2019 sales and non-GAAP EPS of $2.055-$2.105 billion and $1.19-$1.27 per share, respectively (assuming the full-year impact of both Imaging and Automotive).
• The company projects free cash flow of $315-$370 million (or $1.06-$1.24 per share) in F2019; that said, excluding $40-$55 million of one-time transaction costs (for both the Imaging and Automotive transactions) normalized FCF would be $445-$475 million (or $1.49-$1.59 per share), implying a current yield of 9%-10%.
• Given this announcement we will transfer coverage of NUAN to our colleagues at The Spin-Off Report who will be providing in-depth analysis of the impending transaction and whose initial sum of the parts fair value estimate for NUAN is $17 per share.

On November 19, 2018, Nuance Communications Inc. (NASDAQ: NUAN) announced the separation of its Automotive business (“Nuance Auto”) in a tax-free spin-off to shareholders. The transaction is expected to be completed before the end of fiscal 2019 (September fiscal year end), subject to several conditions, including Form-10 effectiveness, and the approved listing of Nuance Auto’s common stock on a national securities exchange selected by Nuance. Nuance intends to appoint an independent management team and nominate members to a separate board of directors for Nuance Auto before the transaction is completed.

Nuance Auto will be headquartered in Boston and maintain a significant presence in Montreal and Aachen, Germany, among other global locations. The company will become a pure-play, next-generation automotive software company specializing in conversational AI (Artificial Intelligence) technologies that help automotive manufacturers deliver connected and personalized experiences for drivers and passengers. Nuance’s deeply integrated and customizable solutions enable automotive assistants to be seamlessly integrated into the in-vehicle connected ecosystem. The Automotive business claims virtually every automobile manufacturer as a customer, including Audi, BMW, Daimler, Fiat, Ford, GM, Hyundai, SAIC and Toyota, as well as virtually every major tier-one automotive supplier. Nuance Auto’s technology can be found today in more than 200 million cars, with voice commands recognized in more than 40 languages. The business generated F2018 (Sep) sales of $279 million, with 7% organic growth and 39% segment margin.

Nuance, based in Burlington MA, with a current market capitalization of $4.7 billion and revenues of approximately $2 billion, is a pioneer and leader in speech recognition and conversational AI innovation. The company, which has grown substantially through acquisitions, reports four operating segments: Healthcare, Mobile, Enterprise, and Imaging.

Healthcare, which generated F2018 revenues of $985 million, focuses on clinical speech and clinical language understanding solutions for increasing productivity—including transcription, clinical document improvement (CDI), and coding solutions. The Enterprise business, which generated F2018 revenue of approximately $483 million, provides software that is leveraged to implement automated customer service solutions that are integrated with a wide range of on-premise third-party IVR (Integrated Voice Response) and contact center platforms. The company’s technologies include speech recognition, voice biometrics, transcription, text-to-speech, dialog and analytics. In the mobile segment, Nuance is perhaps best known for its relationship with Apple Inc. (NASDAQ: APPL) and involvement with the Siri application, which combines speech recognition with advanced natural-language processing.  The Imaging business, which will be sold to Kofax Inc. for $380 million, net of fees and taxes (expected close FQ2), is essentially a legacy business which provides software for document and information processes.

While guidance for F2019 was disappointing, calling for year-over-year organic revenue growth of -1% to 1%, Nuance remains on a path to transform the company into a global AI leader. With artificial intelligence opening up new addressable markets, the spin-off should help Nuance simplify its operations, and focus its voice recognition and natural language computing technology on core growth opportunities in its Healthcare and Enterprise businesses. In addition, the company will wind down its subscription revenue services and consumer devices businesses.

Assuming the low-to-mid point of managements F2019 segment revenue and margin guidance, it can be forecast that the parent entity would generate $1.5 billion in revenue and $323 million in operating income (including corporate expenses), while the spin company would generate $309 million and $78 million in revenue and operating income (including corporate expenses), respectively. Note our parent company projections exclude the Imaging and Other segments. Imaging is being sold for $380 million (after fees and taxes) in FQ2, while the Other business is being wound down over the next 12 to 24 months. Applying interest expense on a pro-rata basis, and a 23% tax rate (in line with management’s commentary for F2019), the parent and spin-company would earn $0.68 and $0.17 per share in F2019. It could be expected that the parent company, post-spin would see a degree of multiple expansion to approximate healthcare focused IT firms, while the new Automotive company’s multiple would remain around NUAN’s current ~13x forward P/E. It can be noted that 13x on the Automotive company would be at the higher end of auto focused peers. Additionally, we assign $1.28 per share in value to the Imaging and Other businesses, which equates to the $380 million post tax and expenses that the company will receive for the Imaging business.

On a pre-spin sum-of-the-parts basis, shares of NUAN are fairly valued at $17.08 per share, implying minimal upside from the current share price ($16.20 as of this writing).

Withdraw recommendation of GHC with shares trading at a modest premium to our base case fair value estimate

• GHC shares have returned ~49% since our initial recommendation in March 2018 (versus ~30% gains in the S&P 500 and Russell 2000 Indexes).
• That said, with the stock trading at a modest premium to our base case fair value (and toward the higher end of our bull-bear scenario) we prefer to maintain a disciplined approach and withdraw our recommendation, as of today’s close.
• We will continue to monitor GHC for an opportunity to re-recommend the shares if valuation shifts or if incremental steps toward potential strategic alternatives materialize.