CHE fair value revised to $209 per share on initial 2018E forecast with a bull-case valuation scenario of up to $227 per share

• CHE recently reported 1Q 2017 consolidated revenue growth of 4% to $406 million with a 12% advance in adjusted EPS to $1.82.  Adjusted EBITDA rose ~10% to $59.8 million (comprised of 7% growth at Vitas and 13% at Roto-Rooter).
• The company ended 1Q 2016 with net debt of $99.8 million, consisting of $47 million of cash and ~$147 million of debt.
• The company reaffirmed its initial 2017 guidance calling for consolidated adjusted EPS of $7.80-$8.00 (versus $7.24 per share in 2016), which implies 7.5%-10.5% year over year growth.
• By segment, CHE expects 4%-5% sales growth at VITAS, pre-Medicare cap, and an adjusted EBITDA margin of 14.5%-15.0%.  At Roto-Rooter, management projects 3%-4% top-line growth and an adjusted EBITDA margin of 21.5%-22.0%.
• Based on 1Q 2017 results and guidance we revise our 2017E EBITDA forecast to $262 million (from $259.5 million).  As well, we introduce our initial 2018E adjusted EBITDA of $279 million, which represents roughly 6% year over year growth and is based on a consolidated revenue and margin profile of $1.74 billion and ~16.0%, respectively.
• Additionally, we increase our fair value estimate to $209 per share, reflecting a blended multiple of ~12x on our initial 2018E EBITDA forecast.
• While not specifically commented on during today’s conference call, previous statements suggest management is cognizant of its potential strategic alternatives, including a split or RMT, and that it would be open to a range of transactions if a premium bid emerged (or the stock’s discount became persistently egregious).
• CHE has returned ~49% since our initial recommendation in October 2016 (versus gains of 10.5% and 11.5% for the S&P and Russell).

On May 3, 2017, Delphi Automotive Plc (NYSE: DLPH) announced plans to separate its Powertrain business into a new, stand-alone publicly traded company via a tax-free spin-off. The transaction is expected to be completed by March 2018, subject to customary market, regulatory and other conditions.

Delphi is the largest U.S. automotive parts supplier, manufacturing electrical architectures, safety products and electronics, powertrain systems, and thermal management products for light vehicles. The company generated revenue of $16.7 billion in 2016. Delphi was originally spun off from General Motors Co. (NYSE: GM) in 1999. The separation was ill-fated, with Delphi having inherited over $10 billion in unfunded pension liabilities for union-covered GM employees who transferred to Delphi as part of the spin-off, while GM began undercutting Delphi contracts by sourcing to other suppliers. After seeking deals with both United Automobile Workers (UAW) and former parent General Motors Corp., Delphi filed for Chapter 11 bankruptcy protection for itself and 38 U.S. units in 2005 (the company’s non-U.S. units were not included), the largest bankruptcy in U.S. automotive history. Despite a four-year restructuring process, Delphi emerged structurally advantaged, having exited higher-cost U.S. operations, while selecting the most profitable businesses of a large diversified supplier. The company adopted a best-in-class low-cost manufacturing footprint, strong geographic exposure, and was able to capitalize on growing trends such as a “safe, green and connected” industry secular growth theme.

While the outlook for automotive production has dampened, Delphi has been able to increase content per vehicle. Further, the company has been able to leverage its attractive geographic exposures and cost base profile. Delphi was early to understand the growth opportunity in China. Today, only automotive peers Visteon Corporation (VC) and Johnson Controls International Plc (NYSE: JCI ) derive a greater portion of non-consolidated sales from China. DLPH’s China sales are also fully consolidated, allowing the company’s greater ownership and management control of these ventures to provide further leverage to this growth market. Finally, Delphi’s under-levered balance sheet and strong free cash flow generation has provided opportunities to pursue accretive acquisitions. Following the spin-off of the Powertrain segment, Delphi will be comprised of the Advanced Connectivity, Autonomy and Mobility (E/EA and E&S segments). E/EA and E&S will remain global technology leaders with unparalleled strengths in signal and power distribution, centralized computing platforms, advanced safety and autonomous driving systems, enhanced infotainment and user experience, vehicle connectivity and electrification, and data services.

The spin-off of the Powertrain business allows the company to continue to pursue its M&A strategy. Recently, Delphi expressed its interest in pursuing bolt-on acquisitions that can be integrated with its Electrical Architecture business (for example, in the connectors & cable management area), citing its success in the quick realization of cost synergies and efficiencies associated with past acquisitions such as Hellermann Tyton.

Powertrain is a global technology leader focused on optimizing vehicle propulsion systems by enhancing environmental efficiency and vehicle performance. The company is a global supplier to original equipment manufacturers and aftermarket customers with 20,000 global employees, and 5,000 engineers. In 2016, the segment generated revenues and operating income of $4.5 billion and $300 million, respectively.

Comparables to Delphi’s Powertrain business include automotive suppliers such as Bosch Ltd. (BOS IN), Continental AG (CON GY), Denso Corp. (6902 JT), and Hitachi Ltd. (6501 JT). These companies trade at a wide range of forward EV/EBITDA estimates, from 11x to over 21x EBITDA. As a starting point for valuation, assuming that the business generates 5% revenue growth in both 2017 and 2018 (consistent with management’s guidance of “mid-single-digits” growth), the Powertrain segment could reasonably generate 2018 revenues of $4.9 billion. Assuming EBITDA margin of 12% (a 50 bp expansion from 2016 EBITDA margin of 11.5%), Powertrain could generate 2018 EBITDA of $593.5 million. Applying a multiple of 11x, the low end of peers, to estimated EBITDA generates an implied enterprise value of $6.5 billion for this business.

The post-spin parent company will consist of two segments: Electrical/Electronic Architecture and Electronics & Safety. The former can be most aptly compared to broad-based automotive electronic component suppliers, including Lear Corp. (NYSE: LEA), and Leoni AG (LEO GY). The latter can be compared to more specialized automotive safety and other components suppliers, including Alpine Electronics (6816 JT), Autoliv AB (ALIV SS), and Visteon Corp. (NYSE: VC). These companies trade, on average, at a multiple of 8x estimated 2018 EBITDA. Note, however, that DLPH has historically garnered a premium multiple to the group owing to the company’s superior profitability and growth rate. As such, it can reasonably be assumed that the post-spin parent company will trade at a premium to peers. Accordingly, applying a multiple of 9x (1x premium, approximating DLPH’s current EV/EBITDA multiple) to estimated EBITDA generates an implied enterprise value of $21.7 billion.

The above exercises generate a total implied enterprise value of $28.5 billion for pre-spin Delphi. Accounting for net debt of $4.8 billion, including $962 million in pension liabilities (balance sheet as of March 31, 2017), and approximately 269.3 million shares outstanding, pre-spin Delphi can be fairly valued at $87 per share. However, given the 9% run on today’s announcement (intraday price of $85.51), the shares appear to be fairly valued at current levels.

HSC raises 2017 EBIT and FCF guidance; withdraw coverage, as of today’s close, with shares trading at fair value and the M&M separation put off for “foreseeable future”

• HSC reported 1Q 2017 revenue up almost 6% to $373 million with adjusted EBIT of $28 million versus $9 million in prior year and guidance of $15-$20 million. Adjusted EPS of $0.11 more than tripled from $0.03 in 1Q 2016 and topped the consensus estimate of $0.02.

• The company ended 1Q 2017 with net debt of $609 million (up modestly from $587 million at the end of 2016) and a leverage ratio of 2.3x (well below to its 3.75x covenant). Total liquidity stood at $304 million.

• For 2017, HSC increased its consolidated EBIT and FCF guidance to $115-$130 million (from $100-$120 million) and $75-$85 million (from $60-$80 million). GAAP and adjusted EPS are expected to be $0.47-$0.61 (previously $0.32-$0.50). Return on invested capital is projected to be in the 8.5%-9.5% (compared with ~7% in 2016).

• To be sure, HSC’s financial results have greatly improved over the last year amid improved fundamentals, particularly in the global mill services market, as well as better internal execution and the monetization of its Brand JV stake in Sept. 2016. To that end, the shares have increased ~125% since our initial recommendation (versus a 25% increase in the S&P and a 38% rise in the Russell).

• That said, with HSC’s indication that it would not pursue a separation of its Metals & Minerals (M&M) business for the “foreseeable future” we will withdraw coverage of the company, as of today’s close. Nevertheless, we will continue to monitor the company and note our fair value estimate of $15 per share reflects a blended multiple of ~7x on 2018E EBITDA of $273.5 million (as well as projected net debt and other liabilities).

NPO posts ~50% gain in 1Q 2017 adjusted pro forma EBITDA and increases full-year 2017 outlook to $193-$198 million (from $188-$193 million); reconsolidation of GST is on track for 3Q 2017

• NPO reported 1Q 2017 consolidated revenue up 1% to $338 million while pro forma adjusted EBITDA increased 50% to $54 million. Pro forma adjusted net income increased 124% to $20 million.

• The company ended 1Q 2017 with pro forma net debt of $472 million and a pro forma leverage ratio of 2.3x. (On the superficial “as reported” basis the leverage ratio is 4.6x.)

• The company increased its pro forma adjusted EBITDA guidance for full-year 2017 to $193-$198 million (from $188-$193 million).

• Importantly, the company also indicated that the confirmation hearing with the Bankruptcy Court is scheduled for the week of May 15th and barring any unforeseen delays the reconsolidation of GST remains on track for 3Q 2017.

• Given this quarter’s results and NPO’s revised outlook, our full-year 2017 adjusted EBTIDA estimate is increased to $194.3 million (from $192.7). We note that our initial estimate was at the high-end of previous guidance and our revised forecast, which could ultimately be conservative, reflects a cognizance that the 1Q and 2Q are seasonally NPO’s strongest.

• Our $88 fair value estimate continues to reflect a blended multiple of 10.7x on 2018E EBITDA of $206 million and implies roughly 20% of additional potential upside.

WYN maintains 2017 EBITDA guidance and backs 2018 growth of 6%-8%; fair value increased to $108 (from $95) as management commentary suggests a spin-off should increasingly be viewed as the base case: 

• WYN reported roughly in-line 1Q 2017 results and maintained its full-year 2017 sales and EBITDA guidance of $5.8-$5.9 billion and $1.41-$1.44 billion, respectively. Net income guidance was slightly reduced to $631-$652 million (from $637-$658 million) due to increased interest expense.

• On the conference call, management anecdotally backed the expectation that EBITDA growth within its long-term target of 6%-8% was “absolutely” achievable in 2018.

• More importantly, management’s commentary continued to suggest an increasing likelihood of a spin-off; to that end, WYN commented that given the Board’s on-going dissatisfaction with the stock’s valuation it continues to keep all of its options open and that the hiring of Mike Brown, formerly the COO of Hilton Grand Vacations (NYSE: HGV), as CEO of the Timeshare business is in keeping with that effort given his public-company, industry and spin-off experience.

• To be sure, with the stock up 10% today the market welcomes these developments and it is our view that investors should increasingly begin to view the separation of the WYN’s Hotel and Timeshare businesses as the base case scenario, which suggests additional upside as at 9x 2018E EBITDA WYN currently trades at discount to both the ~12x and 9.5x multiples awarded standalone Hotel and Timeshare peers.

• Our revised fair value of $108 per share reflects a blended multiple of 9.2x on 2018E consolidated adjusted EBITDA of $1.5 billion. While the applied multiple marks an increase versus our previous assumption of 8.2x it still represents segment multiples that are roughly a full turn below peers.

• WYN has returned ~34% since our initial recommendation in January 2017 (versus gains of ~6% and ~3.5% gains in the S&P and Russell.)

FOR agrees, subject to shareholder approval, to be acquired by Starwood Capital for $605 million or $14.25 per share

• On Thursday April 13th, after the market close, FOR announced an agreement to be acquired by Starwood Capital for $605 million in cash or $14.25 per share, which is an 8% premium to its 90-day VWAP (but less than 1% above its most recent close of $14.15).

• The transaction was unanimously approved by FOR’s Board and expected to close in 3Q 2017 but is still subject to closing conditions, including shareholder approval.

• The so-called “outside date” for the transaction is October 10, 2017 and the agreement includes a termination fee, in the event of a superior proposal, of $20 million from FOR (and $40 million from Starwood).

• In our view, this deal, which was announced at 9:15 p.m. heading into a holiday weekend, represents a decidedly disappointing outcome. To that end, FOR shares are essentially flat since we initially published on the company (despite 18% gains in the both S&P and Russell 2000). On the positive side, we would note that the shares are up about 7% (versus a 6% gain in the S&P and a 2% rise in the Russell) since we highlighted the company as a likely take-out target on our year-end conference call with clients (held December 2, 2016).

Above please find the updated report on Johnson Controls International orginally sent 4/12/2017.

On October 31, 2016, Johnson Controls, Inc. (NYSE: JCI) completed a tax-free spin-off of Adient Ltd. (NYSE: ADNT), its Automotive Experience business. With the spin-off, JCI became a leading automotive battery and building controls manufacturer, and following its merger with Tyco (closed September, 6 2016), the company, now called Johnson Controls International plc, includes a leading fire and safety business. (For more details, please refer to The Spin-Off Report dated August 11, 2016.)

The bull case for the stock centers around a more visible earnings growth trajectory over the next several years driven by a combination of cost reductions and merger synergies. With a target of $2.1 billion in adjusted free cash flow for the year, the company has the ability to pursue mergers and acquisitions in order to achieve incremental growth. While the majority of JCI’s recent strategic moves have been divestments, it is reasonable to expect the post-spin company shifts toward merger and acquisition activity, which could lend incremental support to the valuation over time. With the spin-off, JCI has become a less cyclical story, and, combining this with an improving order backlog and positive end-market demand trends, the shares appear less susceptible to negative macro trends.

Historically, JCI’s valuation has lagged industrial conglomerate peers, due to lower profitability and return on equity (ROE) relative basis (9.4% estimated for F2017 versus a peer average of over 30%). Moreover, shares of JCI have underperformed since the U.S. presidential election in November 2016, having appreciated 1% versus a 9% increase in the S&P 500 over the same period, largely owing to JCI’s inverted company structure, an already low tax rate and limited fundamental leverage to a short-cycle industrial recovery. Peer valuations have disproportionately benefitted from speculation surrounding the impact of border tax changes, which would have a material impact on companies with a high degree of imports and exports. In addition, given weakness in JCI’s recently reported F1Q 2017 results, there is understandable concern that management’s guidance, which calls for a steep second-half earnings ramp, may require an acceleration of merger-related synergies that are currently tracking ahead of guidance.

Despite an impressive cost-reduction story, with guidance calling for over $1 billion in targeted synergies over the next three years ($1.00 in EPS), the most significant potential catalyst for the shares is a re-rating to a multi-industrial company. Such a re-rating will take time, as JCI will likely need to demonstrate improved free cash flow conversion and reduced cyclicality in the event of an industry downturn. Notably, industrial peer Ingersoll Rand (NYSE: IR) still trades at a below-peer multiple, despite a transformed portfolio and improved earnings growth and free cash flow conversion.

Based on an analysis of projected EBITDA, revenue, EPS, and dividend yield, we derive a fair value estimate of $52 for JCI (versus our prior estimate of $49). With the current fair value estimate representing 27% upside to JCI’s current share price ($41.22 as of this writing), we continue to recommend purchase of the shares.

In time, we expect investor focus to shift from integration of the Tyco merger to the broader question of whether JCI should be valued as a true multi-industrial company. In addition, it is important to note that JCI could potentially explore strategic alternatives for its Power Solutions business, whose weak cash flow and capital-intensive nature have been a valuation drag on the shares. Given its limited synergy with the Building Efficiency business, a sale of the Power Solutions business makes sense, in our view, and could allow JCI to garner a higher multiple (and potential re-rating) in the future. In the near term, we view the shares as a more resilient name in a potential sector downturn, owing to a highly visible revenue trajectory, with a large order backlog in the Buildings segment ($8.1 billion), and a predominantly aftermarket auto battery business in the Power Solutions segment, which is less discretionary in nature.

On January 26, 2017, Actelion (ATLN: SIX), a Swiss pharmaceutical company, reached an agreement to be acquired by Johnson & Johnson for approximately CHF30 billion. Actelion is not a small company, having produced CHF2.4 billion of revenues and CHF696 million of net income in 2016. It is focused on developing treatments for pulmonary arterial hypertension, and the addition of its portfolio will assist Johnson & Johnson in further expanding its heart disease treatment franchise.

At the company’s annual meeting held on April 5, 2017, a majority of shareholders voted in favor of the Johnson & Johnson acquisition. Actelion shareholders will receive the purchase price of CHF280/share in cash. In addition, shareholders will be issued shares of a new company, to be called Idorsia, which will trade on the Swiss Stock Exchange. This will be structured as a stock dividend on a one-for-one basis. Idorsia will be comprised of Actelion’s early stage and developmental drug operations. Effectively, this transaction represents the immediate monetization of the company’s commercially successful products, while providing future optionality to shareholders through ownership of a drug pipeline.

Idorsia has several development stage products that could have future value. It will focus on four areas: specialty cardiovascular disorders, central nervous system disorders, immunological disorders, and orphan diseases. Johnson & Johnson will initially own 16% of the Idorsia shares, and have rights to acquire an additional 16% through the issuance of a convertible note. The company will be initially capitalized with CHF1 billion of cash, and presumably no significant liabilities. It is worth mentioning that certain key founders and Board members of Actelion will assume management of Idorsia.

Actelion currently trades at CHF284/share. This represents the CHF280/share future cash proceeds, and CHF4/share assigned to Idorsia. Idorsia is therefore of little consequence to most investors, representing only 1.4% of the share price. If these shares were valued merely at the indicated cash balance of CHF1 billion (as this will likely be a pre-revenue entity), this would amount to CHF9.43/share, or 3.3% of the current share price. This could be an interesting security worthy of further analysis, as the implied current value of CHF4/share is considerably lower than a post-transaction base value of over CHF9/share. Given the small size of this new company relative to the Actelion market capitalization, there is a reasonable possibility that the Idorsia shares may be overlooked by the market and ultimately trade at a noticeable discount to balance sheet cash.

As a development stage biopharmaceutical company, it will have a certain burn rate, such that the cash book value might naturally decline over the near term. The critical issue will be the time frame required for current pipeline drugs to eventually reach market (if ever). This is a venture capital type investment that, if purchased at or below book value, as the Actelion share price currently indicates, could be attractive to certain investors.

Actelion has indicated that it expects the Johnson & Johnson tender offer to be completed sometime during the 2Q2017, with the issuance of Idorsia shares occurring immediately prior.

On April 4, 2017, Liberty Interactive Corp. (NASDAQ: QVCA, QVCB, LVNTA, LVNTB) announced plans to acquire General Communication Inc. (NASDAQ: GNCMA) (“GCI”). The acquisition will be made via a reorganization in which certain assets of Liberty Ventures Group (NASDAQ: LVNTA, LVNTB) (a tracking stock of Liberty Interactive) will be contributed to GNCMA in exchange for a controlling interest in General Communications. Following the acquisition, Liberty Interactive will effect a tax-free split-off of the controlling interest in GNCMA and the contributed Ventures assets into a new, stand-alone publicly traded company, which will adopt GCI Liberty Inc. as its corporate moniker. Liberty Interactive will be renamed QVC Group following the transaction as the tracking stock structure of Liberty Interactive is collapsed. The split-off is expected to be completed by 1Q 2018 and is subject to customary regulatory approvals.

GCI shareholders will receive $32.50 per share in value in the acquisition, comprised of $27.50 per share in GCI Liberty Class A shares and $5.00 newly issued Series A preferred shares based on Liberty Ventures’ reference price of $43.65 (shares of LVNTA are trading at $48.84 as of this writing). The preferred shares will accrue dividends at 5% initially, which would increase to 7% upon GCI Liberty reincorporating in Delaware. On an undiluted basis, the transaction values GCI at an enterprise value of $2.68 billion and an equity value of $1.12 billion. For reference GCI generated $934 million in revenue and $288 million in adjusted EBITDA in 2016. GCI shareholders will own 23% of equity and 16% of voting power in the newly created GCI Liberty.

The transaction should significantly simplify the structure at Liberty Interactive, which should lead to a reduction in the discount that shares trade at versus NAV. In the course of the transactions, certain assets and liabilities will be reattributed from Liberty Ventures to QVC Group. Liberty Ventures should benefit from GCI’s free cash flow generation, which is currently operating with decreased capital requirements and approximately $290 million in NOLs. QVC Group will now be attributed the tax benefits and liabilities of the exchangeable debentures, which were previously attributed to Ventures. Please see Exhibits 3 and 4 in the attached FLASH for a complete summary of pre- and post-split Liberty Interactive corporate structures and a summary of all transactions to occur in connection with the GCI acquisition and split-off.

The GCI business fits with the other public holdings that will be split-off into GCI Liberty, which primarily consist of Charter Communications Inc. (NASDAQ: CHTR) and Liberty Broadband Corp. (NASDAQ: LBRDA, LBRDK, OTC: LBRDB), which itself owns shares of CHTR. Following the acquisition, management commented that there were opportunities to improve margins at the communications provider. Notably, the acquisition of a small regional communications provider may prove to be the beginning of an acquisition strategy to rollup smaller regional communications companies.

Following the completion of all transactions, GCI Liberty will consist of the newly acquired GCI business, which generated $288 million in adjusted EBITDA in 2016, as well as the publicly traded holdings in CHTR and Liberty Broadband. Additional holdings will include Liberty Ventures current ownership stakes in FTD Companies (NASDAQ: FTD), Lending Tree Inc. (NASDAQ: TREE), evite, and other smaller private holdings. Based on last night’s closing share prices for the publicly traded ownership stakes, and the disclosed GCI purchase price of $2.678 billion, post-split shares of GCI are expected to have a net asset value of $6.7 billion, or $60 per share based on 110.9 million shares outstanding. Shares outstanding assume the current 85.4 million combined LVNTA and LVNTB shares represent 77% of GCI Liberty shares outstanding. It can be noted that Liberty Broadband itself trades at a discount to its holdings in CHTR, which if incorporated into GCI’s NAV would provide upside to the fair value estimate.

Following the split-off, the new QVC Group’s holdings will include the QVC operations, zulily, ownership in HSN Inc. (NASDAQ: HSNI) and ILG Inc. (NASDAQ: ILG), as well as some green energy investments. The company will also assume the majority of the exchangeable debentures that were previously attributed to Liberty Ventures. In 2016, the QVC and zulily operations generated 10.2 billion in revenue and $1.9 billion in adjusted OIBDA, representing 11% and 3% growth, respectively. HSNI currently trades at approximately 8x trailing EBITDA. If the QVC and zulily operations are valued in line with HSNI, the operations would be valued at $15.5 billion. Based on current market value of HSNI and ILG, $667 million in estimated cash (QVC cash balance as of December 31, 2016 plus $329 million from Ventures), and assigning $138 million in value to the green investments (as per the company’s presentation), post-split QVC’s assets would total $17.3 billion. Accounting for $7.2 billion in debt, QVC’s net asset value is estimated at $10.3 billion, or $22.30 per share. It should be noted that management tax affects the ILG stake ($260 million versus market value of $342 million), and assumes $750 million in liabilities versus our calculation of $862 million in its presentation; our calculations are based on market values and December 31, 2016 balance sheet information. Accounting for these differences has a negligible impact on the NAV per share estimate.

Withdraw recommendation of ATU with shares trading at fair value; 2Q F2017 earnings set for March 22nd:

• ATU shares have appreciated ~42.5% since our initial recommendation in August 2015 (versus increases of ~19.5% in the S&P 500 and Russell 2000).

• That said, with shares trading roughly in-line with our initial fair value estimate we prefer to maintain a disciplined approach and withdraw our recommendation, as of today’s close.

• Nevertheless, we will continue to monitor ATU for an opportunity to re-recommend the shares if valuation shifts or if we discern incremental movement toward a rationalization of the company’s conglomerate operating structure.

• From a short-term trading perspective, ATU is scheduled to report 2Q F2017 earnings on Wednesday March 22nd before the market open, which could present a degree of volatility, as its F2017 guidance calling for revenue and EPS of $1.1 billion and $1.20, respectively, is admittedly back-half loaded.