Oil States International, Inc. (NYSE: OIS), a provider of specialty products and services to natural resource companies, announced that it would spin off its accommodations business on July 30, 2013, submitted a 10-12B filing with the SEC on December 12, 2013, and expects to complete the transaction sometime during the Summer of 2014.
The tax-free spin off will initially be a C-Corporation in order to expedite the process although the entity will likely seek REIT status from the IRS in order to reduce its tax burden.
The spin off will be one of the largest integrated providers of long-term and temporary remote site accommodations, logistics and facility management services to the natural resource industry with a presence in Canada, Australia and the U.S. During FY 2012, the company generated $1.1 billion in revenue and $352.9 million in operating income with 21,299 rooms in operation, according to its latest 10-12B/A filing.
The company's focus is on providing accommodations where traditional infrastructure isn't accessible or cost effective nearby resource assets with expected 30-40 year production lives. Most contracts are inked on a 2-5 year, take-or-pay basis which provides stable and recurring revenues to shareholders. The high cost of switching housing providers due to long lead times both limits competition and adds to revenue stability.
Through land banked undeveloped locations and permitted expansions to existing locations, the company could deploy approximately 16,000 additional lodge and village rooms over time representing a 75% increase over its existing footprint. The spin off could help unlock value by enabling the build-out of these assets over time without being encumbered by the parent company's higher cost of capital and conflicting goals.
Sum-of-Parts, Post-Spin Value
JANA Partners initially disclosed a $340 million 9.1% stake in Oil States International on April 29, 2013 in a 13D filing with the SEC. The activist hedge fund disclosed discussions that it had with management relating to the separation of its Well Site Services segment from its Accommodations segment and the formation of a REIT for Accommodations. Since then, the stock has risen 28.38% compared to 13.55% for the S&P 500.
According to the 10-12B filing, the accommodations business generated approximately $136,423,000 in net income and RevPAR of $110 during the nine months ended September 30, 2013 with EBITDA of $321,854,000. These top-line figures are marginally lower year-over-year due to poor weather in the U.S. Bakken region, surplus occupancy, and unfavorable exchange rates. Meanwhile, the spin off's balance sheet showed $2,097,280,000 in total assets and $346,614,000 in long-term debt to affiliates.
During a presentation at the Sohn Investing Conference in May of 2013, activist investor David Einhorn suggested that Oil States International could be worth $100 per share or more if the stock fairly reflected the sum of its parts but the conversion of its accommodations business into a REIT could unlock another $55 per share in value based on the tax savings and dividend yield. These figures are significantly higher than the stock's current $97.00 per share price as of February 7, 2014.
To further put this into perspective:
Assuming the spin off grows top-line revenues at a 25% clip and maintains net margins of around 15%, revenues could grow to $4.2 billion with net income of $635 million by 2018. Hospitality REITs like Ashford Hospitality Trust Inc. (NYSE: AHT) trade with a price-sales multiple of 0.7x with an industry average of 2.5x. A price-sales multiple of 1.0x applied to the OIS spin off would mean a valuation of around $4.2 billion by 2018 compared to the current consolidated OIS valuation of $5.4 billion.
Typical Spin Off Dynamics
Several studies have shown that spin offs tend to outperform the overall market over time. While some studies date back to the 1990s, Credit Suisse's 2012 study confirmed that spin offs continue to outperform the S&P 500 (NYSE: SPY) over the past 17 years by a wide margin. The results showed that most spin offs tend to suffer during the first month but outperform the benchmark by 2.2% by the second month and 13.4% by year end.
Spin off exchange-traded funds ("ETFs") like the Guggenheim Spin-Off ETF (NYSE: CSD) have confirmed these tendencies in some ways. Over the past 52 weeks, the ETF has outperformed the S&P 500 38.84% to 21.21%. The performance is even more pronounced over the past five years where it outperformed the benchmark by 280.06% compared to 122.34%. Despite this performance, it's important to note that the ETF's performance could be due to some of its larger holdings outperforming.
Oil States International's spin off of its accommodations business provides investors with an interesting opportunity. With the enormous projected growth in the energy sector, the need for on-site accommodations been expanding. Tenants in these accommodations tend to be both long-term and stable relative to other hospitality REITs. And, many popular hedge fund managers have noted that the spin off will create exceptional value.
Spin offs themselves also tend to outperform the S&P 500 and broader market index for a variety of reasons. As a result, the possibility of higher returns for the OIS spin off are already skewed in favor of investors. However, investors may want to wait to invest until after the first month based on the available evidence since parent company shareholders may sell.
In the end, the OIS spin off of its accommodations business warrants a second look for investors.