April Spin-Off Review

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Includes: ALC, ARNC, BC, DHR, DOW, DWDP, EBAY, IR, KAR, NVS, POST, PPG, VFC
by: Spin-Off Insights
Summary

A stock spin-off results in the formation of a new, independent company.

Ingersoll-Rand announced they will spin-off their Industrial segment.

DowDuPont and Novartis closed the spin-offs of Dow and Alcon, respectively.

Introduction

A stock spin-off is the formation of a new, independent company via the distribution of shares from the parent company. Corporations execute these transactions for many different reasons, including improving strategic focus, closing a valuation discount, removing conflicts of interest, evolving capital allocation priorities, and better-aligning investor bases. As a result, spin-offs have historically performed quite well and frequently represent some of the most compelling opportunities available for active investors.

April was a busy month for spin-offs. One new transaction was announced (Ingersoll-Rand) and two spin-offs closed (Dow and Alcon). This article not only reviews these transactions, but also discusses upcoming spin-offs, the spin-off pipeline, and potential spin-offs.

New Spin-Off Announcement

Ingersoll-Rand: Industrial Segment (Spin-Off)

Ingersoll-Rand is a diversified industrial company that focuses on products and services to improve the quality and comfort of air in homes and buildings, transport food and perishables, and increase industrial productivity and efficiency. In the Climate business, they have leading market positions in HVAC systems with the Trane and American Standard brands, as well as in transportation refrigeration with the Thermo King brand. In the Industrial business, they have strong positions in compressed air and gas systems, as well as power tools and fluid management systems.

On April 30th, they announced the plan to spin-off and merge the industrial segment with Gardner Denver through a Reverse Morris Trust transaction. This new company will operate under the Ingersoll-Rand name. The combined company will be 50.1% owned by existing Ingersoll- Rand shareholders and 49.9% owned by Gardner Denver shareholders. Ingersoll-Rand’s remaining Climate segment will take a new name and be a pure-play HVAC and refrigeration company. The transaction is expected to close in early 2020.

Closed Spin-Off Transactions:

DowDuPont: Dow Inc. (Spin-Off)

DowDuPont is a huge global chemical conglomerate formed in 2017 from the merger of Dow and DuPont. The Dow spin-off closed on April 1st and began trading as a stand-alone entity on April 2nd. Dow is a large global commodity chemical business that manufactures products throughout the chemical value chain.

Dow Inc. generated pro forma revenue of about $49 billion and operating EBIT of nearly $6.2 billion in 2018. They have large fixed assets around the globe, as well as JVs with strategic partners in cost-advantaged locations. The main business driver for this commodity business is the difference between feedstock costs and the price received for their end products (“crack spread”).

Novartis: Alcon Inc. (Spin-Off)

Novartis is a Basel, Switzerland based healthcare company that generates net sales of ~$52 billion. In June 2018, they announced the plan to spin-off one of their segments, Alcon, into a separately-traded stand-alone company. Alcon is one of the largest eye care companies in the world and generates ~$7.1 billion of net sales. The spin-off closed on April 9th.

Alcon develops, manufactures, and sells ophthalmic products and equipment for various surgical procedures, as well as contact lenses and other ocular health products. Their solutions help eye care professionals treat refractive errors, presbyopia, dry eye, cataracts, retinal diseases, and glaucoma. Alcon is fundamentally a good business and should benefit from a handful of long-term secular growth drivers. However, investors must carefully weigh some risks, such as pricing pressure in more mature products and disruption within the traditional sales channels.

Upcoming Spin-Off Transactions:

V.F. Corp: Kontoor Brands, Inc. (Spin-Off)

VF Corp is a U.S. based apparel company with revenues approaching $14 billion. In August 2018, they announced the plan to spin-off the Jeanswear business as a separate company to be named Kontoor Brands. The new company will generate approximately $2.7 billion in revenue and own the Wrangler, Lee, and Rock & Republic brands as well as the VF Outlet business. Management expects the spin-off to be completed after the market close on May 22, 2019, with VF shareholders receiving one share of Kontoor Brands common stock for every seven shares of VF common stock held.

DowDuPont: Corteva, Inc. (Spin-Off)

DowDuPont is a large global chemical conglomerate formed in 2017 from the merger of Dow and DuPont. They completed the spin-off of the commodity chemical business Dow, on April 1, 2019, and are set to spin-off the agriculture business, Corteva, in the first week of June.

Corteva will generate ~$14 billion in revenue and provide seeds (~56% of sales) and crop protection chemicals (~44% of sales), as well as a variety of software solutions to farmers. These products help improve crop yields and farmers’ profitability. While the business has slowed in recent years with weak crop prices driving decreases in farmer income, it remains a good business with significant technology and distribution capabilities.

KAR Auction Services: Insurance Auto Auctions (Spin-Off)

KAR Auction Services runs used and salvage car auctions in North America and Europe. They generate revenue from auction fees, as well as through ancillary services like transportation, reconditioning, inspections, marshaling, titling, and floorplan financing. In February 2018, they announced the plan to spin-off the Insurance Auto Auctions (IAA) segment, which is the salvage auction business that primarily sells total loss vehicles for insurance companies.

Management originally expected the spin-off to close at the end of Q1 2019 or early in Q2, but on the Q4 2018 earnings call they were more uncertain on the timing and included some new language that said they are just on track to complete it sometime in 2019. However, in April, they announced that they received a favorable private letter ruling from the IRS with respect to the tax-free status of the spin-off. This is an important step and implies that the spin-off is likely to happen in the coming months.

Also, the activist investment firm Starboard Value announced a position in the company at an investor conference in April. The firm’s founder, Jeff Smith, believes the spin-off will happen and that KAR’s margins will improve over time.

Spin-Off Pipeline Updates:

Post Holdings: Active Nutrition Segment (Carve-Out)

Post Holdings is a consumer packaged goods holding company that has brands in a variety of different categories. In November 2018, they announced the plan to carve-out the Active Nutrition segment (PowerBar, Dymatize, Premier Protein, etc.) through an IPO of just under 20% of the business.

In April, they made progress towards the transaction. They announced the submission of a confidential draft registration statement with the SEC. This puts the carve-out on-track for sometime in the summer or fall of 2019.

Brunswick Corporation: Fitness Business (Spin-Off)

Brunswick designs and manufactures a variety of recreational products, including marine engines, boats, and fitness equipment. In March 2018, they announced the plan to spin-off the Fitness segment. This portfolio move is consistent with the company’s recent strategy of shifting the business more towards marine engines and boats (acquired Power Products Holdings, a marine electrical components business, for over $900 million in 2018 from Genstar Capital).

Management previously communicated that the Fitness business separation would close by the end of the first quarter or soon after. However, they have since said that they will likely sell the business, with an announcement expected sometime in the second quarter.

Danaher Corporation: Dental Segment (Carve-Out)

Danaher produces a wide variety of medical, industrial, and commercial products. In July 2018, they announced the plan to separate off the dental segment. The dental business produces products used to diagnose, treat, and prevent disease and ailments of the teeth, gums, and supporting bones. While management initially expected the separation to be structured as a spin-off with a pro forma distribution to DHR shareholders, they now expect to carve-out the business through an IPO to raise capital to help finance the acquisition of the BioPharma business from GE Life Sciences.

Danaher reported first-quarter earnings in April. The reported Dental segment revenue declined by around 2% while core revenue grew 2.5%; segment margins were down about 30bps over the prior year. The decline in margins is mainly due to investments in new products, specifically around clear aligners and digital products. Also, on the conference call, they reiterated the plan to carve-out the Dental business in late 2019.

The Dental segment has struggled to grow in recent years with core sales volumes of traditional dental equipment and consumables declining in developed markets. Management is trying to rejuvenate the segment through increased R&D investments in new technologies. These investments should position the Dental business for success when they are a stand-alone company.

DowDuPont: Corteva, Inc. (Spin-Off)

On April 18th, Dow provided an update with regards to first quarter performance. The Agriculture business, Corteva, is expected to report results lower than DowDuPont’s previous guidance. The main reason for the shortfall is due to the flooding across the Midwestern U.S. This created transportation disruptions that stopped farming operations and delayed seed deliveries into April. For instance, fewer than 50% of the planned seed deliveries in the last 5 days of the quarter occurred. As a reminder, this is the busy season for Corteva as they deliver seed to dealers and farmers for the planting season. Overall, DowDuPont’s Agriculture Division expects sales and operating EBITDA to be down 11% and 25%, respectively, versus the same quarter last year.

Arconic Inc. (Splitting into Two)

Arconic is a large metals engineering and manufacturing company serving a wide range of end markets. In February 2019, they announced the plan to separate into two different companies: Engineered Products & Forgings and Global Rolled Products (the SpinCo and RemainCo will be determined at a later date).

On April 30th, Arconic released first-quarter earnings and announced additional details related to the spin-off. The Global Rolled Products company will comprise the rolled aluminum products, aluminum extrusions, and building and construction systems businesses. The Engineered Products & Forgings company will include engine components, fastening systems, engineered structures, and forged aluminum wheels businesses. Management expects the initial Form 10 to be filed in Q4 2019 and the separation to be completed in Q2 2020.

Potential Spin-Off Updates:

eBay Inc. (Operational and Portfolio Review)

In January 2019, Elliott Management took a large stake in eBay and sent a letter to the board outlining a plan that included a comprehensive portfolio review of the eBay Classifieds Group and StubHub. eBay’s margins have fallen from over 30% to the low 20% range during the last five years as they spent aggressively to try to grow the business. Despite this spending, eBay’s growth has consistently fallen short of total worldwide e-commerce sales.

On March 1st, eBay made a significant announcement. They will undergo a strategic review of the portfolio, including StubHub and eBay Classifieds. Furthermore, they will add Jesse Cohn, an Elliott partner, and Matt Murphy, the President and CEO of Marvell Technology, to the board of directors. These moves could set the stage for spinning out the Classifieds and StubHub businesses.

They announced first-quarter results in April and reiterated that the operational and portfolio reviews are underway, but they had no material updates to share at this time.

PPG Industries, Inc. (Strategic Review)

In October 2018, Trian Partners release a white paper outlining their investment thesis for PPG. Trian believes the business has significantly underperformed under the current CEO and Chairman and it could be better off as two separate companies, an Architectural Coatings company and an OEM/Industrial Coatings company.

Not long after Trian released their white paper, PPG announced a strategic review of the business portfolio. They are assessing the relative value associated with the combination or separation of the architectural and industrial coatings businesses. PPG announced first-quarter results in April and reiterated that the strategic review is ongoing and that they will have an announcement by the end of the second quarter of 2019.

Conclusion

There was a lot of activity in April with a new spin-off announcement, two transactions closing, and a handful of companies making progress towards executing spin-offs in the coming months. Many of these companies have interesting characteristics, so it could pay-off for investors to understand these businesses.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.