Versum Materials Spinoff – Versum (VSM) is the recent spinoff of APD, VSM focuses on specialty gases, specialty chemicals, and services and equipment to the electronics industry.
There has been some insider buying of late which is always good to see. However, I don’t think the stock looks that interesting. First of all, it trades at 11.7x EBITDA so it is not that cheap. Second, VSM already improved its EBITDA margins from 22% in 2013 to 35% in 2015. Currently VSM has better margins than its peers CCMP and ENTG. While this is great for VSM and a tribute to the management team’s ability to streamline operations, it makes the stock somewhat uninteresting.
Let me explain why.
When I’m evaluating a spinoff, I look for an inexpensive valuation and the potential for margin expansion. This dynamic can result in significant equity upside. For instance, if margins improve by 30% and valuation improves by 30%, the stock’s valuation will improve 69%. That’s one of the reasons that I like Armstrong Flooring (Ticker: AFI) so much. In Versum’s case, valuation doesn’t appear very cheap and margins have already improved. Thus, it’s unlikely that we will see dramatic upside in the stock. There is a good article on VIC recommending shorting VSM. While I’m not convinced VSM is a short, the article articulates the bear case well.
Conduent (Xerox Spinoff) – CNDT is currently trading in the when-issued market at approximately at $14.31. What does Conduent do? It provides business process outsourcing services to healthcare companies, the public sector and several other sectors. That includes call center services, support for electronic toll collections, and a hodgepodge of other services. 90% of revenue is recurring which is a major positive.
Why is it interesting? Well it is trading at 7.7x TTM EBITDA. Its peers (CVG, DOX, SYKE, G, TTEC, and TLPFY) trade at 10.9x EBIDTA. It has an EBITDA margin of 9.5% versus peers at 13.2%. So if it can expand margins a bit, it should benefit from multiple expansion. Let’s assume margins can eventually expand to 13.2% and accordingly, its valuation improves to 9.0x EBITDA. That would yield a share price of $27.24, assuming no revenue growth.
A couple other thoughts. The business that is now named Conduent used to be a publicly traded company called Affiliated Computer Services (ACS). Xerox acquired ACS in 2009 for $6.4bn. Conduent’s current enterprise value is $4.8bn. In 2009, ACS generated $6.5bn in revenue and had grown revenue at a 6% CAGR from 2007 to 2009 (through the great recession). Its EBITDA margin in 2007, 2008, and 2009 was 13.5%, 15.7%, and 16.6%, respectively. Fast forward to 2016, and Conduent has generated LTM revenue and EBITDA of $6.6bn and $630mm, respectively. So ACS revenue went from $6.5bn in 2009 to $6.6bn in 2016. EBITDA went from $1.08bn to $630mm. What a disastrous acquisition! A case study in shareholder value destruction. I need to do some more digging, but this one looks interesting.
Vistra Energy – In 2007, in the largest LBO in history, TPG, KKR, and Goldman Sachs teamed up to buy TXU for $45bn ($8.3bn in equity and $36.7bn in debt).
By 2014, TXU had to file chapter 11 due to its crushing debt load. Vistra Energy (VSTE) is the post-reorg equity of TXU Corporation. It currently trades over the counter as its shares have been spun off to first lien creditors as part of the bankruptcy reorganization.
Here’s why it’s interesting:
- As I stated above, VSTE trades over the counter so it has limited liquidity currently. VSTE is a major utility with a market cap of $6bn and EBITDA of ~$1.4bn. But it trades over the counter. Why? I’m not completely sure. The Seeking Alpha author believes it is doing so to build volume and investor interest gradually. What I do know is liquidity is currently limited, preventing institutional investors from establishing large positions. What I also know is VSTE will eventually uplist to the NYSE or NASDAQ. Why am I so confident this will happen? Because Apollo, Oaktree, and Brookfield own ~40% of the stock and they are also on the board. Uplisting will be an easy way to increase liquidity and close the valuation gap between VSTE and its peers (more on this below). I think the uplisting will be a significant catalyst in 2017.
- VSTE is very cheap. Currently, the stock is trading at 6.4x 2017 EBITDA and 7.3x 2017 free cash flow. Its peers (NRG, Dynegy, Calpine and Exelon) trade at a median forward EV/EBITDA of 8.5x (min: 7.4x, max 9.2x). Assuming VSTE eventually trades at the median valuation, the stock will be worth ~$21 (versus current share price of $14.35). Is VSTE more risky than its peers? In short, no. It actually looks less risky. Vistra has cut its net debt load from $32bn (pre-chapter 11) to $2.9bn currently. On a pro-forma basis, Vistra has net debt to EBITDA of 2.1x versus peers at 5.9x to 6.5x.
- Utilities are defensive. In the current environment with the US stock market near an all-time high, I think utilities are a good place to invest. Customers and businesses need to use electricity, even in a recession.
- Great investors own the company and constitute the board. As I mentioned above, Apollo, Oaktree and Brookfield own ~40% of the company. In addition, representatives from these firms sit on the Vistra’s board. These firms have reputations as excellent investors and capital allocators. As such, VSTE shareholders can rest assured that the company will do everything possible to maximize shareholder value. Potential value creating actions: uplisting onto the NYSE or NASDAQ, instituting a quarterly dividend, buying back stock, paying a special dividend. Earlier in December, VSTE paid a special dividend to shareholders. I believe this bodes well for additional shareholder returns in the future. Seeing as VSTE is underleveraged versus peers and will generate almost a billion of free cash flow in 2017, the company has significant flexibility to return capital to shareholders.
- Full disclosure. I own the stock.
P.S. If you haven’t already, check out my write up on LSYN. Podcasting pure-play with recurring revenue trading at 3.0x earnings.