Spin-offs Links – May 2023

It’s been a busy five months in the spin-off world.

Let’s get right into it….

Recently Announced Spin-offs

On May 18, 2023, Alibaba (BABA) announced that it will be spinning off its Cloud Intelligence Group in the next 12 months. This follows the company’s March 28 announcement of a large corporate restructuring plan to split into six independent companies.

The cloud business, which includes Cloud, AI, and DingTalk, generated $2.7 billion in revenue during the first quarter, making up 9% of Alibaba’s total revenues, with its cloud business dominating China’s market. Last month this segment released Tongyi Qianwen, their flagship large language model, which currently lags behind GPT-3 in terms of technological capabilities and influence, but it stands as one of China’s most promising alternatives to text-generating AI. This is being integrated with their messaging service DingTalk. Fundamentally, spin seems to make sense, as last week Beijing introduced a preliminary policy urging cloud providers to enhance collaboration with AI companies and provide them with the necessary computing resources.

Alibaba looks intriguing in a lot of ways. On a consolidated basis, it trades at just 10x free cash flow. And a breakup will definitely unlock value. On the other hand, growth is slowing across the board, and I don’t have conviction that it will re-accelerate.

On May 9, 2023, Jacobs (J) announced that it’s spinning off its Critical Mission Solutions business. The spin-off will be a leading pure-play provider of government services. The tax free spin-off is expected to be completed in Q2 2024.

The Spin-off (30% of revenue) and RemainCo (70% of revenue) basically provide the same services: consulting and data analysis to design and manage complex projects. However, they serve different end markets. The Spin-off is completely focused on Government services. It provides nice cash flow and is steady but is less profitable, slower growing and not ESG friendly. Thus, the idea is that the RemainCo should trade at a higher multiple.

Raymond James believes a 10x EV/EBITDA multiple for the Spin-off and 16.0x EV/EBITDA multiple for RemainCo are appropriate which would imply a $167/share price target (current price is $115). I will dig in to try to determine whether this transaction will unlock value.

Recent Spin-offs

On March 31, iStar Inc. (STAR) completed its merger with Safehold Inc (SAFE). In conjunction with the merger, iStar spun off its legacy assets into a new public company called Star Holdings (STHO).

The merger is a part of iStar and Safehold management’s multi-year strategy to focus on building out and growing their ground lease ecosystem and monetizing its non-core assets. The New Safehold trades under the ticker “SAFE” and will be a pure-play ground leasing company.

The SpinCo is an independent company with interests in real estate assets and SAFE stock, and externally managed by New Safehold. The structure allows iStar shareholders to retain these “legacy” longer-term assets in order to facilitate a streamlined monetization.

SpinCo has been capitalized with $400MM of SAFE stock, $50MM of cash, $350MM of real estate (book value), a senior secured loan of $114MM, and a margin loan of $139MM. Add it all up and NAV is approximately $547MM or $41 per share (13.3MM shares outstanding). The spin-off trades around $15.

The current price looks like a nice discount to NAV, but I’m not buying yet. I published a deep dive here (paywall).

On April 4, 2023, Crane Co (CR) spun off from Crane NXT Co (CXT). Crane Co, the spin-off, retains the Crane name/ticker and consists of the Aerospace & Electronics and Process Flow Technologies (valves/pumps) businesses.

The current CEO (Max Mitchell) and current CFO (Rich Maue) went with the spin-off.

Crane Co is trading at $73 per share. With 57.3MM shares outstanding and net debt of $125MM (at the midpoint), Crane Co has a market cap of $3.9BN and an EV of $4.0BN. Guidance for 2023 is EBITDA of $321MM and EPS of $3.55. It’s trading at 12.2x EBITDA. According to Morgan Stanley, the median takeout multiple for Aerospace and Defence companies is 14.1x. Another potential good comp is Pentair Valves & Controls which was acquired by Emerson in 2016 at 14.1x EBITDA. Crane Co looks reasonably valued to me.

Crane NXT, the RemainCo, consists of the Payment and Merchandising Technologies.

The company has supplied currency to the Federal government since 1879 and has been the sole provider since 1964. It provides currency for several other countries as well. It also supplies technology solutions that detect and authenticate payment transactions.

Crane NXT is a good business with high returns on capital. But it’s hard to know the right valuation multiple for it given secular headwinds facing paper currency. Crane NXT is trading at $53. With shares outstanding of 57.3MM and net debt of $650MM, Crane NXT has a market cap of $2.7BN and an enterprise value of $3.4BN. 2023 guidance is for EBITDA of $346MM and EPS of $3.80. As such, it’s trading at 9.8x EBITDA and 12.5x EPS. This seems cheap but not quite a no brainer given secular growth concerns. I was hoping for a juicy dividend but the company will only pay out 15% of EPS which implies a 1.2% dividend yield. I published a deep dive with more details here (paywall).

Madison Square Garden Entertainment (MSGE) broke up into two public companies on April 21, 2023. The spin-off, focused on the live entertainment business, kept the same name and ticker: Madison Squash Garden Entertainment (MSGE).

The SpinCo includes a diverse collection of venues in New York and Chicago, as well as the Company’s entertainment and sports bookings business. Guidance is for revenue of $850MM and adjusted operating income of $150MM in FY 2023. Revenue comes from MSG license arena fees (Knicks and Rangers pay), the Christmas spectacular, bookings business (think Ticketmaster). The stock is currently trading at $35, implying an EV/operating income multiple of 15.0x a price to free cash flow multiple of 33x. It is trading pretty close to its asset value based on my deep dive analysis. The spin-off looks fairly valued.

The more interesting stock is the RemainCo which has been renamed Sphere Entertainment Co (SPHR). With 34.55MM shares outstanding and a current stock price of $23, the stock has a market cap of $829MM. Factoring in its debt and 33% stake in MSGE, I calculate SPHR’s enterprise value to be $1.3BN. For that EV, investors own the Sphere, a state of the art arena in Las Vegas which will cost over $2BN to complete (will be completed in September ‘23) and MSG Networks which Sphere Entertainment acquired in 2021 for an enterprise value of $1.6BN. My one concern is MSG Networks. I don’t think it’s worth $1.6BN anymore given secular challenges from cord cutting. I think it may not even be worth the debt that is associated with it ($929MM). I recently published a deep dive. My conclusion: the stock looks cheap on a SOTP basis, but it’s messy and MSGN is going to provide challenging headwinds on a consolidated basis.

Upcoming Spin-offs

MDU Resources Group (MDU) announced on May 4 that it will spin off its construction materials subsidiary, Knife River Corporation, on May 31. Regular way trading will begin on June 1.

MDU Resources will retain the regulated utility and infrastructure business segments, with the lower-risk, regulated business segment estimated to still make up ~66% of its EBITDA.

Knife River, the SpinCo, will continue to focus on providing construction materials and offering contracting services. The business delivers aggregates, crushed stone, sand, gravel and related construction materials and generated EBITDA of $307MM in 2022. Knife River was the fastest growing segment of MDU on an EBITDA basis last year. It would benefit from continued investment infrastructure by both federal and local governments.

I’m not too excited about this transaction for two reasons. 1) Upon completion of the spin-off of Knife River, MDU won’t be a pure play regulated utility as it will still retain its pipeline business and its construction services business. Thus, the investment case will still be a SOTP story. 2) My initial attempts at a SOTP valuation isn’t yielding that much upside.

Companhia Brasileira De Distribuicao is spinning off its stake in Brazilian grocery company Exito.

In short, this is interesting because the stake in Exito is worth more than CBD’s current market cap.

Great thread that summarizes the thesis here.

I agree it looks interesting, but I don’t own it yet. My one hang up is Exito. It trades at a forward P/E of 13x. Why shouldn’t it trade at 7x after the spin-off?

There are a lot of cheap emerging market stocks out there….

Further, I don’t think RemainCo is worth much. It generates adjusted EBITDA margins of 6% but that excludes rent/lease payments which are currently running at 4.5% to 5.0% of revenue.

Any other spin-offs that you like?

Spin-off Links

Einhorn is Bullish on Vitesco, a European Spin-off

  • Stock is undeniably cheap.

Recent Podcast Interview with Mohnish Pabrai

  • Not spin-off related, I always enjoy listening to Pabrai (he is very articulate and a clear thinker)

Sony: Sum Of The Parts Analysis Reveals Massive Upside

– I think Sony is interesting at a high level. Seems like it has valuable divisions and a breakup would unlock value.

– The other interesting thing is Japan is changing laws such that spin-offs can be tax free (my understanding is they aren’t today). As such, it could open a wave of value accretive spin-offs.

BorgWarner: The Spin-Off Transaction And Further EV Assets Imply Undervaluation

– Good overview of upcoming transaction.

WSJ: Alibaba Shares Are a Bet on Spinoffs, Not Growth

– Good overview of Alibaba.

– I didn’t realize revenue growth is actually pretty modest.