ADT Post-Spinoff

Last week, Keith Meister of Corvex Management LP reported a 5.02% stake in the recently spun-off subsidiary of Tyco (TYC), ADT (ADT). Meister and George Soros are urging management to lever up the company on cheap debt and return the proceeds back to shareholders in the form of dividends or share buybacks. Investors quickly sent the stock price up from $38 to $41 and change. 

I went through Corvex’s presentation. Here are there major points.

Steady State Free Cash Flow

ADT has FCF of around $500 million. However, Corvex argues that this is an understatement because it includes money spent on customer growth acquisitions. The company routinely spends almost $500 million a year buying “dealer generated customer accounts.” It contends that “investors have gotten comfortable valuing REITs and other capital intensive industries on the basis of free cash flow after maintenance capex and then applying a multiple based on growth opportunities and return on investment.” It should do the same with ADT.

Corvex makes steady state free cash flow calculation for fiscal year 2013. The estimates are based on assumptions that EBITDA and average revenue per user (ARPU) grow at historical rates. It estimates that based on $1,707 million EBITDA, ADT would only need to spend $683 million to maintain customer revenue. Thus, their steady free cash flow estimation for 2013 would be around $1 billion. At the current market capitalization of almost $10 billon. The company trades at a price/FCF ratio of 10. 

Their calculations make sense, but there are some caveats that investors should know of:

  • The calculation assumes that EBITDA and ARPU will grow in FY 2013. It has grown historically in the past and there is no reason it won’t do so in the future.
  • The calculation is based on constant revenue not constant number of customers. Based on their calculation, customers would actually go down year after year, but ARPU would go up year after year making up the lost revenue.
  • There is no guarantee that other investors are going to value the company this way just because other industries are valued this way.
  • The real FCF will still be around $500 million for fiscal year 2012. ADT is not going to spend less to acquire less dealer generated customers.
Capital Structure
Corvex believes that ADT is under leveraged. See Figure 1 below.
ADT Leverage Comparison
Figure 1: ADT Leverage Comparison (Source: Corvex Management)

Corvex wants ADT to increase their Debt/EBITDA ratio to around 3 from 1.4 and keep it that way. If it did that, it should be able to borrow more than $2.5 billion, which could be used to:

  • Return money to shareholders through dividends or stock buybacks.
  • Grow through customer acquisition or M&A.
Based on the low interest rates, the cost for the debt would be ~2-4% (after-tax). See figure 2 below.
Improve ADT Capital StructureFigure 2: ADT Leverage Comparison (Source: Corvex Management) 
If they do a huge buyback, it will significantly lower price/steady state FCF.
Other considerations
Corvex also mentions other ADT advantages:
  • Expect low tax rates for the coming years. ADT expects to have $1.0 billion to $1.2 billion federal tax loss carry forward at time of separation.
  • Strong business model with recurring revenue.
  • Under-appreciated secular growth tailwinds.


If ADT increases leverage and uses it to buy shares, Corvex believes the price of ADT could go considerably up. Their base case valuation is $55/share and upside case is $63/share based on a debt/EBITDA ratio of 3 and 3.5 respectively. 

I will sit on the sideline for this investment because:

  • Although, management is in talks with Corvex, there is no guarantee they are going to do anything.
  • The stock price has almost gone up almost 10% since the announcement and this will have an effect on the buyback price.
  • The value case is just not compelling enough. The value case is based on adding more debt to take advantage of the low interest rates. A lot of companies could do this to increase shareholder value.
  • ADT is not cheap enough for the buybacks to have a substantial effect. What happens when the cost of funding goes up in the future?
Check out the full Corvex presentation here.
Disclosure: I do not own ADT

Murphy Oil Spin-Off

Murphy Oil LogoA couple weeks back, Murphy Oil announced it will spin-off its retail gasoline business, pay a special dividend and buy back shares. The news came after hedge fund manager Dan Loeb, of Third Point, amassed a significant stake in Murphy Oil and urged Murphy to spin-off its retail business. Here is Third Point’s case:

“Murphy Oil is a ~$10.4 billion energy company with three primary business segments: Exploration and Production; Refining, which it is in the process of exiting; and Retail and Marketing. Third Point owns a significant stake in Murphy and recently filed for Hart-Scott-Rodino approval to increase our position should we so desire. If Murphy pursues the steps outlined below, we believe its shares could be worth in excess of $90, an increase of about 60% from current levels.

We initiated our investment following a 3-year period in which Murphy’s share price declined by ~15% while the SPDR S&P Oil and Gas E&P Index appreciated by ~49%. We believe this lagging performance can be explained partially by Murphy’s disparate asset base, which makes the company complex and cumbersome to value. This issue has been exacerbated by management’s decision to repeatedly delay spinning off its retail business. Investors in Murphy have grown frustrated, particularly given the obvious merits of the spin due to the large multiple disparity between the retail business and the core E & P business.

We believe Murphy can take four easy steps to unlock the latent value in its lagging shares, and we have shared these proposals with Murphy’s management team previously:

1) Spin-Off Its Retail Business: Murphy’s retail business consists of a network of over 1,100 fuel stations, the majority of which are located on or near Wal-Mart store sites. The business generated EBITDA of $363 million in 2011 and has relatively low ongoing capital requirements, making it highly cash generative. On the company’s 2011 Third Quarter earnings call, management indicated they were evaluating a separation of the retail business. After 9 months of consideration, management recently said that they were not interested in pursuing a retail spin at this time on account of the unit’s “underperformance”.

We believe forgoing this accretive spin-off would be a major missed opportunity. Both public company comparables like Alimentation Couche-Tard, Casey’s General Stores, and Susser Holdings and a forecasted dividend yield analysis suggest the retail business would be worth $2.3 – $2.8 billion if separated into a standalone public company. A spin-off in this valuation range would be worth $12 – $14 per share.

At this point, it appears sentimental attachment by management and the Murphy family is driving a stubborn desire to hold onto these and other non-strategic assets, creating a significant drag on enterprise value. While we hope that reason and a desire to create shareholder value will prevail over sentimentality and inaction, we have filed HSR to keep our options open should our discussions with the board and management not bear fruit for Murphy’s owners.

2) Sell Its Canadian Natural Gas Assets: Murphy owns ~145,000 net acres in the Montney play in British Columbia. Investors may recall our description of the Montney opportunity in our Second Quarter 2012 Investor Letter’s discussion of our profitable investment in Progress Energy Resources. Western Canadian gas assets have become strategically valuable given the large arbitrage opportunity between LNG prices in Asia in excess of $15/mmbtu, and $1/mmbtu F&D costs in Western Canada. Encana recently sold 164,000 nearby acres in the Montney to Mitsubishi for C$2.9 billion, or ~C$16,000 per acre (adjusting for the present value of drilling carry). Applying this metric to Murphy’s acreage and attributing ~$4k per flowing mcfe/d for existing production would result in a value of ~$3.0 billion, contributing an additional $15 per share. Management has told investors previously that they would require $4.50 gas in order to resume drilling the asset, which may occur in late 2018 based on the current futures curve and assuming a $0.40 AECO/NYMEX basis differential.

3) Sell Its 5% stake in the Syncrude Oil Sands Project: In April 2010, ConocoPhillips sold its 9% stake in Syncrude for $4.65 billion. In April 2010, WTI crude prices were $84/bbl vs. $92/bbl currently. Assuming a similar purchase price, we believe Murphy’s Syncrude stake would be worth $2.6 billion, or an additional $13 per share.

4) Complete UK Refining Business Exit: According to management, this exit is currently tying up about $500 million in working capital.

These four transactions could generate pre-tax proceeds of $8.4 – $8.9 billion. Assuming 20% tax leakage on the two Canadian asset sales, we arrive at $7.3 – $7.8 billion in after-tax proceeds, or roughly $37 – $40 per share. Third Point estimates that the associated EBITDA with the assets sales is $750 million or ~20% of our 2013 EBITDA forecast for Murphy. Based on a current enterprise valuation of $10.4 billion, our analysis suggests investors are paying only $2.6 – 3.1 billion for the balance of Murphy’s assets, which we estimate could generate $2.9 billion in EBITDA in 2013.

This “new”, slimmed-down Murphy has tremendous upside. Based on May 2012 company guidance, new Murphy could grow production at a 14% CAGR from 2012 to 2015, with oil and oil-indexed gas making up over 85% of the production mix. This strong, “oily” growth profile is bolstered by an industry-leading Eagleford shale position, where Murphy has over 220,000 net acres, the majority of which are located in the oil and wet gas windows of Karnes, Dimmitt, McMullen, LaSalle, Atascosa and Webb Counties. Murphy also has a collection of cash-generative Malaysian assets comprised of high-margin oil and oil-linked natural gas production with several development opportunities.

Assuming new Murphy trades at an extremely conservative 3.5x EBITDA multiple, we estimate total value of $91 – $94 per share after these four steps are completed. We hope that management ultimately decides to take up our suggestions, and act on its own to benefit all shareholders. In any event, as mentioned above, HSR approval, once obtained, will provide us maximum flexibility with the position.”

Murphy plans to pay the special dividend of $2.50, or about, December 3, to shareholders of record as of November 16. The dividend is worth $500 million. It also plans to spend $1 billion on buying back shares. At the current market capitalization of almost $12 billion, the company is returning more than 10% to shareholders.

Murphy will spin-off its downstream business, Murphy Oil USA, sometime in 2013 in a tax free transaction.

If anybody has any thoughts on this transaction, feel free to comment. I will have more analysis in the next couple of days. 

Disclosure: I do not own MUR. 

Dean Worth $20 to $23

I have been playing around with Dean Food’s (DF) valuation numbers in my head the last 3 days. My valuation range comes out to around $19.6/share to $23.04/share based on sum of parts valuation.


WhiteWave (WWAV) is worth $2.5 billion or $13.50/share based on that fact that Dean holds 150 million Class B shares. Dean will use the $390 IPO million proceeds to pay down debt. That will be reflected in the lower interest expense in Fresh Dairy Direct Segment. Company has stated that it will distribute the shares “no earlier than 180 days following the closing of the IPO.” 


Morningstar is on the selling block. There was a Reuters report this past Thursday that there are multiple suitors for the company and the price tag is $1 billion to $1.5 billion. Let’s assume it gets sold for $1 billion in the worst case and $1.25 billion in the best case. In both cases, let’s assume Dean uses $500 million of the proceeds to pay off debt and the rest to distribute to shareholders. So, shareholders get $500 million or 2.70/share to $750 million or $4.05/share.

Fresh Dairy Direct

Fresh Dairy Direct Income

  • Operating Income will be over $400 million in 2012 even with higher commodity prices in 2012. They earned $226 million for the first half of 2012
  • Interest Expense. They will have $1.6 billion in debt. $1.13 billion of that will be senior notes and the rest of it will be the senior credit facility.
  • Corporate Expense includes things such as non cash share based expense. The company had $210 million corporate expense for the whole company in 2011. So, $150 million is a conservative estimate.
  • One time expenses includes such things as litigation expense, facility closing and reorganization costs that they seem to have every year.
  • Added $60 million to net income for FCF because they will have less capital expenditure compared to depreciation.

If Fresh Dairy Direct gets a multiple of 5 to 8 based time FCF, the value is $635 million to $1,016 million or $3.4 to $5.49.


 Adding all that up, I get a valuation range of $19.6 to $23.04. Obviously there are risks:

  • Whitewave share prices could go down. Right now the float is less than 25 million. Once the 150 million Class B Shares come into the market, there could be downward pressure on the price. Also, it is highly valued just like every other healthy food company. However, it does have the good growth.
  • Morningstar may not be sold or it may not distribute any of the proceeds if sold. However, there is considerable interest in the company based on the latest reports. The company has a history of increasing shareholder value. Besides the latest spin-off, the company in 2007 gave a $2 billion or $15/share dividend. Also, what else would they do with the proceeds? They will not pay off the senior credit facility fully. It does not make any financial sense. 
  • Fresh Dairy Direct is a low margin business and is dependent on commodity and fuel prices. However, the company is focused on cutting cost and lowering capital expenditures to increase FCF, and I have valued it conservatively. 
At the current price of $16.74 and my conservative valuation, Dean is severely undervalued. I would love to hear from everybody on this stock.

Disclosure: I am long Dean.

Dean valuation – Post Spin-off

I have gotten a lot of emails about the big Dean Foods (DF) drop. Here is my valuation:

Value from WhiteWave(WWAV) IPO: $2.95 Billion ($390 million from IPO proceeds + 150 million shares@17) 

So rest of Dean is essentially free at the current price of around $16 and change. 

Take into account:

  • Morningstar sale will be soon for $1 to $1.5 billion based on yesterday’s reports. 
  • Fresh Dairy Direct Segment is the most profitable. Although, they will not get a high multiple.
  • They have $2.5 billion in debt. Debt is made of senior notes and senior credit facility. The credit facility is currently charging less than 3% interest. Senior notes yields are higher, but mature I believe in 2016 and 2018.

My hope is that they don’t pay off the senior credit facility with IPO proceeds because of the low interest expense and if they sell the Morningstar at the range that people are talking about and give back everything to shareholders, this stock is easily worth middle $20s.

I have been buying all the way down to sub $16. My average price should be in the $17.5 range.

I don’t get the price drop today. So let’s see…

Disclosure: I am long DF.

Loading Up on Dean

Dean Foods (DF) is crashing today after the spin-off of WhiteWave (WWAV). It is around $17. WhiteWave has been up and down today between $17 – $19. I have loaded up on shares of DF. I am not sure why Dean is down today. Here is the quick math.

Assuming WhiteWave at $17. Dean still has 150 million shares of WWAV.

$2.94 billion worth from WWAV IPO means rest of dean is valued at 300 millon?


Whitewave Spin-off Prices at $17

WhiteWave (WWAV), the spin-off of Dean Foods (DF), based on strong investor interest increased the size, from 20 million share to 23 million shares, and price, from $14-$16/share to $17/share of their IPO.

At $17/share, the company is worth about $2.9 billion. Given that Dean is worth $3.5 billion, there should be a pop in Dean’s shares tomorrow. 

When the initial pricing was announced, I wrote that Dean was undervalued and urged investors to buy. I initiated a position at $16.96. Read the article here.

WhiteWave starts trading tomorrow. 

Disclosure: I am long Dean. 

Buy Xerox

Xerox LogoXerox (XRX)
just reported their third quarter results. Due to a challenging macro environment and government budgetary pressures, operating margins decreased 1 percentage to 8.6% and this had a negative impact on profits. Investors were not impressed and sent the stock down 7.8% to $6.48. However, the lower stock price is an opportunity to buy shares at a very cheap level.


Xerox has three business segments that generate almost $23 billion in yearly revenue:

  • ServicesServices has three offerings: Business Process Outsourcing (“BPO”), Information Technology Outsourcing (“ITO”) and Document Outsourcing (“DO”). Services allow customers to run day-to-day business operations. It contributes over 50% of revenue and is the companies revenue growth driver.
  • Technology. Technology “includes the sale of products and supplies, as well as the associated technical service and financing of those products.” It contributes over 40% of revenue, and the company is focused on maintaing revenue while improving margins.
  • Other.The Other segment “primarily includes revenue from paper sales, wide-format systems, and GIS network integration solutions and electronic presentation systems.” It contributes about 6% of revenue is not profitable.

83% of the companies revenue are recurring (“Annuity”). “Annuity includes revenues from services, maintenance, supplies, rentals and financing.” The other 17% come from one time equipment sales. 


Bullish case for Xerox:

  • In a challenging year, the company is on traget for $2 to $2.3 billion operating cash flow and $1.5 to $1.8 billion of free cash flow (FCF). The current market capitalization of the company is $8.3 billion. They are trading at around a price/FCF ratio of 5. If they trade at a ratio of 8, there could be 60% upside to the stock.
  • The company is returning money to shareholders. $1 billion will be used to buy back shares in 2012. $300 million be used for dividends. The company has a 2.5% dividend yield.
  • The company can still improve profitability by cutting costs.
  • 83% of revenues are recurring and company is focused on growing the services division which has more of the recurring revenue.
  • The company is targeting 15% earnings growth over the next coming years.


  • In a very competitive industry. In services division, competition comes from Accenture (ACN), Aon (AON), Computer Sciences Corporation (CSC), Convergys (CVG), Dell (DELL), Genpact (G), Hewlett-Packard (HPQ), IBM (IBM) and Teletech. In technology division, competition comes from Canon (CAJ), Hewlett-Packard (HPQ), Kodak, Konica Minolta, Lexmark (LXK) and Ricoh (RICOY).
  • Revenue and margins are down this year even though the company spent $200 million on acquisitions. This can be partly blamed on the economy. A lot of the aforementioned competitors like IBM have lower revenue, but unlike Xerox they have  been able to make it up by cutting costs. Xerox is not the strongest of the competitors, but in a stable economy they should be able to at least maintain revenue and margins. 
  • $9 billion debt load. However, this debt load should come down to $8 billion by the year end and over $6 billion is backed by finance receivables. 
  • There is no catalysts for a higher stock price. 

David Einhorn

One investor who agrees is David Einhorn of Greenlight Capital. Here are his comments earlier this year. 

“XRX is a document management provider that entered business process outsourcing when it acquired Affiliated Computer Services (ACS) in February 2010. The combination allows XRX to sell more value-added services to its current customers and apply XRX’s technology to deliver ACS’s services more cheaply. This is our second investment in XRX since the acquisition. The first time, we bought with the stock price around $9.35, and sold with a modest gain over concerns about XRX’s Japanese exposure after the earthquake. That issue appeared fully discounted by the market during the fourth quarter when we re-established a position at $7.61 per share, which is less than 8x estimated 2012 earnings. In the first nine months of 2011, XRX signed a significant amount of new multi-year outsourcing services contracts. XRX has been aggressively cutting costs within the legacy ACS organization. Over the long-term, XRX is expecting over 6% revenue growth and 10-15% adjusted EPS growth. XRX expects to spend $1.0-$1.4 billion on share repurchases in 2012, which should make a good dent in the share count given its current equity capitalization of $11 billion. XRX shares ended the year at $7.96 each.”

Since these comments, Greenlight has added to their posistion. As of June 30th, 2012, they held 26 million shares. Greenlight will report their next quarterly holdings in the middle of November. 


Xerox trades at a cheap price/FCF ratio of 5. They should be able to at least maintain that FCF over the coming years. If so, they should trade at least at a price/FCF level of 8. This would mean a 60% upside in the stock price.

Disclosure: I am long XRX

Gne Preferred Start Trading

Gne Preferred (GNEPA) started trading today. As expected, the volume is really low. As of 12pm EST, there has been 1750 shares traded and the stock is $7.89. It is trading at around a 8% yield. Investors who exchanged the common shares are making a profit at the current price. The common was around $7.30 when the shares were exchanged one for one.

The dividend should be safe since GNE has plenty of cash and only 1.6 million shares are outstanding. GNE will only have to shelve out $1 million yearly on dividend payments. I expect the preferred to trade in the $7-$8 range. 

Read our article on GNE here.

Disclosure: I do not own shares of GNE.

Pfizer Spin-off, Zoetis

Zoetis LogoOne spin-off that I am keeping a track of is the Pfizer spin-off of its animal unit, Zoetis.

“Zoetis is a global leader in the discovery, development, manufacture and commercialization of animal health medicines and vaccines, with a focus on both livestock and companion animals.” The company had revenues of $4.2 billion and $245 million in fiscal year 2011. In the first six months of 2012, the company had revenue of $2.14 billion and net income of $284 million.

The pricing and terms are not set, but based on the most recent S1 filing, the company is offering Class A shares (one vote per share on all matters) to the public. Class B shares, which have ten votes per share for election of directors and one vote per share for all other matters, will be held by Pfizer.

Pfizer “may make a tax-free distribution to its stockholders of all or a portion of its remaining equity interest in us, which may include a distribution effected as a dividend to all Pfizer stockholders or a distribution in exchange for Pfizer shares or other securities (or another similar transaction).”

Analysts are valuing Zoetis at over $15 billion. Once the terms come out, I will have more analysis.

Check out the S1 analysis here.

Disclosure: I do not own PFE. 

Sears, Genie, and IPOs

Lot of upcoming events and most of them are this week…


Sears (SHLD) , which owns 95.5% of Sears Canada, will distribute about 44.5% of its interest to its shareholders. The distribution will be made on November 13 to shareholders of record on November 1. For every one share of Sears, investors will receive 0.4283 share of Sears Canada. The current price of Sears Canada is $11. So, investors will receive almost $5/share in distribution. After the distribution, Sears will still maintain 51% ownership in Sears Canada.

Read article on Sears here.


Genie (GNE) Preferred will start trading tomorrow, Wednesday, October 24th on the NYSE under the symbol GNEPRA. Only 1,604,591 (7.5% of outstanding Class B) shares were validly tendered. It should be interesting to see how these trade.

Read article on Genie here.

Dean, Lehigh

Dean (DF) spin-off, WhiteWave (WWAV) will begin trading this Friday, October 26th. I expect it to price at the high range just because of the interest in the healthy food segment and low float.

Read our full analysis on Dean here

Lehigh Gas Partners LP (LGP) will also start trading this Friday, October 26th.  

Read our full analysis on Lehigh here.

Disclosure: I am long DF.