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I look for value anywhere, but one space that I have devoted a lot of my years to with investing is the Spinoff space. It is the most lucrative hunting ground for great companies that are in some way dislocated from the market and do not garner much attention.
In a Spinoff corporate transaction, a parent company separates one of its business entities or divisions into an independent, stand-alone company. By distributing shares of the Spinoff company to the current owners of the parent company, two distinct publicly traded entities are created. The new business that results from a Spinoff is frequently referred to as a "Spinoff company". Spinoffs can increase shareholder value by enabling separate companies to concentrate on their core competencies and by releasing hidden value in particular business divisions. In addition, it allows investors to invest in a variety of companies according to their investment preferences and risk tolerance.
More importantly and where part of the value is, Spinoff companies are rarely covered by the mainstream. They are usually very different businesses to the parent business they were spun off from and so they are frequently referred to as ‘orphan securities.’ They can have extreme dislocation from the wider market for several reasons. The main ones are:
- Misunderstanding of the market: Investors may not completely comprehend the business, strategy, or growth prospects of the Spinoff company. Consequently, they may undervalue or overvalue the company, resulting in a gap between the market price of the stock and its true value.
- Spinoff companies, particularly lesser ones, may not receive as much analyst coverage as larger, more established companies. This limited coverage can result in an absence of information and analysis for investors, thereby contributing to price anomalies.
- In some instances, shareholders who receive shares of the Spinoff company because of the separation may not desire to hold on to them and may sell them quickly. This can cause an oversupply of shares on the market, resulting in a technical price decline.
Particularly in these three instances, the market may provide an opportunity for you to invest and it’s important to keep track of the 35-40 situations that become investable throughout the year. Three I currently own that tick the boxes above are here:
Cerence Inc. (CRNC)
The company was founded as a division of the well-known provider of speech recognition and natural language processing technologies, Nuance Communications. It specializes in providing voice recognition solutions to numerous industries, including the healthcare and automotive industries. In October of 2019, Nuance Communications announced that its automotive division would be spun off as Cerence Inc. This action aimed to establish a distinct, specialized entity that could better satisfy the market's particular requirements. Cerence, as an independent company, shifted its primary focus to the automotive industry, offering AI-powered solutions to facilitate voice commands, natural language comprehension, and conversational AI in vehicles. Its technology is designed to enhance the driving experience, increase safety, and enable hands-free operation of in-car systems.
Two years after Spinning off CRNC, NUAN was bought for $19.7bn (including debt) by (MSFT) in one of the largest acquisitions ever made by MSFT (who previously spent $26bn for LinkedIn in 2016). While this acquisition was announced in April 2021, the deal was fully cleared and finalized in Q1 2022 at a +23% premium and NUAN was up more than +200% since its break-up at the time it was acquired.
Longer-term, CRNC is a takeover candidate for companies leaning towards increasing positions in tech mobility, such as (CON.D.DX) , which aims to secure its long-term position in the market. On the other hand, there is rapid growth and cutthroat competition across AI. Some automobile companies like (GM) , (NSANF) , (VOLVB.S.EB) , (VOW3.D.DX), (F) and EV startup (RIVN) are partnering with companies like (GOOGL) and (AMZN) to integrate virtual car software. We believe other big tech companies are also looking to enter this space by acquiring companies operating in virtual assistants, like CRNC. The big plus point on this company is that the Spinoff is through its two-year tax-free rule and a recent study by The Edge Group suggests that 35% of Spinoff names are likely to be taken over around this point.
In addition, relatively newly appointed EVP & CFO Tom Beaudoin (joined May 2022) recently bought 5,000 shares of CRNC at $18.80 for ~$94,000 in December 2022, making this the only insider purchase since CRNC’s Spinoff on October 1, 2019. While this is not the strongest insider buy/indicator that I have seen due to this being Mr. Beaudoin’s first open-market purchase ever, his strong takeover background speaks volumes.
Valuing CRNC by applying a 15.7x 2024 EV/EBITDA multiple (discount of 10% to its peers) to the 2024E adjusted EBITDA forecast of $99.3m. A 15.7x valuation multiple was reached based on the average multiple of Auto Tech and Vertical Software companies; historically, CRNC has traded at a discount of ~35% to peers. CRNC’s strong software position in AI-based virtual assistants for mobility and a strong future growth will reduce these peer discounts by 10% to 15%. The key trigger is CRNC is set to benefit from the increased fixed contracts and its license business remaining strong. The Base case target price is $30, implying an upside of +50%.
Phina Inc. (PHIN)
PHINIA is a Spinoff of (BWA), a global automotive supplier. The Spinoff was completed on July 3, 2023. PHINIA, Inc. possesses a wide range of original equipment in its portfolio, consisting of advanced fuel injection systems, fuel delivery modules, canisters, starters, alternators, sensors, and electronic control modules. With a global presence, the company operates 17 major manufacturing facilities and seven major technical centers strategically located to cater to its global customer base. Post Spin, PHINIA is anticipated to emerge as a prominent leader in fuel systems, starters, alternators, and aftermarket distribution.
The company aims to achieve this by maintaining a balanced and synergistic presence across various end markets, including Commercial Vehicle, Light Vehicle, and Aftermarket. PHIN’s focus would be to excel as a leading provider in its product categories while catering to diverse customer needs across different regions. In addition to serving original equipment manufacturers (OEMs), PHIN also manufactures and sells its products to prominent participants in the aftermarket segment. This includes independent retailers and wholesale distributors who rely on PHIN for high-quality automotive components. The company offers both new and remanufactured products, including diagnostic equipment, ignition coils, smart remote actuators, exhaust gas recirculation valves, brakes, steering, suspension, and various other automotive components.
During their investor day 2023, PHINIA's management emphasized their primary focus on expanding their commercial vehicle and independent aftermarket businesses. These sectors are expected to be less impacted by electrification trends and are poised to benefit from the transition to carbon-neutral and carbon-free fuels. The belief is that carbon-neutral fuels offer the most favorable overall performance and utility for many applications, whether in liquefied or gaseous form. This is especially true for scenarios that involve high power requirements, heavy loads, long-distance travel, off-highway operation, and high uptime demands.
These fuels' energy density, portability, and practicality become essential in such cases. There are some regions focusing on carbon-neutral fuels as their pathway to carbon neutrality rather than BEV. This strategic choice is driven by several factors, including ample renewable power sources, infrastructure development challenges, and national security and independence considerations.
The aftermarket market is experiencing substantial growth and holds significant potential. This expansion is driven by two key factors: (i) the increasing number of vehicles on the road and (ii) the increasing average age of vehicles. However, the commercial vehicle market still faces challenges in terms of electrification. Many electrification efforts are concentrated on lighter vehicles with lower mileage. Given this landscape, PHINI focuses primarily on larger, higher-power, long-haul, and off-highway applications. For PHIN, the aftermarket segment is expected to contribute long-term stability to the overall business. One primary reason is the sustained growth of this market, driven by the significant increase in new car prices, which has raised concerns about the affordability of new vehicles. As a result, more individuals are opting to extend the lifespan of their cars, leading to a greater demand for after-sales products and services.
PHIN also stands to benefit significantly in the event of any setbacks to the electric vehicle transition. This includes potential uncertainties surrounding EV demand, challenges related to supply chain feasibility, or traditional OEMs adopting a slower approach to EV volumes due to concerns about margin impacts. In this context, PHIN can be viewed as an attractive form of hedge for investors who are anticipating a rapid and significant transition toward EVs. By maintaining a focus on technologies and solutions that cater to larger, higher-power applications, as well as off-highway and industrial sectors,
PHIN is well-positioned to thrive even in scenarios where the EV transition faces obstacles or delays.
This strategic positioning allows the company to mitigate potential risks associated with the pace and scale of EV adoption. As a result, investors who want to avoid risk exposure to the EV market can consider PHIN an appealing investment option that offers diversification and resilience against uncertainties surrounding the EV transition.
PHIN is valued by applying a 4.7x 2024 EV/EBITDA multiple (in-line with peers) to a 2024 adjusted EBITDA forecast of $527 million. A 4.7x valuation multiple is reached based on the view that PHIN has lower leverage compared to its peers and has a reasonable margin profile. The management has set a target leverage of around 1.0x, which is lower than the industry average of 2.2x. More importantly, the comfortable valuation is supported by an FCF yield of ~13%. PHINIA is expected to report a free cash flow of $200 million in FY2023E.
When considering the implied market capitalization of $1.5 billion for PHIN and the FCF yield works out to around 13%, based on this analysis and applying the 4.7x multiple, the Base case target price for PHIN is $41.07, implying an upside of +57%.
Sphere Entertainment Co. (SPHR)
MSG announced its intention to Spinoff its live entertainment and media assets into two separate entities in 2023. MSG Entertainment will have ownership of Madison Square Garden, Radio City Music Hall, and MSG Networks. The second entity, MSG Sphere, will own the MSG Sphere Las Vegas, a new, state-of-the-art venue slated to open on September 29, 2023, when rock band U2 debuts the first of 25: UV Achtung Baby Live performances. The MSG Sphere at The Venetian, also known as The Sphere in Las Vegas, is an entertainment venue currently under construction in Paradise, Nevada, adjacent to the Las Vegas Strip.
The goal of the Sphere is to revolutionize the entertainment experience by constructing an immersive environment using cutting-edge technologies. It is the future, and investors should contemplate investing in it for potentially huge returns. The goal of The Sphere entertainment is an immersive, multisensory experience. It is poised to transform live entertainment as we know it, and investors have an opportunity to be a part of the journey.
The MSG Sphere is more than a venue; it is a technological marvel. With an enormous LED exterior in the shape of a dome and an even larger interior screen, it promises to provide visuals that encompass the entire venue. The cutting-edge beamforming technology will immerse you in a world of sound where each note and beat are directed precisely at your hearing. Using haptic technology, you will "feel" the music through the floor, generating an unparalleled sensory experience.
As an investor, you are not simply purchasing a venue; you are investing in the future of entertainment. The optimal viewing and acoustics of the 17,500 seats at MSG Sphere make it the ideal venue for concerts, theatrical performances, product launches, and e-sports competitions. It is a platform for unforgettable experiences, not just a venue.
MSG Sphere (SPHR) is already making strategic moves, separating from Madison Square Garden Entertainment (MSGE), and selling Tao Group Hospitality. However, the true potential rests in what lies ahead. There is speculation that SPHR will merge with AMC Networks (AMCX), creating a synergistic media juggernaut. A merger with MSG Entertainment (MSGE) could create one of the largest entertainment venue corporations in the future.
Investing in The Sphere is about becoming a part of a journey that is transforming the way we experience entertainment. It is about embracing the future, in which sights, sounds, and sensations converge to create the extraordinary. The overarching objective is to provide audiences with an experience that transcends traditional performance spaces by making performances more immersive and engaging than ever before. The Sphere is designed to stimulate all the senses and stretch the limits of what is possible in live entertainment.
Valuation of The Sphere is made by evaluating each division based on available information. For MSG Network, it is valued based on the EV/EBITDA (adj. AOI excluding stock-based compensation). For Sphere, it’s valued it based on the EV/Sales, i.e., the potential revenue it can generate at 85% occupancy with an average rate of 3 shows running for 360 days with an average ticket price of $90 in FY25 from its original content “Postcard from Earth.”
Valuation of the air rights on exosphere and sponsorship deals is not included due to limited information. Due to the lack of information on upcoming events and non-comparable peers, a conservative 20% discount to the base case has been applied. For MSG Networks, a 15% discount has been applied to its peers amid intense competition and losing subscribers, leading to margin pressures. Factoring all the parameters, the Base case target price is $45.93, implying an upside of +28% from the current market price of $36.48.
