By Alex Gavrish, Etalon Investment Research; author of “Wall Street Back To Basics

Kimberly Clark

Kimberly Clark filed a registration statement

On May 6th, 2014, Kimberly Clark Corp (NYSE:KMB) filed a registration statement with SEC for the planned spin-off of its healthcare products division. The spin-off will be effected through a tax-free distribution of 100% of company’s shares to Kimberly-Clark shareholders and is expected to be completed by the end of the third or in fourth quarter. The spin-off will create an independent company which will be named Halyard Health.

Spin-off company profile

Halyard Health is a global company which seeks to advance health and healthcare by preventing infection, eliminating pain and speeding recovery. Its products and solutions are designed to address some of today’s most important healthcare needs, namely, preventing infection and reducing the use of narcotics while helping patients move from surgery to recovery. Halyard has two business segments: Surgical and Infection Prevention (S&IP) and Medical Devices. Surgical and Infection Prevention segment provides products that address the prevention of healthcare-acquired infections and provide protection for both healthcare workers and patients. The product portfolio includes such products as sterilization wrap, surgical drapes and gowns, facial protection, protective apparel and medical exam gloves. Medical Devices segment is comprised of a diverse set of medical device solutions focused on improving patient outcomes, patient safety and reducing the cost of care. Products portfolio includes post-operative pain management solutions, minimally invasive interventional (or chronic) pain therapies, closed airway suction systems and enteral feeding tubes.

Spin-off valuation

Based on pro-forma financial statements for fiscal 2013, Halyard Health generated $1.7 billion in sales, $225 million in operating income and $155 million in net income. Cash flow from operations equaled $224 million and free cash flow was $175 million. Based on the FY 2013 EBITDA of $295 million and applying a valuation multiple of x10, the new company can be valued at an enterprise value of approximately $2,950 million. Adjusting for a net cash holding of $32 million, market capitalization would be approximately the same, or $2,918 million. Such valuation represents 7% of Kimberly Clark Corp (NYSE:KMB)’s market capitalization. According to SEC filing and company’s press release, the new company will incur additional debt (in the amount to be determined later) in order to fund a cash distribution to its parent immediately before the spin-off. Kimberly-Clark plans to use these funds to repurchase shares.

Kimberly Clark insights

In the past, many spin-offs had significantly outperformed the market and provided investors with plenty of interesting investment opportunities. However, they occasionally come with drawbacks, not only benefits. The parent company might be motivated, for example, by the desire to get rid of low or unprofitable operations. Or the parent might be motivated by the desire to dispose of a business segment that consumes too many resources and requires too much management attention compared to revenue and profit that it generates. It still might be a positive development for parent company shareholders, but potential investors in spin-off should exercise caution when this is the case. Consider this: health care products division provides only 7.2% of Kimberly Clark Corp (NYSE:KMB)’s operating income and 7.6% of sales. At the same time, the division employs 16.5 thousand people or 29% of Kimberly Clark’s total worldwide workforce of 57 thousand employees. Also, there are 14 manufacturing facilities that are expected to be included in the spin-off. They represent 13% out of company’s total 106 manufacturing facilities worldwide. Additional drawback is the fact that new company will incur more debt in order to make a “ransom” payment to parent and release itself to freedom. These drawbacks might bring one to a conclusion to focus not on the spin-off itself but on the parent company, as the transaction is obviously looking good from the perspective of Kimberly Clark’s shareholders. Not because spin-off will unlock value as it will be discovered by investors and revalued, but because the parent company makes a good step to simplify and refocus its operations.

Kimberly Clark valuation

Based on a recent share price, Kimberly Clark Corp (NYSE:KMB) had market capitalization of $41.8 billion and enterprise value of $47.8 billion. Company is currently valued at a P/E multiple of x19.5 and EV/EBITDA multiple of x11.6 (FY 2013 financials). Company generated $3.04 billion in cash flow from operations and $2.09 billion in free cash flow. Kimberly-Clark pays a regular quarterly dividend of $0.84 per share which provides an annual dividend yield of 3%. Company also allocates substantial amounts of capital to share buybacks: over the last three years it had spent $1.25 billion annually (average) on share repurchases. Based on the current market capitalization this translates into a 3% annual buyback yield. Kimberly-Clark plans to return shareholders about $2.5 billion in FY 2014 through dividends and stock buybacks. This translates into a total shareholder return yield of 6%. Long-term, income-oriented investors might take advantage of the upcoming spin-off in order to acquire Kimberly Clark’s shares with a certain margin of safety: spin-off will provide an immediate return of about 7% of investor’s capital (if sold at the price/valuation discussed above) while dividends and buyback should provide an annual yield of 6%.

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