National-Oilwell Varco (NYSE: NOV ) is planning to spin off its distribution business from the rest of the company, creating two standalone, publicly traded corporations. According to National Oilwell Varco's press release on the matter, the new company will have 415 locations and operations in 26 different countries. In addition, the press release states that revenues from this new company will be equivalent to 85% of National Oilwell's distribution and transmission segment revenue for the six months ending June 30, 2013, which was around $2,143 million, or $4,287 million annualized.
If we assume that the new entity will trade at around 1.5x sales (based on National Oilwell Varco's current valuation) then a market capitalization of $6.43 billion is appropriate .
Not so fast
Having said that, MRC Global Inc (NYSE: MRC ) , an oil services and distribution company, which was spun off from PVF Holdings during 2012, has similar traits to National Oilwell Varco's new proposed distribution company. MRC currently trades at a price-to-sales ratio of 0.5, indicating that National Oilwell Varco's new spinoff could take on a valuation closer to $2.144 billion.
Being honest, I would say that MRC is boring, the company's profits are slim, and growth is illusive; I would expect National Oilwell Varco's spinoff to exhibit the same traits, as it is in the same business. In particular, during the first half of this year, MRC's operating profit margin was a little above 6.8%, which is actually higher than the operating margin of 5% reported by National Oilwell Varco's distribution and transmission segment for the same period.
All in all, it is likely that National Oilwell Varco's spinoff could be assigned a valuation similar to that of MRC. Still, investors should place some premium on the fact that the new entity will have close ties with National Oilwell Varco, which should boost its product offering and profits.
Demand has been strong for spinoffs
Still, demand for low-margin spinoffs has been high during the past year or so. After its spinoff from ConocoPhillips, Phillips 66 (NYSE: PSX ) is up 60% year to date. Meanwhile Valero Energy's spinoff of low-margin CST Brands Inc (NYSE: CST ) quickly saw the stock pop 17% before consolidating to fall back in line with the S&P 500.
That said, these companies were spun off on dismal price-to-sales valuations. CST was launched into the specialty retail sector with a P/S ratio of 0.17, while the sector traded at an average ratio of around 1. Meanwhile, Phillips 66 was spun off on a ratio of 0.13, bearing in mind its closest competitor, Hess, is currently trading at a P/S ratio of 1, making Phillips 66 look cheap on a revenue basis, as Phillips 66 is nearly five times larger than Hess.
Still, like MCR both Phillips and CST have since fallen out of favor with the market. Phillips has been hurt by a general decline in profitability throughout the refining sector as the Brent-WTI spread closed, and CST has been hurt by falling earnings, which were down around 50% year on year at the end of the second quarter.
Admittedly, information surrounding National Oilwell Varco's spinoff is currently thin as the deal is yet to be voted through by both the board and shareholders. Additionally, the company is yet to reveal how much it will receive from the spinoff and how many shares it will make public.
That said, after the spinoff the two companies will be better placed to grow through acquisitions than one company by itself. It appears that National Oilwell Varco's management is already well aware of this as the word "growth" is mentioned many times within the press release announcing the spinoff. However National Oilwell Varco structures the deal, the company is likely to make money in the long term, opening the door to growth through acquisitions or shareholder returns in the future.
What's more, National Oilwell Varco had a net-debt-to-asset ratio of only 5% at the end of the fiscal second quarter, keeping this debt on its balance sheet, as the parent would give the new spinoff company a clean bill of financial health, allowing it to acquire competitors.
Although the future is uncertain, it is likely that National Oilwell Varco's spinoff will be rewarding for both the company and investors. The new entity should have a clean balance sheet, so it'll be able to buy up growth. Furthermore, spinning off its low-margin distribution business should improve National Oilwell Varco's profitability and open up the possibility of acquisitions, buybacks, or higher dividends.
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