Description

Loews is the well known Tisch-family conglomerate that has an excellent long-term track record of value creation and trades at a significant discount to the sum of its parts.  Loews has recently announced a spin-off/split-off of their Lorillard division which should simultaneously serve to increase per share value of the parent company and help to close the valuation gap with its components.

Overview: Given how well known Loews Corporation is, I will not belabor the history of the company.  Today Loews has controlling interests in four public companies/subsidiaries and a collection of private assets, one of which it may take public at some point in the future.  The Tisch family owns 22% of the company and has compounded per-share value at 17% a year for the past twenty five years.  Their strategy has generally been one of buying out-of-favor assets and managing them effectively to maximize cash over a long time period.  Today Loews has a $3.5 billion cash hoard, a valuable asset in a world where private equity buyers have been sidelined (at least for the moment).  You can buy Loews today at 80% of the value of its public stakes and private assets.  Even better is to short out Loews’ stake in the P&C insurer CNAFinancial and create the remaining assets at 73 cents on the dollar.  (Conceivably you could short out all the public stakes and create the private assets for free, but if you had to choose only one to hedge out, it seems that the P&C business with its asbestos liabilities and assorted other surprises is a good place to start.)  Once Loews completes the Lorillard split-off transaction, those same assets will be trading for 64 cents on the dollar. 

Management has clearly long been focused on creating shareholder value.  They have reliably been good purchasers of assets, and the Tisch family has repurchased an average of 30% of outstanding shares each of the past three decades.  Loews announced a meaningful transaction this past week that should help to reduce the conglomerate discount it receives; it also sends a very clear signal that the Tisch family thinks Loews stock is substantially undervalued and they are putting real money to work to take advantage of that fact.

One of the (quasi)-public subsidiaries of Loews has been The Carolina Group (CG), a tracking stock of Lorillard Corporation, the maker of Newport cigarettes.  Loews will be converting all existing CG stock to real shares of Lorillard Corporation.  In a second step, Loews will then pursue an exchange offer with the $6 billion stake that it currently holds in CG/Lorillard, effectively repurchasing Loews shares with its CG/Lorillard stock.  If the exchange offer is subscribed for, it would have the effect of reducing LTR shares by roughly 20% using CG stock instead of cash on hand.  (If Loews shares are deemed too expensive or CG/Lorillard stock too cheap in mid-2008, then they will simply spin-off CG shares to LTR shareholders.)  This transaction should accomplish multiple things: 1) It makes LTR incrementally easier to understand by eliminating one of the public subsidiaries and making LTR corporate reporting more straightforward 2) Those who did not want to own Loews because of the tobacco litigation (or perhaps moral) issues are no longer conflicted 3) By repurchasing a massive chunk of stock at a discount to intrinsic value, that captured value is distributed to the remaining shares making the discount even larger 4) Shows that the Tisch family is working hard to isolate the value that they see in Loews and are not content to let a huge discount persist without taking action.

Net Cash: At the end of the third quarter, LTR had $3.2 billion of cash.  They hold a note from Carolina Group (which will be fully paid off before the split-off) with a value of $829 million.  There is $865 million of debt at the LTR parent level.  LTR will receive proceeds net of tax of $208 million for the sale of their Bulova division (another sign that they will monetize assets when the price is right), and has received $171 million of dividends from their public subsidiaries during the fourth quarter.  That adds up to $3.54 billion of net cash at the present or $6.66 per LTR share.

CNAFinancial: A P&C insurer with a fairly diverse portfolio of business lines.  Loews owns 241,484,000 shares at $32.89 for a total value of $8.2 billion or $14.94 per LTR share.

Loews Hotels: This is a collection of eighteen luxury hotels across the US and Canada, generating an estimated $80 million to $90 million in annual EBITDA; we value the hotels at $750 million or $1.41 per LTR share. 

HighMount: This is the collection of natural gas assets that LTR purchased from Dominion Resources this past summer for $4 billion.  There is $1.5 billion of debt at the subsidiary level, and we value the equity at their cost of $2.5 billion or $4.70 per LTR share.  These are long-lived assets (20+ years) located in the Permian Basin, Antrim Shale and Black Warrior Basin and have characteristics typical of domestic shale plays with its high success (95%+) drilling rates and predictable decline curves.  There are 2.5 Tcfe of proved reserves and 4.9 Tcfe of 3P reserves.  HighMount is seen at Loews as a platform with a great management team (who came with the assets) that they can build on over time.

Carolina Group: LTR owns 65,445,000 shares at $85.12 for a total value of $5.6 billionor $10.48 per LTR share.  The main brand at Lorillard is Newport which is the dominant menthol cigarette brand in the US with market share of 33% and total domestic cigarette share of 10%.  Newport has been steadily gaining market share over the past several years and is the only major cigarette brand to see volume increases.  As a result, EPS have grown an impressive 43% from 2005 to 2007 in an otherwise stagnant market.  Books can be written on the legal history of the cigarette industry, but I will simply say that the litigation environment has substantially cooled off due to several rulings that were particularly favorable to the cigarette manufacturers the past two years.  Detailed discussion of the cases can be found in the 10K.  Not only will the separation be beneficial for LTR shareholders, but it should also help Lorillard/CG shareholders.  The company is essentially unlevered today (it will be debt free Q2 ’08), and because of the intra-company note, has been paying the vast majority of its cash up to Loews.  Once independent, Lorillard will be able to assume a 75% payout ratio that will simultaneously deliver a higher current dividend to individual CG shareholders than they receive now and allow Lorillard to retain capital to reinvest in the business.  Finally, there have been a few substantial tobacco industry transactions over the past two years and this should position Lorillard well to participate in further global consolidation. 

Diamond Offshore: LTR owns 70,104,620 shares of DO at $128.36 per share for a total value of $9.0 billion or $16.92 per LTR share.  DO is an offshore rig operator and the closest thing to a pure deepwater fleet that exists today in the public markets.  DO management has been fairly conservative in its contracting, and is taking advantage of the high day-rates E&P companies are willing to pay for high spec deepwater rigs to sign long-duration contracts.  (A more aggressive approach would be to sign shorter contracts with the belief that day-rates will continue to escalate, and so reserve more capacity that can re-price quickly to a rising market.)  As a result, the $10.7 billion contract backlog creates tremendous earnings visibility growing to more than $14 per share out to 2010.  DO is unlevered and pays out essentially all of its cash in the form of regular and special dividends.  From a valuation perspective, it trades basically in-line with RIG, the largest company in the industry. 

Boardwalk Pipelines: LTR owns 86,350,000 shares of BWP at $30.49 per share for a total value of $2.6 billion or $4.95 per LTR share.  Boardwalk is an MLP in the natural gas pipeline industry.  It has two main assets, the Texas Gas Transmission pipeline which is a traditional long-haul pipeline and the Gulf South Pipeline which is more like a large-scale gathering system.  BWP’s business model is primarily driven by take-or-pay contracts, though approximately one quarter of its revenues come from actual usage fees.  These are fairly stable assets with modest underlying growth, though they do support a 6% distribution yield which is in-line with the industry.  There is, however, substantial growth coming in the form of new build construction tying into its existing systems.  Over the next two years they will spend $3.5 billion of expansion projects serving the Barnett, Fayetteville, and Woodford Shales.  The projects slated to come on line over the next six months are already sold out and have an average contract life of eight years; importantly these are all additions in areas that are incredibly capacity constrained in terms of ability to ship gas east.  The expansion projects will be financed half with equity and half with debt, and are expected to add $400 million to $450 million of EBITDA once fully operational.  That growth is particularly relevant for the General Partner.

Boardwalk Pipeline GP: This is fully owned by LTR.  The GP today shares at 25% of incremental per share distributions, but is very close to receiving half the incremental per share cash flow.  Quarterly distributions today are 44c per BWP share and above 52.5c, the GP breaks into the highest split level.  While the distributions to the GP are not huge today, with the planned growth over the next few years it could reach $100 million annually.  GP interests rightfully receive substantial earnings multiples and this could prove to be a highly valuable asset in the intermediate-term; we currently value it at $500 million or 94c per LTR share.

Corporate G&A: The corporate expense at Loews minus Bulova is approximately $100 million per year on a pre-tax basis.  Capitalizing this at 12x earnings (higher than consolidated Loews multiple) yields a liability of $720 million or $1.35 per share.

Taxes: This analysis does not penalize Loews for tax liabilities on their holdings as management has demonstrated with the Lorillard transaction that there are opportunities to monetize assets in a non-taxable fashion.  I would expect any future large-scale asset disposition to be done in a similar fashion. 

Consolidated earnings: While not the driving factor when using a sum-of-the-parts methodology, it is worthwhile to note that on a consolidated basis, Loews should earn $4.75 to $5.00 in 2008.  Because the payout ratios at the publicly-traded subsidiaries is less than 100%, not all of that cash will actually pile up on the parent company balance sheet for redeployment, though those are real earnings to Loews. 

Conclusion: Simply buying Loews shares today gives you the opportunity to purchase assets at 80c on the dollar with a 10% consolidated earnings yield, great management team and excellent balance sheet.  Management is undertaking a transaction that will sell the remaining Lorillard stake and repurchase 20% of Loews shares, effectively giving investors the opportunity to buy the non-Lorillard Loews at less than 75c on the dollar.  And finally, if you choose to short out the insurance subsidiary, you can create the remaining assets at 64c on the dollar.  Given the long history of value creation at Loews, a discount of this magnitude seems wholly unwarranted.  With a combination of earnings accretion and modest valuation gap closure, an investment in a Loews “stub” offers investors the opportunity for 50% type gains over a two year time horizon.  The upcoming Lorillard split-off could serve as a catalyst to accelerate that process. 

Catalyst