There could be a way to trigger a turnaround of the underperforming share price of Lendlease Group (ASX: LLC) and trigger a re-rating in the stock.
That would be welcomed news for shareholders who've seen the diversified construction and engineering group slump 10% over the past two months when the S&P/ASX 200 (Index:^AXJO) (ASX: XJO) index is down 2%.
This is despite Lendlease having a number of tailwinds supporting its outlook, including its leverage to the infrastructure boom and its overseas expansion which will help offset risks in its Australian residential property portfolio.
A key reason for the underperformance is likely due to its Engineering division, which recorded a $218 million loss in FY18.
Citigroup thinks there's a simple way to reverse the downtrend – jettison the Engineering division. History has shown that such a strategy usually works in turning investor sentiment. Wesfarmers Ltd's (ASX: WES) decision to spin Coles supermarket off into a separately listed company has won the backing of several experts.
There are also several other positive examples that include BHP Billiton Limited's (ASX: BHP) separating from South32 Ltd (ASX: S32) and Amcor Limited (ASX: AMC) with Orora Ltd (ASX: ORA).
All these spin-offs are/were seen to be holding back the parent company.
Besides history, there are five other reasons why it makes sense of Lendlease to spin-off its Engineering business into another ASX company where existing Lendlease shareholders will get a share in the new company, according to Citigroup.
The first is market valuation. The broker believes Lendlease is worth around 4% more without the underperforming business and that shares in the new Engineering company could be worth between $0.74 and $1.96 a pop.
Secondly, Engineering is a distraction to management. Even if the business is turned around and hits $200 million in full-year earnings before interest, tax, depreciation and amortisation (EBITDA), its contribution to group EBITDA is only about 11% of Lendlease's expected earnings in FY22.
Further, the division lacks scale. Citi notes that Lendlease currently has 16 projects underway, which is well short of its targeted 25-30 projects.
There's also a lack of synergies between Engineering and the other parts of Lendlease's business.
"If Engineering is an important element to urban regen then why is LLC so successful in securing urban regen projects in London without an Engineering capability?" asked the broker.
Lastly, using an in-specie distribution (where Lendlease shareholders get shares in the new company based on the number of shares they own in the parent company), the group can avoid the danger of selling the asset at the wrong time.
This is something that company boards worry about – the criticism from investors that they sold an asset too cheaply at the bottom of the cycle.
