Divesting for value: how to make the most of carve-outs
(As originally published in FEI Canada F.A.R. member e-newsletter, December 2012)
By Graeme Deans, Leader, and Raj Saxena, Senior Manager, Operational Transaction Services, Ernst & Young LLP
In challenging economic times, companies need to optimize their portfolios effectively to stay competitive. One means to achieve this is by divesting non-strategic assets.
While people sometimes view divestiture as acknowledging failure, you shouldn’t look at it negatively. Instead, look at it as a strategic way to manage capital.
When companies make the decision to divest assets, you must remember one very important point: carve-outs are not the same as acquisitions. Carve-outs are complex procedures and can present both seller and buyer with an array of challenges.
Many companies do not have in-house capabilities or experience executing divestitures, and, as such, they can run into complications they didn’t anticipate. A CFO’s first task should be to assess the company’s internal resources and capabilities and determine any potential experience gaps. Very often, a company needs to engage an external advisor with the necessary experience to help guide the company through this process.
Focus on the details
On both buy and sell sides, a transition services agreement (TSA) is an essential part of the process. The TSA should lay out the specific services the buyer wants the seller to provide during the transition of ownership as a standalone or merged entity.
Because of changes in resources or support structures, the seller could lose the ability to provide services at the level expected by customers and other stakeholders. While the buyer may impose penalty payments on the seller in such situations, it’s much more valuable to the buyer if a high quality of transition services is maintained. Both sides need to reach a realistic consensus about what the buyer needs functionally, and how long it will take the buyer to develop the capability to perform the operations on its own.
Another must for CFOs is to qualify the separation costs — both one-time up front and ongoing. On the sell side, the CFO must be transparent about costs, particularly if the carved-out business will be a “standalone” entity, given the impact on after-tax cash flows. Both sides need to have a clear understanding of the carved-out entity’s standalone value early in the process, to allow the business to confidently evaluate all available options. A carve-out may not be the best approach, and another avenue could generate more value.
The buyer should also obtain a detailed inventory of services required that the seller should provide. This will help form an independent view of the true economic value of the assets being acquired. Often, the carved-out business will lose access to important corporate functions — for example, treasury, sales, audit, finance, human resources, tax and IT — which must now be replicated.
CFOs on both sides must also consider the impact of the deal value on the closing costs. For the seller, the CFO should also take into consideration any negative impacts of a divestiture on the remaining business. The carve-out might affect continuing operations, cash flows for the company’s remaining assets and the tax structure. For instance, underperforming assets may trigger significant impairment or an increase in the effective tax rate.
While CFOs on both sides must consider many aspects of the impact of the deal to their businesses, there are some issues of greater concern to the buy-side CFO.
Synergies: come to terms with the components of the assets
It’s essential for the buyer to get an accurate understanding of the boundaries of the target early in the process. Only then can synergy opportunities be identified and validated. A full assessment of operational considerations is critical for accurate pricing and achieving maximum value from the deal.
Integration: make readiness a priority
Buyers want to maintain value, gain control of operations and minimize disruption to make the new operations productive as quickly as possible. Even experienced acquirers of carved-out assets underestimate the work required to capture the value of such deals. Meanwhile, the market is watching and ready to critique the overall performance.
Proactive planning for the integration — ahead of deal close — is a leading practice that can make a substantial difference in a successful integration.
Above all, patience is an absolute must! Carve-outs are a complex process and can take a long time to negotiate and execute. By reviewing any transaction from the perspective of both buyer and seller, CFOs can avoid surprises, gain a clearer understanding of where value can be created or destroyed and, by following through, make a good deal even better.
For further insights, please read Ernst & Young’s new report, Capturing value through carve-outs.