9 minute read 10 Dec 2018
Scientist holding test tubes in foreground

How life sciences is creating shareholder value through divesting

Authors

Arda Ural, PhD

EY Operational Transaction Services Life Sciences Leader, Transaction Advisory Services

Co-author of numerous whitepapers and a frequent speaker about biopharmaceutical strategy at industry conferences. Married father of two.

Ambar Boodhoo

EY Americas Life Sciences Transactions Leader

Transformation leader in life sciences. Passionate about gender equity and access to education.

Peter Behner

EY Global Life Sciences Transactions Leader

Transformation leader in the development of new strategic direction for life sciences companies. Family focused. Loves fast cars, good wines and history books.

9 minute read 10 Dec 2018

Using portfolio reviews as an effective corporate finance tool.

As the life sciences (LS) industry continues to be challenged by anemic organic revenue growth, the value of divesting — as a way of refocusing business portfolios on long-term core assets and long-term growth areas — is obvious. Reasons to consider divestment include slow organic growth, aging portfolios, reimbursement headwinds and internal R&D productivity that is insufficient to fuel the pipeline in underserved therapeutic areas.

The research suggests that significant opportunity exists for life sciences companies to improve performance, free up capital and create shareholder value by optimizing their portfolio on an ongoing basis. While many companies hesitate to divest because they are concerned with distractions to the ongoing business and investor reaction, EY teams see overwhelming benefits to pruning the portfolio and redeploying capital toward higher-growth adjacencies.

Do divestitures improve capital efficiency or create value?

In the study, EY teams examined whether LS companies are sufficiently leveraging divestitures as a corporate finance tool and whether the divestitures led to improved operational outcomes by eliminating the potential dilutive effect of a lower net income contributing business within the portfolio.

EY teams also explored whether the divestiture decision would be appreciated by the investor community and would create shareholder value for the RemainCo (the seller) post-divestiture.

  • EY teams focused on 661 publicly traded life sciences companies that have executed an aggregate number of 1,436 divestitures and spins-offs within the period of 2008–17. EY teams measured the impact of divestitures in two dimensions:

    • Internally focused capital efficiency as defined by operational metrics that resulted in return on capital employed (ROCE)
    • Externally focused as measured by investor reaction and share price appreciation to reward or penalize total shareholder return (TSR)

     

Five key factors to take into account for successful divestitures

To maximize shareholder value from a divestment, the CEO, CFO, head of corporate development and business unit leaders should keep the following factors in mind:

  1. Be decisive to take timely action
  2. Importance of the transferring executive team
  3. Keep the DivestCo performing
  4. Designate a leader to focus on governing the separation
  5. It isn’t over until TSAs are exited and stranded costs are eliminated

1. Be decisive to take timely action

In the October 2018 Capital Confidence Barometer study, 59% of life sciences respondents said they were reviewing their portfolios more often than once a year and 72% said that the main result of their most recent portfolio review was divesting an asset identified as underperforming or at risk of disruption. Once the value case is established with insights from the financial, tax and operational advisors and bankers, the board should quickly make the decision and keep the momentum of the implementation.

Life sciences respondents on portfolio reviews

72%

reported that the main result of their most recent portfolio review was divesting an asset identified as underperforming or at risk of disruption

In the 2018 Global Corporate Divestment study, 48% of life sciences executives said they’ve held on to assets too long. Executives with a long career in the same company may have a tacit bias to keep an underperforming legacy business, which they may have even run at some point during their careers. Factor in the years and money invested in capex or R&D to turn around the business and executives at life sciences companies can be even more reluctant to let a business go.

Portfolio reviews

48%

of life sciences respondents reported that they’ve held on to assets too long

At the same time, for a company that has historically grown to be more comfortable in making acquisitions, divestitures pose a different challenge. It’s the equivalent to exercising a new set of corporate muscles in a workout.

Expected valuations and time windows will change based on macro-economic conditions or geopolitical risks at the global arena. Speed to value should remain a key success indicator once the divestiture decision is made. If the board and the executive team fail to act within the right time frame, the valuations initially desired will not be within reach (e.g., assets sold at a fraction of their initial valuation, in some cases after a year or two when they were first considered for divestitures, as the executive team did not act timely to exit the asset).

2. Importance of the transferring executive team

In large life sciences companies, executives tend to rotate roles in a two to four-year cycle in order to gain diverse experience, give perspective to the new business unit and train the future generation of executives in different market conditions and portfolios. When the divestment decision is made, one of the critical factors is to determine whether the value of the asset will be maximized with the current leadership team during the sales process or whether some of the members of the existing leadership team should be moved to the “mothership” since they may be better suited for running other portfolio businesses.

This decision should not be made lightly. In the case of a PE buyer, it is important that a knowledgeable management team is in place for day one. If it is a strategic buyer, the know-how that comes with the leadership team is key to keep the business on a successful path. Depending on the buyer profile, at the end of a one to two-year period, upon the completion of the retention bonus period, the management team may exit and be replaced by the buyer-determined team or they may continue to stay in their roles if the business continues to perform and deliver on the transaction’s investment hypothesis.

3. Keep the DivestCo performing

Ongoing mediocre performance will erode deal value, but in the 2018 Global Corporate Divestment study, 40% of life sciences executives said that the performance of the business deteriorated during the sale process. Selling a well-performing asset is much easier than an underperforming one as the out-year projections and the typical “hockey stick” turnaround will be hard to justify as the potential buyers will challenge the seller as to why they have not performed that turnaround while they had the asset under their control.

Sell and separate

40%

of life sciences respondents reported the performance of the business deteriorated during the sale process

The reason the seller may want to exit the business is that performance is suffering as a normal course of business value erosion potentially due to lack of investment from the RemainCo given its total portfolio prioritization. But underperformance might also be caused by management being distracted by the transaction and not giving full attention to running the business during the transition period. In either scenario, it is essential to meet forecasts for the business, especially if the asset’s performance is material for the seller and must be disclosed to the investors.

Overall, making short-term, focused and high ROI improvements to support the value story before the sale process begins and clearly demonstrating this to the buyer pool will help make the asset more compelling.

4. Designate a leader to focus on governing the separation

While any decision will require teamwork, it comes down to one lead executive to manage this essential process to create value for RemainCo and DivestCo. The executive will have to make some tough calls, manage employee morale and keep the performance on pace through what can be a tedious process. It is ideal to separate the roles of the business operator from the executive sponsor who will plan and implement the carve-out and separation process. EY professionals have seen two types of executive profiles in divestitures:

  • A seasoned executive uses this experience as a way to make his or her mark and build a legacy
  • An up-and-comer uses this divestiture as a springboard to roles with bigger scale and scope

In either case, the appointed executive should embrace this challenge for one to two years.

Put somebody in charge of running the divested business as a separate business if it isn’t operating that way already. Get clarity into what operations will be separated and how assets and employees will be aligned in both the divestiture and the remaining company. Decide who should go with the divested company and who should stay with the parent. This will involve several questions for senior management, including how to retain the management team through the divestment process, how a potential buyer will react to the management team and whether that buyer will instead want to bring in its own team.

But not only leaders will feel the uncertainty. Key talent may also opt to seek new opportunities if they feel the new culture does not align to their personal values. It is critical that the sellers identify key talent and make sure they know what to expect throughout the process. Take steps to retain key employees by explaining “what’s in it for you” so that they will still be around to add value when the unit is divested.

5. It isn’t over until TSAs are exited and stranded costs are eliminated

The signing or even the closing of the transaction does not end the value-creation process for the seller. Numerous transition services agreements (TSAs) put in place during the negotiation process will almost always outlast the close date of the deal by months to years.

The deal management team governing the separation process should not lose sight of managing the TSAs when the buyer exits them. There will be stranded costs across all functions that the seller needs to endure while providing these transitional services over the course of the agreed-upon period. A TSA wind-down process has to be established early on with a clear action plan to pull the proper levers for cost take-out tied to the exit timing. In the 2018 Corporate Divestment study, 67% of life sciences executives said they wished they had used analytics in the identification of stranded costs. Starting separation planning earlier and utilizing analytics helps to identify areas of entanglement and understand the magnitude of stranded costs, potentially avoiding delays in closing.

2018 Global Corporate Divestment study life sciences respondents

67%

said they wished they had used analytics in the identification of stranded costs

Ultimately, the stranded cost identification and elimination process should be in place once the dust settles and the asset becomes part of the new owner.

When used timely and effectively, portfolio optimization combined with divesting leads to improved operational outcomes and efficient employment of capital as measured by return on capital employed (ROCE) and total shareholder return (TSR).

Consider a thoughtful and recurring portfolio optimization process that identifies non-core assets that may be a better fit to other portfolios and will raise capital for sellers to innovate in key areas.

Summary

Portfolio review and optimization combined with divestitures can be a powerful tool in the corporate finance executive’s tool box. When used frequently, timely and effectively, portfolio review and divesting can lead to improved operational outcomes and efficient employment of capital as measured in the ROCE and TSR, as shown in the EY study of life sciences companies. Knowing what to divest can help the organization focus on future growth and sustainability. 

About this article

Authors

Arda Ural, PhD

EY Operational Transaction Services Life Sciences Leader, Transaction Advisory Services

Co-author of numerous whitepapers and a frequent speaker about biopharmaceutical strategy at industry conferences. Married father of two.

Ambar Boodhoo

EY Americas Life Sciences Transactions Leader

Transformation leader in life sciences. Passionate about gender equity and access to education.

Peter Behner

EY Global Life Sciences Transactions Leader

Transformation leader in the development of new strategic direction for life sciences companies. Family focused. Loves fast cars, good wines and history books.