15 minute read 11 Sep 2019
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Indian companies are increasingly divesting non-core businesses to unlock value

By

Amit Khandelwal

Ernst & Young LLP India Transaction Advisory Services Managing Partner

Leader of Transaction Advisory Services in India. Focused on diligence. Go-getter. Numbers enthusiast.

15 minute read 11 Sep 2019

Companies are now streamlining operating models to capitalize on the growth opportunities presented in India.

According to the EY Global Corporate Divestment Study81% of surveyed companies in India are planning to divest in the next two years. Companies continue to divest non-core businesses in order to streamline their operating models. A constant review of business portfolios helps organizations build trust with their stakeholders, thus generating greater shareholder value.

Indian corporate boardrooms are increasingly facing critical issues that directly impact their business strategies and future directions. Shifting customer expectations, regulatory and tax changes, along with geopolitical and global macroeconomic changes, will all affect how businesses operate in the future. Companies are now streamlining operating models and focusing on core business fundamentals to capitalize on the growth opportunities presented in India. Fueling this growth agenda requires capital, and divestments are an effective source for funding investments in technology, products, markets and geographies.

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Chapter 1

Why so many companies are divesting

Refocusing on core business

Divesting is largely driven by the companies looking to deleverage their balance sheets. The evolving regulations (e.g., Insolvency and Bankruptcy Code [IBC]) and business environment in India are adding pressure on corporates to streamline their business models. Shareholders are becoming increasingly aggressive, which is driving corporates to place divestments at the core of their growth and transformation strategy.

Macroeconomic uncertainty, along with regulatory and technological changes, are causing unprecedented business disruption globally. In India the drive for resolution of non-performing assets and shareholder pressure are making corporates confront an important issue: how do they best deploy their resources to stay competitive in an evolving market?

  • Re-focus on core business

    During the record credit growth between 2004–09, many Indian corporates diversified their business into emerging industries such as infrastructure (highways, power, etc.). However, in the past decade, regulatory changes and business cycles have forced corporates to reassess their business and capital allocation strategies. Some of the capital allocation challenges that companies face today are:

    1. What, where and when to divest?
    2. When should they dispose of part of the business that no longer fits into the future strategy?
    3. How do they raise sufficient capital to invest in new technologies, markets and sectors? 
  • Streamline operating model

    Faced with evolving sector landscapes, businesses are continually evaluating their growth strategies. Corporates need to be agile and have access to capital for investment. Seventy percent of surveyed companies divested assets because they needed to generate more capital.

    The result is a streamlined operating model that gives companies the ability to quickly execute their capital agendas. Our survey shows that 63% of companies identified the need to streamline their business model as one of the primary drivers for their recent divestment.

    More than half the executives surveyed (56%) say that proceeds from the last divestment were used to fund investments in new products, markets and geographies.

  • Geopolitical shifts: a constant variable in the divestment equation

    Despite uncertainty within global markets, whether driven by tariffs or trading costs, companies must continue to diligently review their portfolios. Recent events such as changes in global foreign trade policies, Brexit and immigration matters add to the complexities of making strategic portfolio decisions.

    Almost all companies (88%) expect these geopolitical shifts to push operating costs higher, while 75% are unsure whether they can depend on existing cross-border trade agreements remaining in force. They will have to factor these rising costs into their divestment strategy and timing. Whether these factors can otherwise be addressed through vendor negotiations, price increases or cost reductions may factor into whether a company decides to divest a unit that is affected by tariffs, trade disputes or geopolitical uncertainty.

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Chapter 2

How you can operationalize a divestment for success

Creating value

In a constantly evolving environment, companies need to regularly assess all aspects of their business to ensure that they remain competitive. A majority of the survey respondents say that shortcomings in their portfolio review process have sometimes resulted in failure to achieve the intended divestment results.

  • Speed vs. value

    Companies surveyed are more concerned about creating value from the divestment rather than the speed of the transaction. Of those companies who say their focus has shifted from speed to value in the past three years, 75% report a better understanding of the sale process based on previous failures.

    While in their most recent divestment, most companies prioritized securing the best price over speed of execution, achieving that expected value can be a significant challenge. Strengthening the business to be divested, developing the equity story and executing a seamless separation process should be the highest priority for any seller.

  • Weigh the merits of different structures

    Eighty percent of executives say their most recent divestment was a carve-out of the business unit. Companies should also explore other deal structures (e.g., JV, partial divestment, etc.) that can sometimes support greater return to shareholders.

    On a recent divestiture, an Indian steel company chose to form a JV with a foreign partner for some of its divisions. This allowed the seller to raise capital to pare down debt as well as provide them with access to global markets. The buyer in turn was able to diversify geographically while remaining in the same sector. The JV structure helped minimize investment risks for the buyer and provided tax benefits to the seller.

  • Always be divestment-ready

    Companies underestimate the impact a lack of preparation has on the deal timeline and shareholder return. The majority (63%) of companies report that their divestment took five months or longer from signing to closing, far beyond the three month closing timeline that shareholders have come to expect.

    A seller should proactively complete the tax assessment and provide its analysis to the buyers before they have a chance to develop their own model. For example, a seller can highlight the tax efficiencies associated with the manufacturing process, such as any tax holidays, which enhance the value of the asset. In our survey, 44% of executives indicated that over the last 12 months, highlighting tax upsides to purchasers helped them to drive value. Companies can take the following approach:

    • Complete a comprehensive tax review of the target, understand tax implications of divestment and identify tax data that will be required from a buyer’s perspective
    • Create a point of view on tax risks to address concerns of potentially skeptical buyers
    • Emphasize the upside by building out a buyer’s potential tax benefits

    The Indian tax environment has undergone significant changes in the past three years and this adds an additional layer of complexity which needs to be addressed during the divestment process.

  • Interdependencies between business units

    Many business processes and functions such as HR, finance, IT, etc., are shared across an organization, which adds an additional layer of risk.  While divesting, the seller needs to clearly identify these interdependent processes and functions and adequately plan for separation. Sixty-nine percent of the respondents say that inadequate understanding of interdependencies delayed or derailed the deal close.

    Areas with a high degree of interdependencies that consistently cause divestment delays:

    • IT — shared ERP, applications, infrastructure and network have long lead times and are expensive to separate
    • Shared business activities — common business activity such as shared customers and vendors, require communications and/or negotiations that can be disruptive if not properly handled
    • Shared services — centralization of business processes means commingled transaction processing and data that can be difficult to identify and require separation

    During a recent divestment, the seller conducted a detailed assessment to understand the interdependencies between the various legal entities and prepared a divestment blueprint. This enabled them to establish the financial, operational and commercial implications for both the target and the parent company. This allowed the seller to make informed decisions on the structure and valuation of the business to be divested.

  • Mitigate stranded costs

    Companies need to examine shared costs across business units, including those charged to the carved-out entity. Corporate allocations, business charge-ins and charge-outs, services provided with no, under, or over-allocated costs, shared people and facilities are all key inputs relative to stranded costs. There are several sources of stranded costs and related key considerations and knowing these can save precious time, while preserving value going forward for the seller.

  • Pre-empt regulatory hurdles

    Widely varying country-specific requirements, along with insufficient time to capitalize and operationalize a legal entity, can delay the buyer from being able to effectively operate in a jurisdiction. Forty-four percent of sellers say it was a challenge to capitalize and operationalize a legal entity in their most recent divestment. In many countries, sellers may face a 60-, 90-, or 120-day review requirement to be met before they can put capital into a local entity.

    Regulatory requirements can include antitrust approvals, business licenses, capitalization of new legal entities, registration of products, labor requirements and obtaining various tax IDs. Many of these activities must occur in a specific sequence, can be lengthy and can change based on rule-making bodies in each country and locality.

    Actions taken in successful divestments include:

    • Identifying key regulatory requirements in every current and anticipated jurisdiction, by leveraging local subject matter experts
    • Prioritizing the countries of significant importance based on a combination of size and importance to the day one operating model (i.e., location of key facilities)
    • Building out the proper timeline to address activities such as product registration, product labeling, business licenses, tax IDs, labor requirements and contracting with third-party service providers
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Chapter 3

How to maximize value from the next wave of buyers

Be prepared yet flexible

In a marketplace driven by high valuation expectations, sector convergence and technological disruption, who will be your next buyer? How will you anticipate the needs of different buyers and maintain competitive tension? How do you maximize value?

  • Price gaps are increasing

    There is an increasingly large gap between buyer and seller expectations that needs to be bridged.

    Two-thirds (67%) of respondents say the price gap between a seller’s expectation and a buyer’s willingness to pay is greater than 20%. Hence, it is critical for sellers to build a credible value story with supporting data and start preparation early to realize their desired valuation.

    The research shows that 65% of the respondents believe that a lack of fully developed diligence materials (including product or service roadmap), led the buyers to reduce their price. A well-managed divestment process, with timely conclusion of sell-side functional diligence (financial, operational, etc.), enables the seller to be better prepared by:

    1. Identifying, analyzing and preparing critical target data
    2. Identifying critical issues which when resolved can increase sale price
    3. Helping management understand all the operational and financial nuances of the business and be better prepared for buy-side diligence
    4. Creating a level playing field and information symmetry for all buyers at the start of the sale process
  • Leverage the power of private equity (PE)

    Appealing to private equity buyers sometimes requires significant time and effort, but these bidders also bring increased competition and sharper focus on the business value. Critically, PE involvement potentially brings an increase in multiples during divestiture, which 56% of the executives confirm.

    Sellers should take the following steps to maximize PE participation in a competitive process:

    • Build a compelling picture of the asset as a stand-alone business: PE firms say a well-thought-out, stand-alone case and related cost model are key to keeping them in the sales process. Sellers may need greater flexibility in financial reporting systems as a first step in developing an accurate picture.
    • Keep an eye on operational performance: Missed forecasts concern potential buyers, particularly if the business misses forecasted performance outlined in marketing materials. Thirty percent of private equity bidders cite this as the most likely reason they would drop their price or walk away.
    • Help PE “see” the exit strategy: The nature and timing of an exit is of ultimate importance to PE. Sellers should articulate their perspective around potential monetization strategies early in the process.
    • Be prepared to generate granular data: Nearly half of the PE firms say access to granular data was a key factor in their decision about whether or not to stay in an auction process. The seller may need to have monthly historical and projected information down to transactional and SKU-level detail.
    • Tell a consistent story: Sellers need to have a clear sense of financial forecasts, growth opportunities, capital requirements, the management team and overall business strategy going forward. These are focus areas for PE, as they drive the financial and operational business models as well as the exit strategy.
  • Use analytics to maximize value

    The research indicates that in India only 33% of the companies surveyed continued to create value in the business unit before divestment. This is in marked contrast to the Americas (64%) and Europe (55%).

    Analytics can help companies create value before a sale. Sellers who leveraged analytics in their pre-sale preparation say that analytics assisted them more than anything else in making the divestment decision. Sixty-five percent of sellers now believe that advanced analytics would create even more value when used during buyer negotiation. For example, analytics can be used to help the buyer identify growth opportunities for the business. This could include identifying opportunities to grow revenue, such as new customers or markets; improving operations to deliver better margins or rightsizing or outsourcing the workforce.

  • Build value through stand-alone operating models

    In carve-outs, buyers may recognize greater value when sellers present a stand-alone operating model. Buyers have confidence in the operating model and know that the business has been properly prepared for sale, with a comprehensive separation plan. Seventy-one percent of the companies surveyed mentioned that they took detailed steps to create the stand-alone business and provide a clear picture to the buyer.

    The benefits also extend to sellers by:

    • Helping them to easily understand the impact of potential deal perimeter changes in “real time” — to make the business more attractive to a buyer
    • Assisting with TSAs, one-time costs and stranded cost remediation, which impacts the deal model for both the buyer and seller
    • Serving as key input into and aligning with the stand-alone cost model that drives deal economics
    • Building the foundation for the seller’s separation planning and the buyer’s integration planning, both of which will be greatly accelerated
    • Allowing for proper planning relative to capitalization and regulatory requirements, which avoids delayed or deferred closings

Key takeaways

If you are one of the 81% of Indian companies planning to divest within the next two years, what steps should you take now to maximize shareholder value?

  • Streamline for agility — Divestments can provide capital for companies to streamline their operating model and invest in their core competencies, thus helping them remain competitive.
  • Be prepared yet flexible — Early preparations can help sellers identify potential issues to be addressed which will help to maximize sale value.
  • Develop a value story for all potential buyers — Sellers should understand the needs of a widening range of buyers. This breadth of buyers, including PE firms, drives competition and a potential increase in purchase price.

Summary

The EY Global Corporate Divestment Study focuses on how companies should approach portfolio strategy, improve divestment execution and future-proof their remaining business.

About this article

By

Amit Khandelwal

Ernst & Young LLP India Transaction Advisory Services Managing Partner

Leader of Transaction Advisory Services in India. Focused on diligence. Go-getter. Numbers enthusiast.