8 minute read 12 Feb 2019
How can you operationalize a divestment for success?

How you can operationalize a divestment for success

Authors

Rich Mills

EY Americas Divestiture Advisory Services Leader

Leader of complex divestitures that help enhance shareholder value and drive more efficient capital allocation. Dedicated husband and father.

Paul Hammes

EY Global Transaction Diligence and Divestiture Advisory Services Leader

Leader in transformational global divestitures. Catalyst for profitable growth. Innovator. Value driver. Passionate about diversity in business. Husband. Father.

Paul Murphy

EY Asia-Pacific Divestiture Advisory Services Leader

Change advocate. Focused on the divestment programs for the global mining industry.

Carsten Kniephoff

EY EMEIA Divestiture Advisory Services Leader

Dedicated advisor to transforming companies. Ambitious front runner implementing tech tools, new solutions for companies selling and separating. Enthusiastic and innovative. Fun-loving father of two.

8 minute read 12 Feb 2019

Execution considerations for divestitures, including deal structure, tax and regulatory.

Ongoing pressure from shareholders has created a new normal of frequent and disciplined portfolio reviews, with companies more actively identifying assets for disposal. However, companies that don’t prepare for a transaction early enough risk holding onto assets too long and losing value once they’ve launched the monetization process. According to the EY Global Corporate Divestment Study, nearly 40% of companies say their last divestment did not meet timing or price expectations.

Weigh the merits of different structures

Seventy-nine percent of companies say their most recent divestment took the form of a carve-out sale, but other deal structures (e.g., joint ventures, tax-free spins, full enterprise sale) can sometimes support greater return to shareholders, or align better with the long-term goals for the remaining organization.

Divestment readiness

63%

of companies say they held onto assets too long, up from 56% in 2018.

In Europe, for example, joint ventures have grown in popularity as part of the divestment landscape, with companies more often contributing assets to these deals. This structure is helping some companies tackle innovation-related challenges by bringing in a partner with capital, experience and technological expertise. Examples include Swiss engineering group ABB’s joint venture with Hitachi to tackle new markets in energy infrastructure, and the two-year Arlanxeo JV between chemicals maker Lanxess and Saudi Aramco to support product innovation that recently led to a buy-out. These arrangements may help companies accelerate growth more quickly than a buy-or-build strategy.

In the US, even with major tax reform, tax-free spin-offs (i.e., demerge a business to existing shareholders) remain an effective strategy for creating shareholder value and deleveraging by moving debt to SpinCo while restructuring the remaining organization. This structure is effective in distributing to shareholders a business with a low tax base that may otherwise result in taxable gains and a large tax bill. In addition, tax-free spin-offs can help a divested business achieve its desired value, especially if the target price cannot be realized through a traditional sales process. Further, as a separately traded public company, SpinCo may now more effectively manage its strategic objectives and capital agenda, thereby achieving a valuation more appropriately reflecting its value.

Be flexible to improve your outcome

Thirty-two percent of companies indicate that optimizing the legal structure was the most important factor in enhancing value in their last divestment. Conversely, 57% of companies say lack of flexibility in the sale structure caused value erosion. To maximize value, companies may need to evaluate structures ultimately through greater flexibility in the deal perimeter. This allows room to optimize according to market conditions, tax efficiencies, timeline, anti-trust considerations or net proceeds.

In some cases, morphing to another deal structure may be the only way to get the deal done. For example, a low valuation for an outright asset sale may result in a shift to a joint venture structure that entices a buyer to participate in the upside of the business with the seller. Another option is dual tracking deal structures, which can maximize the likelihood of achieving your divestment goal — though it’s worth noting that fewer than one in 10 businesses took this approach in their last divestment. Companies considering dual tracking a tax-free spin and an outright sale should proceed with caution. For example, if more than 50% of either SpinCo or RemainCo is sold within two years of a spin-off, the US tax rules contain provisions that can cause a tax-free spin-off to become a taxable transaction. Therefore, companies must consider the US tax safe harbor rules during any dual tracking process to understand the impact on future plans.

Always be divestment-ready

Companies today are broadly better at identifying assets that should be divested, but are increasingly slower in launching the process. In fact, 63% of companies say they held onto assets too long, up from 56% in 2018. A well-defined portfolio strategy, coupled with the right resources and expertise to effectuate the divestment, should give companies more confidence in their ability to act when the time is right. Sellers who say they did not hold onto assets for too long are twice as likely to secure a better price from the transaction.

Companies may underestimate how lack of preparation impacts their deal timeline and total shareholder return. The majority (51%) of companies report their divestment took five months or longer from sign to closing, far beyond the three-month close that shareholders have come to expect. Deferred closings, increased transitional service agreements (TSAs) and other obligations can plague the remaining organization when appropriate time is not invested in preparing the business for sale. Lack of preparation is a critical factor for the 41% of companies that say their last divestment did not meet expectations in impacting the valuation multiple of the remaining business.

Optimized legal structure

32%

of companies reported that an optimized legal structure was the most important step in enhancing sale value.

Companies are increasingly pursuing a “carve-out platform” approach to make businesses divestment-ready. Under this approach, systems, processes and even legal entity separation work begin before the deal process starts. Initiating this work before a buyer is known helps accelerate the separation and stand-alone timeline and minimize TSAs. For example, 32% of companies reported that an optimized legal structure was the most important step in enhancing sale value. Sellers may also negotiate reimbursement for the related separation and stand-up costs because buyers receive control of the divested business sooner.

Make tax a top consideration

Tax is a central consideration during the carve-out process, and work should align with the portfolio review process. Far too often, a decision to divest is made without appropriately considering tax implications. In fact, two-thirds of companies say a lack of preparation in dealing with tax risk was a major cause of value in their last divestment.

Sales processes often stall when sellers fail to recognize that potentially skeptical buyers may have a completely different view of the risks associated with tax-efficient structures implemented historically.

Companies must also consider country-by-country requirements. As tax reform initiatives continue to roll out around the globe, 45% of companies say they expect an increase in tax challenges as they execute deals.

Understand work stream interdependencies

Businesses built on years of acquisitions, complex systems consolidation or shared service centers are intertwined at functional levels, including finance, tax, supply chain, treasury, procurement, legal, technology, human resources and sales. More than half (56%) of companies say lack of understanding around work stream interdependencies — and the critical path to disentangle them — derailed or delayed the closing of their last carve-out. And 50% of companies say failure to present the business as a stand-alone “scared off” potential buyers, eroding value in their last divestment.

Companies can evaluate how to disentangle the business for sale before the formal process by:

  • Appointing leaders to oversee each function from the start of the process and establishing clear lines of communication
  • Reviewing revenue streams to allocate costs within the asset to be divested and avoid stranded costs
  • Developing the post-transaction operating model for the parent company as well as the carve-out business, with work streams clearly defined
  • Devising the optimal short- and long-term tax strategy as part of the separation strategy and operating model
  • Minimizing transitional services agreements (TSAs) where possible

Mapping out interdependencies early and creating an ongoing dialogue between cross-functional teams drives transaction governance and ultimately value for all stakeholders in terms of timing and net proceeds. In a recent divestment, a seller’s preferred buyer — also with the highest bid — walked away during the diligence process because of obvious entanglement issues. This resulted in the seller accepting another bid 20% below that of the first and more complicated public financing requirements.

Mitigate stranded costs

Identifying potential stranded costs early can allow sellers the opportunity to develop mitigation plans. Companies often minimize the effort required and the time pre- and post-closing to complete those plans. We often hear from companies, “This can only be done close to closing” or “We know the costs included in the deal, so this will be easy.” However, many costs in the deal are often shared or allocated in nature. Accordingly, companies need to examine shared costs across business units, including those charged to the carve-out. 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 — knowing these can save precious time while preserving value going forward for the seller.

Pre-empt regulatory hurdles

Sellers need to identify regulatory requirements in every jurisdiction to set clear work stream timelines. Forty-nine percent of companies say their divestment was delayed or deferred because they didn’t fully understand regulatory requirements.

Regulatory hurdles

49%

of companies say their divestment was delayed or deferred because they didn’t fully understand regulatory requirements.

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-three percent of sellers say capitalizing and operationalizing a legal entity was a challenge 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 requirement 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 even locality.

Delayed closings pose operational and administrative burdens to sellers post-close and often delay their receipt of cash. They also delay the buyer from implementing the changes required to achieve value capture goals. Overall, these issues are suboptimal for buyers and sellers.

In summary, identify long lead time regulatory requirements early in the divestiture process and start developing country-specific plans to minimize delays and transition cost overruns.

Summary

Companies can take the following steps to operationalize a divestment for success: Weigh the merits of different structures. Be flexible to improve your outcome. Always be divestment-ready. Make tax a top consideration. Understand work stream interdependencies. Mitigate stranded costs. Pre-empt regulatory hurdles. Read the full Global Corporate Divestment Study (pdf).

About this article

Authors

Rich Mills

EY Americas Divestiture Advisory Services Leader

Leader of complex divestitures that help enhance shareholder value and drive more efficient capital allocation. Dedicated husband and father.

Paul Hammes

EY Global Transaction Diligence and Divestiture Advisory Services Leader

Leader in transformational global divestitures. Catalyst for profitable growth. Innovator. Value driver. Passionate about diversity in business. Husband. Father.

Paul Murphy

EY Asia-Pacific Divestiture Advisory Services Leader

Change advocate. Focused on the divestment programs for the global mining industry.

Carsten Kniephoff

EY EMEIA Divestiture Advisory Services Leader

Dedicated advisor to transforming companies. Ambitious front runner implementing tech tools, new solutions for companies selling and separating. Enthusiastic and innovative. Fun-loving father of two.