Michel Driessen, Ernst & Young
As companies attempt to navigate challenging market conditions, the typical approach to divestments has been to “wait and see”. This is clearly evidenced in the decline in number of divestments that have been announced in 2012 Vs 2011. The recent Ernst and Young Global Divestment Study finds that many companies take heed of the “wait and see” approach and continue to use divestments primarily as a short term tactical tool to raise cash or pay down debt.
The Ernst and Young Study suggests that companies may be missing out on opportunities by delaying divestments. Among respondents, 77% intended to accelerate divestment plans over the next two years and 46% are in the process of divesting or planning a divestment. Given the prolonged period of low growth forecasted, companies are recognising in real terms what economists refer to as “The New Normal”. In this environment, divestments can become more of a strategic tool that drives value for the company. Companies that do not subscribe to “The New Normal” and continue to take the “wait and see” approach are likely to struggle. Divesting effectively and efficiently in today’s economic environment is no longer optional and needs to become an active part of a companies’ value creation strategy.
So, the exam question posed is how do companies avoid leaving value on the table in “The New Normal” environment? The Ernst and Young Study which is a study based on a survey of 567 corporate executives across the globe has attempted to answer this question through looking at value with respect to two measures – value expectation and speed expectation. The study’s empirical analysis shows that companies that adopt the following five leading practices are closing deals ahead of schedule and achieving higher prices than expected.
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Firstly,companies need to understand the importance of regular and structured portfolio management and how capital should be allocated across their business. Scheduling regular reviews of the asset pool can assist with better understanding of opportunities that may be present, allowing divestments to be employed as a forward-thinking strategic tool rather than as a reactive move. The study implies that the main drivers for divestment are often the impact on earnings per share (EPS) and financial benchmarks such as return on capital employed (ROCE). Whilst these are solid foundations for assessing the potential impact of a divestment, there needs to be further work embedded in the portfolio assessment process to more closely align with an overall strategy for shaping the future of a business. Seeking immediate results oriented around financial measures may serve to blinker the path to optimising shareholder value or focussing on core business. The study finds that 55% of high performers have a structured process and reviewed their portfolio regularly.
Secondly, the study finds that sellers need to consider a full range of potential buyers by widening the search for prospective buyers to ensure every angle of opportunity is explored prior to advancing a deal. Whilst there may be a sensible reluctance to invest in an exhaustive and costly process, there are some simple steps that, when embedded in the core of a divestment strategy, can enable companies to shape deals based on the most appealing factors to the relevant buyers. For example, seeking out cross-border opportunities and tailoring marketing collateral and transaction information for specific buyers can greatly enhance asset valuation.
The third leading practice, linked to this holistic view of the buying environment, is the idea that companies should invest in articulating a compelling and well-founded growth story for potential buyers. Investment in due diligence materials and analysis for each of the buyers, development of an M&A plan for the asset and identification of upsides and potential synergy can be extremely effective; cumulatively, they can enhance a sellers’ negotiating position and provides buyers with confidence, both of which go a long way towards increasing deal value. The study found that only 50% of respondents carried out these activities.
The fourth leading practice identified is to prepare rigorously for the divestment process. Ensuring the right focus on speed of execution and having flexibility to manage a myriad of buyers whilst still being in control of the process is critical to the success of a divestment. Additionally, investing resources and time to enhance the value story through strong operational performance and synergy opportunities for potential buyers is imperative to deal success. The study found that sellers who prioritise value place more emphasis on pursuing multiple divestment options in parallel and on performance improvement.
Last but not least is understanding the importance of separation planning.56% of respondents said that creating a separation roadmap has become more complex over the past two to three years. Companies need to consider the following: interdependencies between the carved out entity and the remaining business, additional recurring costs required for the standalone carved out entity, stranded cost implications for the seller and one off costs to implement the separation plan. Globalisation and efforts to streamline back office and IT infrastructure and support through the use of shared service centres and outsourcing contracts are also making divestments increasingly complex.Plans require clear exit objectives, specific end dates and absolute clarity over scope, length and the costs of Transitional Service Agreements (TSA).
By recognising the seismic shift in the rationale for making divestments, companies should take an inward look at their operational practice as well as their asset portfolio itself to ask blunt questions of the strategy: is portfolio management market-leading, has the buying market been adequately interrogated, is there a compelling growth story tied to an asset and is there confidence in the preparation and execution process? Tying these aspects together can help meet shareholder expectations at the same time as realising maximum value from assets. Divesting effectively and efficiently has always been an option to build value; in “The New Normal” economic environment, ensuring a divestment is strategically effective is no longer optional.
‘In a difficult stock market environment in which returns are very low, companies need to be more focussed than ever on ensuring that their strategy is absolutely clear and communicated properly to shareholders.’ – The head of a European investment bank.
‘Prospective buyers may not be aware of the advantages of a local business environment. Presenting that information to them or bringing them into the country to meet government agencies can be a powerful lever to keep the buyer interested and enhance the value of the asset.’ – Executive at a technology company.
‘It pays dividends to do some preparation work a year or two ahead of a potential divestment because it enables you to get the timing right. Doing some legwork around carve-out financials, or thinking about the business as a standalone entity makes it easier to move forward with the transaction once you decide that now is the right time to invest.’ Executive at an industrial products company.
‘In every transaction we have done, dealing with IT separation issues has been among the most challenging aspects. You need to negotiate new license agreements with the IT provider as well as addressing separation and security issues. One of the most important lessons for us has been to think about IT issues earlier in the process.’ – Executive from the aerospace industry.