Take a Piece of Me

Why shedding parts of a merged entity can make a company whole.
Rob GarverApril 1, 2007

In late February, the former WPS Resources Corp. announced that it had completed its $1.8 billion acquisition of Chicago-based Peoples Energy Corp. and changed the company name to Integrys Energy Group. At the same time, it decided to divest one of Peoples’s major assets, Houston-based Peoples Energy Production.

Divestitures are booming. According to Dealogic, 10 of the 40 largest deals announced this February were divestitures. Of those, 5, including The Blackstone Group’s $2.9 billion sale of real estate to Maguire Properties and Anadarko Petroleum’s sale of its $860 million stake in oil fields in Texas and Oklahoma, followed mergers. Last year’s major postmerger divestitures included Baker Hughes’s $2.4 billion sale of Western Geco and Time Warner’s sale of its German and British AOL businesses, according to Mergermarket (see “Merge and Purge” at the end of this article).

But just because divestitures are popular doesn’t mean they’re easy. At Integrys, “first we needed to understand the projected earnings for [Peoples Energy Production] and the risks associated with owning it. Then we needed to estimate the value if we were to divest,” explains CFO Joseph O’Leary. Integrys’s financial needs naturally played a role in this calculation. Peoples was the firm’s third acquisition in 18 months, including the $660 million purchase of two natural-gas utilities in Michigan and Minnesota. Those deals had required the firm to float significant short-term debt — $723 million at year-end, according to O’Leary. The sale, which is being facilitated by JPMorgan Securities, will allow the company to pay down some of this short-term debt.

Another factor is focus. Integrys is increasingly focused on energy delivery rather than production, so the sale of Peoples Energy Production, an oil and natural-gas extraction company, allows it to continue concentrating on its core business. The divestiture also lowers the company’s risk profile, because energy delivery is less volatile than energy production. This stabilizes Integrys’s credit rating, which is vital for public-utilities firms as they negotiate rates with municipalities.

A Delicate Procedure

In some respects, disposing of unwanted portions of an acquired company is as complicated as planning the acquisition in the first place, especially if the asset is deeply intertwined with the rest of the business. Still, if a company has decided to maximize its returns on a particular asset by selling it, every day it delays represents a loss at least equal to the difference between the return the asset generates as part of the firm and the expected return on the sale. Moreover, hanging on to an unwanted asset can distract management from the core business — sometimes with unforeseen results.

For instance, following its acquisition of Segue Software in February 2006, Cupertino, California-based Borland Software announced its intention to sell a division that creates software tools for program developers, in order to concentrate on automated lifecycle management. But the division languished well past the third-quarter deadline set for finalizing a sale when the company could not find an adequate buyer. Finally, in November, Borland announced that it would no longer attempt to sell the division and instead took steps to spin it off as a wholly-owned subsidiary. Software analysts believe the subsidiary will have trouble competing in an increasingly tight marketplace.

At least Borland figured out which business it needed to divest, not always an easy task. In general, the amount of premerger divestiture planning correlates with the size of the deal, says Rick Naschold, a principal with Dominion Partners, a Richmond, Virginia, advisory service that helps guide small and middle-market companies through mergers and acquisitions. In smaller deals, he says, there generally isn’t a significant separate business line to sell, and the sale of unneeded real estate and equipment can usually occur after the deal is completed. When you have a large business, of which only a few are salable, he says, the planning is often extensive and “needs to happen before the purchase.”

Take the recent $39 billion leveraged buyout of Equity Office Properties Trust by The Blackstone Group. Within days of the announcement, says Naschold, Blackstone had buyers in place for millions of square feet of office space in New York; Washington D.C.; and multiple California markets. Clearly these deals had been negotiated in advance of the closing and allowed Blackstone to reduce the considerable debt it had taken on to complete the deal.

Of course, sometimes the decision to divest isn’t the acquirer’s. The Department of Justice continues to eye every deal for hints of anticompetitive outcome. In late February, for example, as a condition of Mittal Steel Co.’s $33 billion acquisition of Arcelor SA, the DoJ ordered Arcelor Mittal to sell its Sparrows Point mill near Baltimore over concerns about competition for tin mill products in the eastern United States.

Unintended Consequences

In some respects, the better the target company, the more difficult it is to divest a portion of it. “Where you have, in the acquired firm, a well-integrated company in terms of systems, accounting, and other issues, you may run into problems,” explains Howard E. Steinberg, chairman of the M&A practice group at law firm McDermott Will & Emery in New York.

One common unintended consequence is difficulty retaining talented executives from the acquired company as responsibilities are shifted or removed. “An operating person [in the retained portion of the business] may have jurisdiction over a part being sold,” says Steinberg. A senior manager with the acquired firm, who perhaps had some supervisory authority over the divested part, may find it difficult to stay in a diminished role.

In some cases, fully separating the acquired company from the divested asset involves more than a simple asset sale. “The divesting company may have to agree to provide at least temporary operating services to the buyer, particularly in software systems and in anything having to do with human resources or customers,” says Steinberg.

Done correctly, however, postmerger divestitures allow acquirers to more fully focus on the core business. In her fourth-quarter earnings call in February, Karen Hoguet, CFO of Federated Department Stores, told analysts that she counted the successful divestiture of $4.5 billion of assets acquired in the 2005 merger of Federated and May Department Stores as one of the company’s primary financial accomplishments of 2006.

There is always an element of “Be careful what you wish for.” After Integrys announced the divestiture of Peoples’s energy production business, which is scheduled to be completed by the end of this year, Moody’s Investors Service upgraded Peoples Energy Corp. senior unsecured debt to A3 from Baa2 with a stable outlook. But in its statement, Moody’s said that while the risks associated with the divested energy and production business had caused Peoples’s two-notch downgrade last year, “the divestiture will [now] focus the ratings more on the challenges facing Peoples’s core LDC [gas distribution] business.”

Rob Garver is a freelance writer based in Springfield, Virginia.

Merge and Purge
The top postmerger divestitures of 2006
Date Target Bidder Seller Deal Value
4/21/06 Western Geco
(30% stake)
Schlumberger Baker Hughes $2.4 billion
4/4/06 Virgin Mobile Holdings
Virgin Media Virgin Group $2.1 billion
12/26/06 Anadarko Petroleum
(Vernon and Ansley Fields)
EXCO Resources Anadarko Petroleum $1.6 billion
3/6/06 Marine Harvest
International G.V.
Pan Fish ASA Nutreco Holding N.V.;
and Stolt-Nielsen S.A.
$1.6 billion
4/13/06 Quilmes Industrial S.A.
(Quinsa) (34.46% stake)
InBev S.A. Beverage Associates $1.2 billion
Source: Mergermarket