The COVID-19 crisis has underscored the need for companies to consider divestitures to solve immediate liquidity needs and to free up the capital to invest for the future. CFOs, with their view of the overall business from both a financial and strategic perspective, can accelerate the divestiture process and take steps to help preserve transaction value.
We have seen companies use past economic downturns as a catalyst to transform their businesses and emerge stronger. Companies that divested during the 2008-2010 global financial crisis outperformed by 24 percentage points in median total shareholder return[1] (TSR) those that did not.
Median change in total shareholder return (2010-18) of divestors vs non-divestors (divestments in years 2008-10)
Not surprisingly, in the current environment, 57% of companies expect to initiate their next divestment within the next 12 months, according to the 2020 EY Global Corporate Divestment Study.
Furthermore, 96% of activist investors surveyed as part of the study said they plan to recommend that a target company carve out and divest non-core or underperforming businesses, a sharp increase from the 64% pre-crisis. Their expected time frame from initial investment to announcing a divestment is also accelerating: 84% expect such a divestment to take place within six months, up from 36% previously.
Overall, economic conditions, business needs, and activist pressures have increased the need to accelerate the divestiture process. How can CFOs help?
Accelerating the Divestiture Process
Tze-Liang Chiam
Help lead asset selection. CFOs, with knowledge of how interconnected different parts of the operation are, can help select assets that stand-alone operationally and are easy to carve out. In a time when speed is of the essence, the priority should be on smaller, digestible assets. And the deal perimeter should be articulated so that core operations are not compromised by the divestiture. The CFO also needs to make sure the CEO and board of directors are aware of the tax ramifications when an asset is chosen for divestment, though potential tax leakage may be acceptable in order to expedite the closing.
Proactively vet the buyer pool. Starting with the right set of potential buyers is critical for completing a deal quickly. CFOs should assess the experience and credibility of the buyer in deal-making, as well as their ability to finance and close the deal quickly. Also, an attempt should be made to target potential buyers that would not trigger antitrust concerns and regulatory delays.
Make diligence easier for the buyer. This starts with providing a clear value story for different potential buyers that can be understood quickly. The value story should include pro forma data that can show the true value of the asset versus short-term effects caused by the pandemic. Any projected revenue growth assumptions should be supported by credible external studies that include views of market growth, competitive landscape, and the company’s differentiation. On the operational side, the value story should include a clear picture of the current operating model, vis-à-vis the level of entanglement, and a view on the future-state operating model, opportunities, and cost structure.
Identify what is absolutely critical to be transferred. What does the buyer need to operate the business as either stand-alone or part of a broader corporate structure? In coordination with the operations team, the CFO can help prioritize the setup of specific legal entities, focus on minimizing systems and infrastructure separation, and initiate employee (e.g., works council, if applicable) negotiation early. For anything that is not critical to be transferred, Day 1 workarounds can be developed (e.g., transitional service agreements (TSAs), agency model setup, or the like).
A large pharmaceutical company, divesting a $4 billion business unit, co-anchored the diligence process to align not only on the financials but on the proposed Day 1 operating model. The company proposed a full scope of operational “accelerators” to transition the business quickly and asked all potential buyers to submit their proposed Day 1 operating plans as part of the overall bids. This alignment from the very early phases of the negotiation allowed the seller to significantly reduce the sign-to-close phase of the deal.
Preserving or Creating Value
An accelerated process can lead to tradeoffs between speed and value preservation or creation. Some tradeoffs may be inevitable, but a proactive CFO and finance team can help minimize value leakage.
Andrew Nawoichyk
Defend EBITDA. Don’t let the buyer make assumptions that drive down the price. Especially during the current crisis, it is essential to articulate the future operating model, as well as a defensible future cost structure. Make sure to have data to support your assumptions. This could include new forms of data such as social media analysis of customer behaviors when traditional sales data is no longer reliable. Highlight value-creation opportunities, such as cost synergies for strategic buyers.
Take steps to improve working capital. Companies often leave cash on the table when they don’t consider working capital improvement prior to divestment. Even before the divestiture process starts, the CFO should look for improvement opportunities among the primary drivers — accounts payable, accounts receivable, and inventory. A business with a healthier, sustainable cash flow will always command a better valuation, and potentially allow the seller a one-time cash extraction ahead of divesting.
Execute a plan for managing stranded costs and dis-synergies for RemainCo. Negotiate TSA pricing and duration to be as advantageous as possible for the seller so that services for the buyer do not cause operational strain. Use the sale as a trigger to revamp or restructure the remaining businesses, to mitigate stranded costs, and to create a best-in-class cost structure.
The current crisis is unprecedented for most businesses. Asset valuations may be depressed but divesting in a downturn can free up cash to improve liquidity and enable reinvestment in the core business to help companies emerge stronger from the downturn. CFOs are vital to identifying all available levers to accelerate the process while also preserving, or even creating, value.
Tze-Liang Chiam and Andrew Nawoichyk are Principals of EY-Parthenon. The authors would like to acknowledge contributions to this piece from U.S. Transaction Strategy & Execution Leader Sonal Bhatia at Ernst & Young LLP, EY Global Divestment Leader Rich Mills, and Ernst & Young LLP Senior Managers Nikhil Singh, Ghassan Khoury, and Tarun Gupta. The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.
[1] Source: EY Analysis and S&P Capital IQ
