Busting finance jargon with Roger Esler #2
Non-core disposals, carve outs, strategic divestures & corporate simplification
Large corporate groups are evolving organisms that can go through fits and starts of acquisitions and disposals. The drivers for periodic bursts of such activity can be strategic, financial or both, but the catalysts can include a change in economic conditions or, indeed, a change of guard in the boardroom bringing a different outlook.
Large, multi-business groups are motivated to maximise shareholder value (capital gains and dividends) for a particular level of risk. They might be PLCs or be backed by private equity institutional investors or HNW family offices, together with management and possibly employee shareholders. Ultimately, it is the owners of these groups that vote with their money and their feet in response to a board’s strategic plans.
The age of the conglomerate has long since passed and investors now look for clarity of a group’s commercial proposition, ideally one which is operating in a new or growing market, differentiated through scale, technology or focus to its competition and capable of market outperformance. Some groups chase growth and some, high levels of lower risk income to fuel dividends. In short, a group’s strategy needs to align with the investment criteria and risk appetite of its owners and shareholders.
In practice, this means that corporate strategies shift to attune to a changing market and/or shareholders’ expectations. Some subsidiary businesses can, therefore, become “non-core” because of their geography, operational activity, market focus, growth and margin characteristics, relative valuation multiplier or risk profile. Additionally, as capital has a significant cost, redeployment of group funds to “core” businesses and strategy can be both value amplifying and structurally “simplifying” for a particular group.
Such “strategic divestures” or “carve outs” can, or should, be planned someway in advance and managed through a conventional sale process, be that a wide or targeted marketing. There can be considerable complexities, however, particularly if a business has been part of the fabric of a group for a very long time.
For example, there can be heavy reliance on group central services for such functions as finance, HR, real estate and marketing. This can stray into aspects of management continuity where a subsidiary business might be very operationally focussed and not have a full senior management team travelling with it. Transitional service agreements are, therefore, very common as group functions migrate to the new owner over a period of time.
Such issues can be compounded by management information struck at a high level of group materiality, without the granularity that a buyer of a subsidiary business might seek, together with complex group recharges, intragroup trading and transfer pricing arrangements that need unpicked to assess value from the perspectives of both buyer and seller and create the need for new, arm’s length commercial agreements.
For some trade buyers with a deep understanding of the market and the business, it is possible to take a view on these aspects. For funders relying on due diligence, however – including backers of management buy-outs of non-core businesses – it can be much harder, and this can go directly to valuation and/or cost of finance.
Ideally, therefore, separation aspects and presentation of clear financial, commercial and other deal-relevant information should receive early consideration by the seller and the business be prepped and positioned for sale with as clean an operational and financial exit as possible. However, in practice the seller’s management can be rightly preoccupied with the group’s core operations and it does not always resource and seek specialist advisory support on the divestment project, including assessing its appeal to private equity investors as well as to trade buyers.
Some corporate carve outs, particularly in times like these, are motivated by financial stress and scarcity of capital. This could be at group level, where it might be going through a publicised restructuring or even be in administration, or at the subsidiary level where the business being sold is a drain on group funds and senior management time.
The key motivations of the seller here are speed and simplicity, often more so than valuation as the group’s senior creditors can be highly influential. It is buyers and investors with the risk appetite, experience and resources to acquire in an accelerated process with limited opportunity for due diligence, that will have the advantage. To accommodate such a deal, the seller might have to contemplate an asset sale rather than a share sale, the former being a more definitive position for the buyer but potentially leaving the group with legacy liabilities within the corporate entity.
In the current environment, where shareholder and investor sentiment is evolving and financial pressure is high in some sectors, the volume of corporate divestures is increasing as large groups seek to recalibrate their strategic focus and redeploy capital for improved risk-adjusted returns. The extent to which such businesses are prepared for separation and sale varies wildly, as does the realism and resource with which buyers and investors approach these transactions.
What is a non-core business for the seller of course might be strategically core to another trade party and so this constructive corporate churn goes on, hopefully to the benefit of the overall economy. Notably, the substantial level of private equity funding currently available in the market is such that buy-outs and buy-ins will also feature heavily in facilitating corporate simplification, and if there is such an investment case for a business, this needs very careful preparation for sale to both maximise value and ensure deliverability.
Roger Esler – Partner Dow Schofield Watts Corporate Finance, North East Office