Moderator: Welcome to another addition of Deloitte Insights, a production of Deloitte LLP. Deloitte Insights is an audio newsmagazine that looks at important business issues. Today’s program – Spinning off Successfully: What Companies Need to Know About Divestiture Strategy.
Breaking up is hard to do, as the old song says. It’s hard for companies as well as couples. Divestiture isn’t simply integration in reverse. It’s a complex process that requires special skills. Companies have to stay focused on their day to day business while the carve-out is taking place and they have to make certain that the separation of shared services goes as smoothly as possible. In spite of the difficulties of divestiture, companies have been doing it a lot lately.
In 2007 alone the number of large scale divestitures soared by nearly 40 percent with almost 140 spin-offs valued at more than $1 billion each. The stakes are too high for a company to think about divestiture without having an effective strategy in place and a management team with the experience and training to execute it. Otherwise breaking up may turn out to be more costly than staying together.
Here today to tell us how companies can plan for and carry out a successful divestiture are Jefferey Weirens, Marco Sguazzin and Will Frame.
Jefferey Weirens is the national managing director of Deloitte Consulting LLP’s Carve-Out and Merger Integration practice. Marco Squazzin is a principal with Deloitte Consulting LLP’s Merger and Acquisition [M&A] practice, and Will Frame is the managing director of the Paper, Plastics and Packaging practice at Deloitte & Touche Corporate Finance LLC.
Welcome to Deloitte Insights.
Jefferey Weirens: Thank you. Happy to be here.
Marco Sguazzin: Thank you. Thrilled to be here today.
Will Frame: Thanks.
Moderator: Why do you think the number of divestitures has been increasing so dramatically in recent years?
Jefferey Weirens: There are three structural shifts that have happened in the market over the last three to five years that have fueled the increase in carve-outs and divestitures. The first is the increasing overall mergers and acquisitions trend. What happens in that situation is, more companies find themselves doing larger transactions and they were looking for a set of crown jewels, in terms of the acquisition. But then they also got a fair bit of excess baggage and other business units that weren’t core to their new strategy so they’re actually looking to carve out those pieces that don’t fit with the strategy that were, quite frankly, just came with the deal on a larger acquisition.
The second factor that I would look to is the private equity investors. As they’ve risen in prominence over the last number of years, what you see is a more focused effort around shareholder returns and, again, trying to release some shareholder value. So they will very aggressively look at acquiring some of those businesses that are being carved out because they’re not core to organizations. And then operationally look at improving the performance and then further spinning those out and/or selling them. Those two factors really go hand in hand and there’s a linkage there that we see in the marketplace.
And then the third factor that we see is the increasing role of globalization, including the rise of sovereign funds as well as cross-border transactions.
Marco Sguazzin: Globalization has certainly come to prominence in the last few years and will probably increase in the next few years even farther than it has today. And it’s all about being exposed to global competitors that have structural or other cost advantages to you. If you can’t be the number one or number two provider of a service or a product in your space, then why are you doing it? This questions the previous vertical integration strategies that companies have had. If you can’t be that number one or two, why not just buy that product or that service and focus your resources on the area where you can be number one or number two? I think globalization is really showing that up to be quite an important factor and certainly around the former vertical integration strategies and now bringing those into question.
Will Frame: Hedge funds don’t just focus on private companies. Activist hedge fund investors are becoming much more targeted on large public companies and the information is out there. Managers of large global or domestic businesses are under pressure to maximize returns and shareholders are really focusing on capital allocation and returns on capital. And that’s raising all sorts of questions about divestitures and, frankly, what businesses you should be in that are becoming more to the fore than they have been.
Secondly, for private companies, private equity is bringing the types of rigorous public market style discipline to private companies, particularly decent size private companies. And the same questions are being asked. I would suggest that private equity groups are like one single activist investor constantly looking to maximize value in their portfolio companies.
Moderator: So just what is it about a divestiture that makes it such a challenge?
Marco Sguazzin: I think that divestiture execution simply isn’t as intuitive as you might think and it’s certainly not a well practiced art. Unraveling everything that has taken you years and years to put together and then doing it in a number of months is quite a challenging task. The devil is really in the details. And [there is a large] amount of detail that you’ve got to get down to in order to successfully unravel some pretty complex and pretty integrated business processes. The workload becomes extreme pretty quickly. The workload is almost always underestimated going in simply because it’s pretty unintuitive as to what’s got to happen. In fact, many divestitures can consume up to a quarter, even a third, of a company’s employees. So the workload is certainly affected. That makes it pretty difficult.
Jefferey Weirens: One of the key factors driving that workload that Marco was describing is, think back over the last 20 years over the large scale ERP [Enterprise Resource Planning] implementations. So the SAPs, the Oracle implications that tie together a company’s back office and many times even front office operations. And those projects, as most organizations have gone through that life cycle, take five, six, eight years many times, and it’s a never-ending challenge to continue to upgrade those. It’s a matter of, how do you actually, in a very short period of time, disentangle that web of integration that’s been driven through by that ERP wave over the last number of years?
Will Frame: And following that you’re dealing with a buyer on the other side of the transaction – a pretty obvious question for a buyer to ask is, “What exactly are you selling?” All of the preparation work really comes down to being able to answer succinctly. If we buy this spin-out, these assets, what exactly are we getting? What’s coming with it? Whether it’s IT [information technology] systems, whether it’s people, whether it’s management or whether it’s hard assets. The thought process to answer the simple question, what are we getting, really goes to the root of an organization and is quite, as Jeff said, quite counter to the principles often that have been built up over many, many years, where integration and being one single entity and facing the market in a joined-up fashion are certainly common principles that a lot of organizations have built their management style around.
Moderator: What are the best practices that companies should follow when they prepare for divestiture?
Jefferey Weirens: Building on what Will was referring to in terms of looking at the buyer perspective and having the buyer involved, I’ll give one best practice from a seller [on] the parent company side, as well as the “spin Co.” entity side.
First, on the parent company side, two things – one is packaging that business for sale and being able to ring fence employees and provide a crystal clear vision for how day one operations, that is the day of close, that that business is truly going to operate seamlessly, no negative impact on customers, no negative impact on employees. An investor looking for that business, that’s going to be one of the key factors they look at as well as what the actual discounted cash flow analysis has to say.
So if you’re a seller of a business packaging up that business for sale and having it demonstrate that it’s ready to operate is going to be a key best practice. From a spin Co. perspective, recognizing that there are a lot of different things in play trying to set up an organization from legal entity structure all the way to helping ensure business continuity, again, on that day one, on that transaction close date. A best practice is having clear carve-out plans that the organization will rigorously execute on. And that’s a key word, execution: how well they actually execute those plans to ensure that no negative impact on the customer and the employees. So there’s actually a shared interest there for both the seller and the spin Co. entity and those would be two key best practices that I would point to.
Marco Sguazzin: Yeah, a couple of others. You really need to identify and start addressing the long lead time items as quickly as you can. So we spoke a little bit earlier about the importance of IT and the fact that IT is typically one of the long lead time items. You’ve got to get on top of IT as fast as you can. You can break it down into some smaller decision points and make smaller decisions along the way that really help you. But accelerating IT, accelerating procurement contracts and supplier contracts and customer contracts, those are a couple of areas that you’ve really got to get on top of pretty quickly.
A couple of others might be the appropriate use of TSAs, or Transition Service Agreements. TSAs certainly help a lot to make sure that you can reach a successful divestiture date as quickly as you can. Another area might be to really hold the line on cost reduction or at least stop any cost increase or “dysinergy,” as we might call it in the divestiture world.
And then lastly, I think it’s all going to come down to day one and the day that you spin and being ready to operate, as Jeff has pointed out. And a best practice there would certainly be to focus on what is required to have a successful day one, almost build a checklist of what that day one is going to look like and then work backwards from there. Use the checklist to drive your activity and then certify your organization’s readiness to reach day one in an operational state.
Will Frame: Prepare, prepare, prepare, I think all of the best practices come down to being prepared, even before day one. The last thing you need is to be out in the market in a divestiture without a clear end date. That has the potential to destroy value both for the seller and can create uncertainty for the spin company going forward, which is really in no one’s best interest. So the best way to both maximize value and prepare for a clean spin-out is to not only be ready at day one but to minimize the period between starting to have serious discussions with buyers and being able to close and execute an emanations action.
Jefferey Weirens: I would even challenge the group, that what we’re talking about in terms of best practices are table stakes. There [is] a whole other set relative to post close what the parent company should be looking at from rationalizing their cost structure to avoid this [kind of] cost problem. There are best practices that the spin Co. entity should be looking at from a very clear rolling 30-day plan. So every 30 days they know exactly what are the key projects, what are their key milestones both from a separation perspective as well as hitting their ongoing operating commitments to the market.
Will Frame: We often think about winners and losers in the heat of an emanations action. Typically the seller is trying to get as much value as they can and the buyer is trying to get as good a deal as they can. But a lot of the concepts and the principles behind their divestiture – when you plan and execute a transaction efficiently, the mythical win-win situation really is possible because the seller gets the best value and the buyer gets a business that’s ready to go on day one and is positioned to create value for the buyer and the management team going forward.
So this can be taken away from the heat of the battle and the traditional fairly tame M&A discussions into processes that really can be additive to both sides of the transaction.
Moderator: Divestiture is sometimes wrongly thought of as integration in reverse. But it’s a completely different animal. Is divestiture more or less difficult than integration?
Marco Sguazzin: Oh, it’s really far more difficult than an integration. If you think about it, in a divestiture you need to be – you need to arrive at day one with everything executed and ready to operate your business on day one. Whereas in a merger there is very little execution that can take place by competition law before day one; it’s also unintuitive, as we may have mentioned. The volume of work grows pretty rapidly.
Here’s a good example. If you look at, for example, procurement contracts, any organization may have anywhere from thousands to tens of thousands of procurement contracts. Going into a transaction most executives might think that they’ve got a handle around all of these and they have them in one place. Well, what we’ve found in our research in the marketplace is that very few organizations actually have one repository of all of their contracts. So you’ve really got to go out and inventory these contracts and then subject them to several different types of review. You may have a legal review to look at the terms of the contract. Is it assignable? Can you replicate it? Who needs the contract? Does the parent company need the contract? Does the spin Co. company need the contract or do you both need the contract? There may be a tax review. There may be tax implications of the spin-off that manifest themselves in the contracts too.
So there’s an example where you may end up with tens of thousands of contracts, each one of which needs to be dispositioned before you reach day one. And from that perspective the workload and the complexity grows enormously before day one.
Jefferey Weirens: I actually was smiling on the inside when you asked that question because I reflected back to 10 years ago when I did my first carve-out. And at that time I actually said, well, it’s going to be just like doing integration in reverse – I had done integrations for years. And, in fact, we talked about it being essentially an 80 percent photographic negative of an integration. In reality it’s the total opposite. It’s much more difficult for all the reasons Marco described as well as an additional factor, which is a set of diverging agendas between all the different parties. So you actually have three parties involved at a minimum as opposed to an integration where you would only have two. Additionally, whereas on an acquisition or an integration you actually have typically two stand-alone companies that are fully operational. In a carve-out you actually do not have that situation where you have an entity that is not typically a stand-alone enterprise and further complicates things because of those transition service agreements that Marco described as well as a myriad of other services that they may be relying upon, as well as providing back to the parent company. And all of those factors just increase the level of complexity and interrelatedness between those three parties that really drive a fair bit of the complexity.
Will Frame: Typically we’re professionals and we talk about complexity in terms of contracts and assets and all of these good categories. But really the people are what drive the value of the business in most cases. And a divestiture process, just by definition, creates uncertainty. Planning an efficient communication can reduce that uncertainty but it doesn’t go away. So you have to realize that as you enter this process there are going to be difficult questions and that you need to plan and think about how to answer these difficult questions because they will have to be addressed. I tell sellers that really the best time to address these things is behind closed doors, that the worst time to address them is in the middle of a negotiation with a potential buyer.
So dealing with the people issues and all the cultural issues and all the rest really is important because it’s very, very easy to send out, even inadvertently, the sort of signal that can create difficulties. I’m sure that people around the table here have numerous examples of working with different countries and in different time zones where even a throw-away comment can just get out of control. When you’re dealing cross-culturally it really is important to think and be sensitive and communicate openly on day one.
Moderator: What does a company need to do to stay focused in the midst of divestiture?
Jefferey Weirens: One of the best things that an organization can do, both in terms of the selling entity as well as the spin Co. entity, is they need to continue executing on their day to day business plans. That’s a little counterintuitive because you asked about the separation and what I’m talking about is focusing on achieving their ongoing operating commitments. So what that means is if that’s the end goal, because they’re not in business to separate; they’re in business to achieve their commitments to Wall Street, to their customers, to their suppliers, to their employees. The best thing that they can do is have 80-plus percent of their people in their organization more focused on the day to day business operations.
So what that means by reverse logic is you would have a small senior focused dedicated team on the task of separation. And that way what you have is the majority of the organizations being stable and focused on the market and business operations and that small dedicated team on a very focused effort on actually separating the businesses, helping ensure that they’ll have a seamless day one as well as our position for success post close.
Marco Sguazzin: So the small executive team that Jeff is talking about, there is more often than not a very centrally led team working from one plan with one set of integrated milestones and regular review dates. And it’s important in the unbundling of any process or of all of your processes to address the interdependencies and that everybody arrive at day one together in an integrated fashion so that the processes don’t break.
Will Frame: I would just add timing is critical. In all of these processes there’s a lot going on and it’s important to make sure that the timing is choreographed so that it all happens together and you don’t get stuck with a 90 percent done and 10 percent of the activities dragging on. You need to have a clear end date and a clear start date and hopefully make the period between A and B as short as possible.
Moderator: You mentioned TSAs. Companies often rely on transition service agreements to continue services between the parent company and the spin-off on a temporary basis. What are the advantages of these TSAs? Do you see any drawbacks to such agreements?
Marco Sguazzin: I think the big advantage really is one of timing, and using a transition service agreement really enables you to take some of the longer lead time items off the critical path and onto a different kind of time schedule where you’ve got up to two years to execute on some of those. So we spoke about the example of separating IT systems and that can often take up to two years in order to do that.
Other examples might be the separation of your physical supply chain or the set-up of new supplier relationships, even down to sometimes the moving of corporate headquarters and real estate can sometimes take quite a while to do and TSAs are a very useful tactic in taking those items off the critical path and not holding up the divestiture because of that.
From a drawback perspective, of course, the provider of that service, most often being the parent company, is not really in the outsourcing business. So they’re not geared to provide the service to you and continually enhance it and maintain it and upgrade it and deal with all the change requests that come in. They’re just simply not in the outsourcing business.
So you can expect that with any TSA service you won’t really receive the level of service that you need and, in fact, it’ll deteriorate as time goes on.
Jefferey Weirens: Building on Marco’s points, a couple of thoughts. One is, my clients tend to view these TSAs as necessary evils. So recognizing that the service over time deteriorates, it tends to be a high cost option, although a very important option from a business continuity perspective, high cost nonetheless.
For example, one of my clients, on an annual run rate basis the TSAs were approximately $100 million. By very rigorously looking at how to prioritize the services that were being provided, what ones were the long poles in the tent, what could they accelerate and looking at all the interdependencies across those over the course of one year, they actually saved $28 million by early exiting the TSAs. So not an insignificant amount of change coming back into their pockets from a cost avoidance perspective and from the seller’s perspective they were actually happy that the carved-out entity was able to exit earlier because that just meant that they were able to then pursue their business strategy that much quicker.
Will Frame: Transaction service agreements can be very efficient in terms of making a transaction happen and although uncertain, no contentious matters to be dealt with in an orderly fashion post close. The devil is in the detail, however, and it’s important to bear a couple of things in mind.
Firstly, the principle of a TSA is that it’s not about a value transfer. It’s typically about an efficiency and allowing processes and the business to continue to be run efficiently for a fairly short period post close. I’ve seen a couple of occasions where very contentious negotiations ended up occurring around the TSA agreements to the extent where I’m sure that the cost of the various attorneys in the room exceeded the value that was being discussed any point in time. Hundreds of dollars among company car allowances really do not need ten M&A lawyers to negotiate the finer points. This is all about the principle of it being a no win/no lose from a value perspective.
The pitfall on a TSA is that the carryover from the M&A discussion continues and that either side starts to see it as a value transfer opportunity to win or lose, frankly. I think taking the winning or losing off the table and looking at it as a, how can we efficiently move forward together, is the way that you get to the right answer on a TSA.
Moderator: The interest of the parent company and the spin-off are usually quite different. Could you tell us how the priorities of the parent and spin-off diverge?
Will Frame: Very, very, very simply. The seller wants to get as much value as possible for the assets that are being sold and the buyer wants to get the assets, presumably, and pay as little as they have to. That’s the principle behind every M&A transaction really. I think what we’ve talked about today and what Jeff and Marco can elaborate in more detail, is that if you set up the right frame work for a divestiture there really is the possibility and the likelihood that both sides will win and both sides will get the value they want.
Marco Sguazzin: Nevertheless, I think that there are some priorities and interests that do diverge still. If you look at the life cycle of a divestiture from deal announcement to day one – deal announcement you’re really one integrated business, more often than not with shared objectives and a very collegial behavior towards each other. And as you work through the divestiture planning process you start to forge different business strategies and different business plans and you may name employees either to the spin Co. or to the parent company, and people start to act in their own self interest or at least in the interest of the company in which they’re representing. So as those different business plans and business strategies get built you will find that the people start to line up behind those and ultimately the interests diverge to the point where by day one really both companies are in a position to execute on completely separate business plans.
Jefferey Weirens: From a parent company perspective, since they’re many times providing ongoing transition services, that’s embedded in their cost structure, and as those transition services are exited that leaves the potential for a stranded cost problem for the parent company. So one of the challenges that the parent company has is, many times, the executives believe, well, they’ve closed the transaction, they’re done with that spin Co. entity. Whereas a fair number of people in the organization are still day to day working with and supporting that spun entity. The diverging agenda piece happens whereas those day to day employees are getting a lot of pressure from their executive team to get focused on different initiatives within the parent company and they just, frankly, don’t have the time. So there’s this competing agenda for time within the parent company still, as well as needing to deal with these stranded cost problem so there isn’t an exploding G and A [general and administrative] cost issue one quarter post close because there’s still a set of costs that are stuck and embedded in the parent company’s books.
Will Frame: At the end of the day often times the reason for the divestiture in the first place is that the underlying businesses are going in different directions, whether it’s markets or capital or shareholder requirements, but there’s a sense that the businesses are going in different directions. And there’s an evolution toward the businesses being entirely separate and in the period between typically announcement and six months post close that there’s a lot of real nitty-gritty items to be worked through where people can have different interests. There’s a lot of clarity and consistency and communication to management to make sure that everyone is onboard and knows what direction they’re going in is absolutely critical in getting the whole thing done.
Jefferey Weirens: One example would be with one company where they spun off a business and it was sold to, quite frankly, a competitor. They were exiting that line of business. It was sold to a competitor and now you had a situation where the parent company was providing services to their competitor in a number of markets around the world. So that led to a number of constraints and concerns on all the different parties involved and clearly their agendas were aligned much differently, especially as they went to go to market and compete with one another. And that went everywhere from pricing information and go to market strategies all the way through to supplier information and supplier contracts, and ultimately, even into the data systems where you’re looking at customer master data that was being shared between these entities and needing to put in the appropriate firewalls and limitations around access to that data. So the agendas among the different parties can really start to get convoluted and very complex over time.
Will Frame: Absolutely. Another, a very sensitive example that we worked through not so long ago was a group at the parent company, who are absolutely critical to making sure the transaction happened efficiently, but as soon as the transaction happened or 60 days thereafter that same group really had no role at head office. So this was a clear case of mixed agendas where these individuals were being asked to work extraordinarily long hours and demonstrate real commitment but at the same time they didn’t have to be rocket scientists to see that pretty soon after the close their role would be either reduced substantially or would disappear.
We had a long discussion with our client in this case and they put together a series of offers, if you will, up front where they had early discussions with this group and there was a combination of exit packages and relocation for various individuals, such that they were all comfortable and they knew up front where they were going and they were rewarded for their commitment and they could seen an end that worked for both the team, the parent company and the individuals themselves. That type of real detailed thinking is, almost on a ground level sometimes, is really important to getting the whole spin-off and divestiture on the road successfully.
Moderator: Could you talk about the interests of other stakeholders in a divestiture besides the parent and spin-off? Put another way, what constitutes a successful divestiture for all concerned parties?
Jefferey Weirens: So we started the discussion around shareholder value and now we’re ending it around stakeholder value. What my clients look to is, at the end of the day did they have a seamless customer experience? Were they able to take orders? Were they able to ship product? Were they able to not lose a single customer through the transaction?
The other stakeholder group that they tend to look at is employees. Were employees able to be paid? Were they able to gain access to the facility? Were they able to access the computer systems and e-mail to do their day to day jobs? So those two constitute groups from a no negative impact on employees and on customers tend to be some true north guiding principles that my clients look at.
Marco Sguazzin: Those are pretty important from an operational perspective. I might add that the other set of stakeholders here is, in fact, the shareholders themselves. In that instance they might be looking at the spin-off company and looking at the business strategy. Do we have an articulate business strategy that works for this company in this market? And that becomes evident pretty often, the proof of the pudding is in market performance and they’ll be looking for an uptake in market performance immediately following a divestiture.
Will Frame: Another stakeholder and pretty important stakeholder and shareholder in this whole debate is the selling company, the owner. And often imes there’s more value to the selling company to – as soon as the divestiture is announced to executing their transaction and moving on with their new strategy, communicating that strategy to their customers, their shareholders, their employees and every other stakeholder that’s involved. And making sure there’s a clean exit and no lingering doubts, value transfers or any other issues and both sides can move on happily towards independence, is often critical to getting both sides fully onboard to moving forward as independent entities without any distractions through to the spin-out and fully focused on businesses is key to all shareholders on both sides of the transaction.
Moderator: Thanks for joining us today on Deloitte Insights.
Jefferey Weirens: Thank you. It was a pleasure.
Marco Sguazzin: Always a pleasure talking with you.
Will Frame: Absolutely. Thank you.
Moderator: Visit Deloitte.com to find Seven Secrets of Highly Successful Divestitures, which served as the basis for today’s discussion, as well as articles, newsletters and other information of interest.
You’ve been listening to Deloitte LLP’s production of Deloitte Insights, the program that looks at today’s important business issues. We want to hear from you. Contact us with your feedback or suggestions for future podcast topics and find Deloitte Insights at Deloitte.com/US/podcasts.
This has been a production of Deloitte LLP. Thanks for listening and bye for now.
