Thanks to the recession, restructuring plans are nearly standard procedure for many public companies these days. Factor in private equity’s considerable stockpile of dry powder and conditions are ripe for a spike in corporate carve-outs by buyout shops.
The examples run the gamut from the dramatic makeover of an American icon like General Motors through a Chapter 11 bankruptcy process to tiny biotechs on their last legs offering up the rights to years of research in exchange for enough cash to turn the lights off in a dignified fashion. Indeed, each passing day adds to the list of potential carve-out targets for buyout shops. Among the most recent: Dallas-based Zix Corp., which said on June 11 it had hired Allen & Co. to review options for maximizing the value of its e-Prescribing drug prescription automation services business.
Frank Hayes, a partner at mid-market firm
And a broken balance sheet isn’t the only driver for public companies to do these deals. Ernst & Young, the global professional services giant, found 56 percent of respondents participating in its 2009 global divestiture survey said the most important factor in their decision to pursue a divestiture was increasing focus on their core business. The global survey polled 360 senior vice presidents and C-suite executives in December 2008, more than 75 percent of which worked at public companies.
Jeffrey Greene, who works in Ernst & Young’s transaction advisory services practice, said he expects to see a jump in the number of carve-outs in part because public companies are raising the bar on strategic fit. “Any activities that divert management’s attention away from the core business are going to get a hard look,” he said. Today’s higher capital costs are also a factor, he said, as well as a desire to shed non-performing assets to reduce the strain on shared resources, and to re-deploy funds to more profitable uses.
Early June saw an LBO-backed transaction of this ilk when Kroll Inc., a unit of publicly-traded Marsh & McLennan Cos., completed the sale of its U.S. government security clearance screening business to
Ernst & Young’s Greene said that buyout shops evaluating carve-outs need to think hard about being able to reproduce what the parent company is providing the division or subsidiary. Most divestitures do include some sort of transition service agreement, or TSA, wherein the parent company continues to provide support for the divested business, typically for six to eighteen months. Beyond that, the big question to ask is how will removing the infrastructure and influence of the parent company impact the divested business’s bottom line. “You really need to build a stand-alone operating model,” Greene explained.
Greene also stressed the importance of getting clarity on exactly what is being sold. For example, many businesses within a large corporation are supported by employees who spend only a portion of their time on that particular business. How is that labor going to be accounted for in terms of both costs and execution going forward? The same situation can crop up with other elements of the business being carved out, such as physical assets, systems and contracts. All these questions require well-defined answers, Greene said.
One trend Greene has been seeing in the United States is for sellers to use third-party advisors to provide detailed due diligence on the assets being shopped. This is typical for carve-outs in Europe, he said, and it’s becoming more common here. This vendor due diligence is conceived as a protection for the seller, which is looking to anticipate and address issues bidders could raise. The reports can also be helpful to potential buyers, since they are designed to give an objective perspective on the strengths and weaknesses of the business.