- EY’s annual divestment report shows 84% of surveyed execs plan to prune groups that underperform or don’t align strategically
- That record level of divestiture activity may increase M&A action in 2020 and beyond
- PE firms are playing an outsize role as they look to bolster their portfolios; CFOs must be ready to respond to offers that may be too good to refuse
The rate at which companies are seeking to shed misaligned or underperforming divisions, sell prime properties to raise capital or prune down to gain regulatory approval for acquisitions has surged since 2018 — despite geopolitical factors that would historically drive more of a “stand pat” mindset.
Ernst & Young’s latest Global Corporate Divestment Study shows 84% of companies intend to sell lines of business in the next two years. That’s nearly double the 43% of executives surveyed by EY for its 2017 report who said their firms were planning divestitures.
These latest findings are based on 1,030 interviews, primarily with C-suite executives but also repping 100 private equity fund managers.
What’s fueling this Marie Kondo mindset? A majority, 81%, are looking to simplify operating models so they can focus on growth. Sixty percent said they plan to re-invest the proceeds of their divestments into new products or geographic markets. And 63% are playing catch-up, saying they held on for too long to businesses they recently sold off, or plan to.
“Companies are clearly looking at their portfolios and looking at pieces that they can divest,” said William Casey, vice chair of EY’s Transaction Advisory Services , during a panel discussion at the annual Corporate Development Conference in New York City. “And I think where a lot of that [capital] redeployment is probably going is to innovation, as well as doubling down on some of the core businesses.”
As we previously reported, the Conference Board event largely focused on the outlook for M&A activity. However, where there are buyers, there must also be sellers.
On the “buy” side, private equity is playing a key role. After all, fund managers are sitting on piles of cash that they are hankering to put to work.
“There is an incredible amount of pressure on the PE funds to invest all the capital — there is almost a half-trillion dollars of money sitting on the sidelines,” Casey said.
Activity isn’t concentrated in any one industry sector, either. Among notable recent moves, Pfizer announced plans to spin off its Upjohn patent drug business, which it acquired in 2002 for $60 billion, for just $12 billion to make room for its acquisition of biotech provider Mylen; eBay is selling off Stubhub to smaller rival Viagogo for $4 billion; and Hudson Bay recently sold its marque retail property, Lord & Taylor, to Le Tote for $100 million.
M&A executives from companies including Caterpillar, Medtronic, Siemens and Wolters Kluwer speaking at the conference advise finance chiefs at all size companies to regularly review their portfolios to see if there’s any dead wood, or shoots that while healthy, don’t fully support the business’ growth strategy.
“There are lots and lots of cases where small organizations have successfully sold off units,” says Marty Wolf, president of martinwolf M&A Advisors and a Brainyard contributor. “The dilemma is, as Clint Eastwood says in the movie Dirty Harry, ‘Do you feel lucky, punk?’ If you have a small, fast-growing, desirable asset embedded in a slower-moving, less-valuable, larger business, do you sell the winner and reinvest in lower valuations? Or do you sell the more-valuable but slower-growing asset?”
You’re taking a chance either way. Wolf says the key is what drives your company’s decision-makers.
“We’ve seen both – and both can work,” he says. “Taxes too are an issue. At the end of the day, it comes down to the expertise of the management team.”
In annual portfolio reviews at Wolters Kluwer, a software and services provider with four divisions focused on different industry segments, leaders look at several angles, said SVP and head of M&A Elizabeth Satin.
“All of our divisions are charged with looking at their portfolios and figuring out what might not fit from a strategic perspective, and what is potentially underperforming from a financial perspective,” Satin said. “Those two things don’t always align.”
The company also considers whether a division is demanding an inordinate amount of attention.
“We’re reluctant sellers,” she said. “Our CEO says that ‘you can’t shrink yourself to greatness.’ It really is only after figuring out that [a particular business] is just either taking too much management time, and it’s really taking time away from us growing at a much faster rate — those are the kinds of things that we consider.”
Companies are also more willing to carve out business units after completing a large acquisition, even if a given group is profitable and aligned. Often, the reason is acceptable margins — or lack thereof.
That was the case after medical equipment provider Medtronic’s $43 billion acquisition of rival Covidien in 2015. A year after the deal closed, Medtronic leadership determined that while Covidien’s core businesses were complementary, its patient care unit that distributes consumable goods, such as syringes, to hospitals operated with much tighter 5% margins than the 25% Medtronic was accustomed to.
Similar to Wolters Kluwer, Medtronic is a reluctant seller, said Chris Cleary, Medtronic’s VP of corporate development.
“I think a lot of people do portfolio management but don’t ultimately pull the trigger,” Cleary said. “If you’re a public company, you’re going to have to wade through whether or not you think you’ll get multiple expansion on a reduced pool of earnings so that your share price won’t go down by virtue of having sold off earnings but not redeployed it.”
Medtronic eventually sold the 11,000-employee Covidien medical supplies division to health care services company Cardinal Health for $6.1 billion .
Spin or Sell?
Once they resolve to pull the trigger, divesting companies need to determine whether to spin off a group or sell it outright. When choosing the latter, you’ll find two pools of potential acquirers: strategic buyers and private equity firms. Opinions vary as to which is more likely to pay a higher premium, but private equity firms typically require ongoing involvement from the seller in areas ranging from data generation to executive retention.
“If we’re preparing for a private equity buyer, especially because of the nature of the businesses and what we're selling them, it will often require us to have a long-term relationship with the buyer,” said David Martin, head of strategy, corporate development and venture capital at Caterpillar.
Siemens, which in May disclosed plans to spin off its $34 billion power and gas unit, vets private equity firms differently as well, said Jelena Guzenko, the company’s director of M&A.
“We have to make sure that the property we are selling our company to is in good standing financially from a compliance perspective, and we want to know what's going to happen to our employees and whether or not customers will be receiving [adequate] treatment,” Guzenko said. “We really consider different bids and the quality of the overall bids and the structures before we decide to pursue one bid versus another.”
For CFOs of growing firms, takeaways from the report include always being ready to tell the “value story” of your business units and reining in potentially unreasonable expectations of how a unit can operate outside the larger company.
For the former, Wolf advises CFOs to actively monitor public companies that look like theirs — including keeping an eye on their business units and non-core assets.
“It’s imperative to understand the valuation metrics of various business models,” says Wolf, whose company focuses on, and offers intelligence on margins, growth and multiples in , IT sector verticals including services, supply chain and software/SaaS. “Different subsets of companies trade at different multiples. CFOs should similarly put assets in buckets and look at them accordingly.”
In addition, for carve outs, EY recommends having in place a stand-alone operating model, where, for example, a unit’s key facilities and tax liability are contained in one jurisdiction. Forty-three percent of survey respondents said understanding tax impact was a major challenge in shaping deals.
Wolf says that as businesses grow, the most relevant structural element when it comes time to divest assets is alignment — among the management team, the board and, if the company is public, its investing community.
Alignment is also a matter of executive salaries.
“Frequently, the problem is in compensation,” says Wolf. “If you get paid based on a $100-million business and want to sell the non-core asset that’s worth $30 million, compensation will not be the same as it was on the $100 million. There are different growth rates, different margins.”
Wolf advises CFOs to be choosy — if a business unit has enough scale and a sexy product, in almost every case, there will be a second, perhaps better, buyer.
“It’s very rare that CFOs do not inherently understand which part of the business is a non-core asset,” he says. “The question is, how do they go about disposing of it?”
As we discussed previously, CFOs should always have a ballpark idea of the market worth of the business as a whole as well as individual units assets lest they end up under-valued. Here’s how to set a price.
EY agrees, saying that 39% of sellers in its survey used divestment analytics tools to map assets and model factors like churn and pricing trends when negotiating with buyers. More than half said they should have taken this step.
“For example, I recently spoke with a client whose business trades at 10x EBITDA,” says Wolf. “The company has units in business intelligence and artificial intelligence, and those businesses trade between 10x and 30x revenue. If you have a services organization that trades at multiples of EBIT, and combine that with a nascent technology such as AI/BI that trades on multiples of revenue, the combined company will trade at multiples of EBIT.”
So are we entering a seller’s market for desirable spinoffs?
In our new Brainyard Winter 2020 survey, which will be available soon, 29% of 370 respondents said their companies would acquire versus 22% saying they expect to or are now preparing to be acquired, a seven-point gap. Those planning acquisitions disproportionately expect a good year and strong economy, and they’re planning larger-than-average spending increases across the board.
Jeff Schwartz is Brainyard editor-at-large, covering technology and trends across different industry sectors. He has covered all aspects of technology and its impact on business for three decades as an editor and writer for a wide range of publications. Currently he’s a freelance writer. In addition to Brainyard, he contributes to Channel Futures and SD Times, among others.