What's driving levels of non-core disposals and carve-out transactions in the UK
2021 saw record levels of non-core disposal and carve-out transactions from UK public companies. Ollie Chambers looks at what is driving this and the key preparation points in preparing to sell a business unit.
Divestments have long been used by UK corporates as a means to realise value from operations that are no longer seen as strategic priorities and re-allocate resources to areas of focus within the business. During times of economic volatility and turbulence, M&A activity in this space is typically accelerated as companies seek to streamline their operations, bolster liquidity and strengthen the balance sheet to service existing debt obligations. The COVID-19 pandemic proved to be no different in this regard with the value of UK carve out transactions during the fiscal year ended 4th April 2021 exceeding £30.8bn, a 182% increase on the prior year.
As the economic recovery and transition into a post-COVID world continues, the volume of these transactions will remain high during 2022. With the considerable impacts felt by the pandemic fresh in the minds of business leaders, continued emphasis will be placed on reviewing the strategic direction of travel and streamlining the operational profile of companies. Companies looking to supercharge their recovery and growth prospects for the coming financial year will seek targeted acquisitions across core sectors. Rising interest rates will only make non-core disposals more appealing as a source of funds for such initiatives.
The rise of private equity carve-out funds
Historically private equity houses have struggled to compete when looking at the often-complex assets corporates wish to sell but a new wave of carve-out focused institutional money has changed this. Indeed, the number of private equity backed carve-out deals in the UK rose by 27% to 14 in 2021 up from 11 the previous year, and 6 in 2019. This trend is indicative of the increasing comfort corporate sellers have in private equity being able to close complex deals.
Against the backdrop of an increasingly active and robust regulatory framework, private equity acquirers can deliver attractive solutions that provide sellers with surety of both transaction timeline and execution. Indeed, their ability to deploy capital quickly without the cumbersome approval ladders associated with some corporate decision-making can be a differentiator in a competitive process. Private equity houses are typically also much happier to accept vendor diligence reports and other Seller-friendly processes such as use of locked box completion mechanisms.
In the absence of any material commercial sensitivities, antitrust legislation is unlikely to apply which removes a degree of complexity around both information provision during the transaction process and the mechanics of exchange and completion. An increasingly muscular CMA in the UK means this is a very serious advantage.
None the less, the right strategic acquirer should be able to deliver a premium valuation compared to private equity, reflecting the strategic upside available to them and their ability to access cost synergies on incorporation of the target asset. Furthermore, often the existing operational infrastructure of strategic acquirers will enable them to transition the target off of the sellers’ systems and services in a shorter timeframe than private equity companies. This can result in the seller negotiating shorter timeframes for transitional service agreements and ultimately achieve a cleaner exit.
Set against the benefits of premium valuations and streamlined separation arrangements, strategic acquirers do pose a number of challenges to carve-out transactions. From both a purely commercial and a legal standpoint (application of antitrust legislation), the provision of commercially sensitive information to competitors must be managed carefully, with the most sensitive information typically redacted or withheld until the latter stages of negotiations. Whilst the use of clean teams can somewhat circumnavigate this issue, it also brings additional complexity to the process which can place further strain on already stretched management teams.
On the execution side, with the Competition and Markets Authority increasingly active in reviewing proposed transactions, consideration must be given as to the viability of certain acquirers relatively early in a transaction process to mitigate the risk of a blocked deal or worse, the reopening of a completed deal for review.
Keys to successful divestments
With the significant amount of complexity associated with carve-outs, a well-structured and comprehensive period of preparation is fundamental to the success of a transaction. For the seller to secure the cleanest possible exit and minimise any disruption for the retained group, it is important to identify any areas of particular concern well in advance to afford acquirers sufficient time to get comfortable with the proposed arrangements. Focus on the following to position yourself to be successful:
- Clear identification and agreement of what is being sold and what is being retained by the seller at the outset is important so diligence can be appropriately scoped and separation considerations accurately identified. In addition to the legal entities being disposed of, key areas to consider include fixed assets, intellectual property, employees, supplier and customer contracts, pension arrangements and more.
- Developing a robust standalone financial profile of the target as early as possible in the process gives clarity for both valuation purposes and articulating the growth story for the potential acquirers. With the increasing prevalence of private equity acquirers, incorporating this exercise into a formal vendor due diligence exercise is recommended to give acquirers comfort that they can rely on the financials presented.
- Sitting alongside standalone financials, the seller should prepare a detailed blueprint that clearly sets out the key separation considerations, actions required to address them and any associated financial impact. Increasingly sellers are looking to third parties to prepare detailed summaries of separation considerations to give acquirers further comfort that all matters have been identified and addressed.
Intercompany Balances / Transactions
- A clear, detailed steps plan to settle any intercompany balances owed to/from the target at completion should be prepared to identify any areas of concern from a tax perspective as early as possible.
- Detailed schedules of any intercompany services between the target and other entities outside of the transaction perimeter should be prepared to support the separation plan.
- Early involvement of technology focused personnel to assist with the design and implementation of the separation plan for IT systems is crucial. Untangling highly integrated, often fairly antiquated IT systems from the wider group can be a very time consuming and costly exercise and acquirers will place a great deal of emphasis on agreeing a transition plan.