Lessons Learned: Unlocking Value with Carve-outs and Divestitures
The whole is not always greater than the sum of its parts. In some companies, huge value can be unlocked by carving out a segment of the business as a separate entity, and then taking that entity to the capital markets. Much has been written about mergers and integration, but substantially less on carve-outs and divestitures. Carve-outs and divestitures are not the flip side of mergers and acquisitions (M&A). They pose a different set of challenges, require a distinct approach, and create unique risks.
Consider the following case study:
A large government contractor had grown by acquisition, strategically adding a combination of service offerings and contracts that at first seemed diverse and unrelated. As markets shifted and the business grew, the new offerings began to form a cohesive solution that came into high demand from the largest client in the world: the U.S. federal government. The company recognized the intrinsic value of this component of its business, and looked for a way to package the offering into a separate entity that could drive outside investment or be sold for significant profit.
To achieve this goal, the company needed to effectively “IPO” a section of its business. As with any significant transaction, the company expected rigorous audit review, and needed to capture and report accurately on the ledgers and accounts supporting this piece of the business. The difficulty was in allocating specific components of the company’s overall financials to the carve-out entity. Too much allocation would burden the entity with a cost structure that would make it unattractive to outside investors. Too little would not accurately capture the true cost of running the entity.
Audit support, reconciliations, and accounting treatments needed to be developed. Outside investors were anxious to see the details of the potential offering. Speed was critical. Confidentiality was paramount.
One fundamental challenge the company faced was that its full workforce was not available to support the effort. For a public company involved in carve-out activities, confidentiality is an absolute requirement—both to protect the potential investor marketplace and to manage employee risks that could be created by a potential transaction. As with any transaction, a carve-out may not always reach completion. In this case, creating unnecessary fear and uncertainty could hurt the business more than a potential transaction could help it.
In this example, a very small group of key financial and business stakeholders was aware of the carve-out activity. The project was code-named, and documents and files were collected and added to a data room maintained outside the company. External advisors were brought in to supplement internal staff and to help prepare the reconciliations and support for pro forma financials being created in relation to the carve-out entity. The company’s auditors were careful to avoid conflict of interest concerns, both for the carved-out entity and the parent. Coupled with the need to maintain confidentiality, the field of available resources for the project was small.
Supporting IT systems, contracts, and financial reports had to be tweaked in order to group and segregate important data reported to the carve-out entity. Much of this work had to be completed outside the corporate systems and around daily tasks that needed to continue to function as configured to support the parent’s operations. Tactical data solutions and reporting tools were utilized to facilitate this effort. Scanning and coding systems were used to control document flow, create workflows for approval and pre-audit review of vital information, and organize data for external review. The effort was complicated by the fact that the parent company’s growth through acquisition had left in place several legacy point systems and solutions that needed to be collapsed or consolidated for effective reporting.
What was the outcome of these coordinated efforts? The company was able to provide audit-ready information to potential outside investors in less than six months. Compared to IPO readiness calendars, which typically span 18 months or more, this effort was extremely fast. Success factors included dedicating a small core group of resources, removing most of their daily operational responsibilities so they could focus on this activity, and encouraging constant communications within the group to ensure no ground was lost. Also critical was the effective use of external resources to complete crucial tasks. Finally, a collaborative relationship between all advisors—from audit to business stakeholders—was integral to driving success.
In the M&A world, attention is paid to alignment of sales strategy, consolidation of products, cost savings that can be achieved through consolidation, and growth forecasts for future operations. In the carve-out world, however, priority is given to documenting the true financial position of a subset of the parent company, as well as compiling key data into an investment prospectus. Investor gains and profits are the goal in both worlds, but the roads to attaining that goal differ greatly.
Dee Mirando-Gould serves as Director in MorganFranklin’s Financial Management and Performance Improvement practice. She has 20 years of experience in accounting and auditing, including extensive expertise in public company reporting such as initial and secondary equity and debt offerings, annual and quarterly reporting, and internal controls over financial reporting. She specializes in complex technical accounting and reporting issues, and previously served as Associate Chief Auditor with the PCAOB. Learn more at www.morganfranklin.com.
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