Is Now the Time to Consider a Carve-Out?
Levi Preston consults with many middle-market companies as a principal with Riveron Consulting. He is a CPA who received his M.A. and B.B.A in accounting from the University of Texas.
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The current volatile markets are challenging CFOs to craft strategies during 2016 that will improve balance sheet health and deliver shareholder value even in an uncertain operating environment.
The number of initial public offerings filed in the United States through mid-March is only half the total for the same period a year ago, according to IPO Monitor. Apparently, the “go public” option lacks appeal for many companies. So, this may be the year CFOs might want to renew consideration of carve-outs.
For purposes of this article, a carve-out is a corporate reorganization that creates a new subsidiary where one did not exist, intentionally structuring it to function as a self-operating entity. The parent company may create the subsidiary with intent to sell it or retain an equity stake and management control. A carve-out also can be a pathway to pursuing an IPO for the new entity by issuing shares in it to current or new investors.
Importantly, carve-outs offer CFOs a promising way to maximize shareholder value and show investors they have a clear strategy to strengthen the balance sheet while achieving operating efficiencies.
Identifying the Best Candidates
If you’re a CFO who wants to assess the viability of a carve-out strategy, start by identifying the best candidates. Optimal carve-out candidates often fall into one of two categories:
Market Share Candidate: If an asset or business line of a consolidated entity has a large share of its targeted market but is a relatively small (less than 10%) piece of the parent company, it can be an attractive target for a carve-out. Pursuing this type of candidate likely would create minimal ripple effects for the consolidated entity.
Non-core Subsidiary: In many mergers, acquisitions, or other business combinations, the final consolidated entity will have absorbed one or more locations or business lines that don’t fit with its long-term strategy. These are ideal carve-out candidates within the first 12 months after the transaction.
Non-core assets and lines of business may also emerge without the catalyst of a business combination. The non-core assets may be performing poorly or not be aligned with management’s vision for the future. In these cases, carve-outs present a source of liquidity while making the parent a more cohesive entity.
Evaluate Carve-out Complexity
Once you identify a candidate, it is important to perform an internal diagnostic to analyze the asset and determine the complexity of the carve-out.
In assessing complexity, a key question to consider is how autonomously the carve-out operates from people, processes, and systems perspectives. The degree of complexity relates directly to the cost of execution.
The more obvious costs to execute a carve-out include the expected deal preparation items, including sell-side document preparation, engaging outside counsel, new audit requirements, and data-room management.
Additional, valuable insights to inform your decision-making can be gathered by asking the following questions about complexity and cost.
- Is there already functional leadership in place, or will the carve-out require an interim management team?
- How reliant is the business line on a consolidated shared service center for back-office operations?
- Does the business line have sophisticated financial reporting resources to dedicate to the transaction that can move at deal speed?
- How many disparate systems warehouse the transactional data of the carve-out business?
- How comingled is the transactional data with that of other divisions that won’t be carved out?
- Does the carve-out candidate share customers and/or vendors with other divisions?
- How many legal entities house the material contracts of the carved-out entity?
- How many employees and executives will be severed from the parent entity?
- Are there international regulatory impacts that have not been previously considered?
- Does the carved-out entity have easily identifiable segments?
If the internal diagnostic determines that the benefit of pursuing a carve-out exceeds the associated costs, there are at least four traditional approaches to a successful exit.
The consolidated entity can: spin off the carved-out entity to current investors and maintain operating control; market it to competitors or private sponsors; prepare it for an initial public offering; or pursue those various options simultaneously to see which direction proves to be most compelling.
While these tracks share some common due diligence interests, the various exit options have differing needs for information that can be difficult to satisfy simultaneously. Pursuing multiple tracks requires a dedicated finance team that can respond quickly to a wide variety of questions and produce the necessary reporting documents at deal speed.
To ensure the deal remains on track, maintain a central conduit and consistent bridge among the multiple iterations of the information that potential buyers or investors will want to review (e.g., confidential information memorandums, pro forma results, audited historical financial statements, publicly filed management discussion and analysis).
Ultimately, you’ll go a long way toward ensuring a successful carve-out by proactively identifying the best candidate, evaluating the complexity, and thinking through exit considerations. This process could lead to a transaction that supports your company’s strategy while also offering liquidity through this alternative to an outright IPO or some other form of M&A.