Carve-outs – Active portfolio management through the demerger of a business division
Types of demergers
The basic form of a carve-out
In the context of a corporate transaction, a carve-out is concerned with demerging from the group a subsidiary company or non-autonomous parts of a business. In the course of this, individual divisions, business units or lines are separated. In the case of divestitures, where individual business units are separated out from the parent company in order to make them independent, essentially, a methodological distinction has to be made between (equity) carve-outs and spin-offs.
As part of a spin-off, the parent company proportionately distributes shares in the hived-off subsidiary company (‘pro rata’) to its current shareholders in the form of a special dividend. The existing shareholders benefit because, after the demerger, they hold shares in two separate companies.
The stock market listing of Siemens Energy AG, as the biggest spin-off on the German market to-date, has shown that the IPO of a subsidiary company can be used as an effective value-based management instrument for both the group parent company as well as for the divested business.
The example of Siemens Energy – In the case of this spin-off, each Siemens shareholder received one Siemens Energy AG share for every two Siemens shares. After the spin-off, the Siemens AG share price remained largely steady at around €108 and, by 11.3.2021, it had climbed to €136.24. Siemens Energy AG shares closed at €21.21 on their first trading day. The market capitalisation of the company thus totalled €15bn. By 11.3.2021, the share price of Siemens Energy AG had climbed to €32.
The term ‘equity carve-out’, in the literature, is used in some cases as a synonym for the term ‘spin-off’. However, a clear distinction should be made between these methods because, unlike an equity carve-out, in a spin-off no additional capital accrues to the parent company.
In an equity carve-out, less than 50% of the shares of a subsidiary company are floated on the stock market. After the stock market flotation, the majority of the voting share capital is still held by the parent company. Consequently, the subsidiary company is still controlled and consolidated by the parent company. In the future, however, the parent company will not provide further equity, instead, the subsidiary company can raise capital on the stock market.
Carrying out a carve-out transaction
For everyone involved, the challenges increase according to the size and complexity of the carve-out and the potential group of buyers or investors. A lead time of up to 12 months or even 18 months is not uncommon here. In the context of a carve-out, the challenges and milestones listed below, in particular, need to be successfully met.
- Early identification of the operational complexity and ensuring operational performance prior to, during and after the carve-out.
- Optimisation of the new company structural set-up for tax purposes.
- Delineation of the relevant assets and liabilities.
- Implementation of a coherent reporting system due to the lack of historic financial data; this entails, in particular, providing carve-out financials and fact books for a, potential, subsequent IPO including roadshows.
- Continuous coordination with the buyer (from an anti-trust perspective between the signing and the closing).
In order to make it possible for a structured and smooth process to be set up and supported for the carve-out, normally, an external consultant facilitates the (content-related) separation of the unit that is to be hived off or divested – the so-called ring-fencing. In this respect, the main point is to define the business scope as well as to schedule the timing for the individual steps of the separation process. In the course of this, normally, advice will also be provided on the implementation and supervision of a cross-border project management office (PMO).
In view of the very high degree of integration, previously, both at the organisational level as well as with respect to financial reporting, generally, there are no financial indicators from the past for the business unit that is to be hived off. Besides delineating the relevant assets and liabilities, this is also a matter of identifying the nature and extent of the integration with the group. In the context of developing a coherent reporting system, there is a need for support, in particular, with the drawing up of the so-called carve-out financials on the basis of which it is possible to calculate not only the internal KPIs but also the ‘stand-alone value’ of the (transaction) object. This is necessary, especially with regard to company valuations as well as determining the purchase price and, potentially, complex (re)negotiations with the purchaser.
Following on from the operational, cross-divisional activities in all phases of the carve-out process, furthermore, preparing and ensuring so-called ‘Day-1 Readiness’ needs to be a working premise for (among other things) successful post-merger integration.
In view of the hitherto close integration with the group, during the period of transition to systemic and operational autonomy of the division that is to be hived off, generally, the parent company still has to provide support. The primary objective here is the so-called ‘business continuity’ so that it can be ensured that the business operations can continue running.
It can be observed that, particularly for companies where it can be demonstrated that there is a greater difference between the enterprise value and the market capitalisation, in practice, portfolio management is enhanced. In a tense economic climate, divestitures can make it possible not only to generate fresh liquid funds but also to bring about a strategic reorientation of a business.
Pertinent practical experience demonstrates that equity carve-outs and spin-offs are very appropriate instruments that can be used to revitalise business divisions; their particular achievement is to reflect the ceaseless dynamics of a complex environment.
Recommendation: For carve-out transactions of different magnitudes and in various industries, we would recommend comprehensive consulting that covers the development of a concept through to the actual demerger. PKF can advise on and provide support for ensuring that all the relevant activities are transferred as well as assume the operational accounting functions on an interim basis.