Strategy and tools to accelerate divestitures

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Strategy and tools to accelerate divestitures

Live webcast discussionJuly 15, 2020

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Today’s speakers


Doug Cogen

Co-Chair

Mergers & Acquisitions

Fenwick & West LLP

Bomi Lee

Partner

Corporate

Fenwick & West LLP

Adi Maheshwari

Partner

Strategy and Transactions

Ernst & Young LLP

Shari Yocum

Principal

People Advisory Services

Ernst & Young LLP

Manish Dabas

Principal


Ernst & Young LLP

Ora Grinberg

Associate

Tax

Fenwick & West LLP

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Disclaimer


This material has been prepared for general informational purposes only and is not intended to be relied upon as legal, accounting, tax or other professional advice. Please refer to your advisors for specific advice.

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Agenda

I. Welcome

II. Divesting through a downturn

III. Critical path activities, levers to accelerate the

divestiture timeline, key risks and considerations

IV. Closing and Q&A


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Recent economic uncertainties have offered an opportunity for companies to rethink traditional growth channels and shift their focus toward building resilience and driving long-term value …


… the most resilient and successful companies will be those that have shown discipline and an accelerated focus on portfoliotransformation.

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The EY Global Corporate Divestment Study reveals that divestment activity is poised for a sharp rebound as companies aim to rebalance portfolios


78%expect to divest within the

next two years; 57% within the next 12 months.

72%say they continue to hold

onto assets too long, up

from 63% in 2019.

65%say they will reshape their

portfolio to prepare for a post-crisis world.

67%plan to use divestment

proceeds to invest in their

core business.

Key considerations:

► Companies can benefit from taking bold action and exploring

avenues beyond traditional sales during the downturn to

boost longer-term total shareholder return (TSR).

► A more aggressive rebalancing of portfolios will help

companies free up capital to refocus on their core

business and fund technology in response to rapidly

changing customer demand.

► Emphasis on divestment preparation will be required to

preserve value in a downturn, with 73% of sellers reporting

they would only accept a 10% or less reduction in sales

price in the next 6 to 12 months.

► Companies may have only a short time to prepare for

what’s next on the activist agenda as recommendations for

carve-outs are on the horizon.

► By communicating to key stakeholders the path to long-term

value, companies can mitigate risk to hostile campaigns

and the heightened activist activity set to come in the next

12 months.

2020 corporate survey key findings

2020 activist survey key findings

96%will recommend carve-outs of

underperforming or non-core

businesses within 12 months.

76%say slowing growth and declines

in operating margins will

influence choice of new targets.

Page 7 Strategy and tools to accelerate divestitures

An accelerated divestiture approach can help organizations unlock value and create liquidity amid today’s challenges

► Rebalancing portfolios as a result of the

COVID-19 crisis1

► Continued activist pressure for more

corporate focus and simplicity2

► Advancement in technology that is lowering

barriers to entry and increasing the likelihood

of disruption3

► Rapidly changing customer demand

requiring increased investment in technology3

► Divest assets

► Shut down plants and furlough employees

► Scale back on CapEx maintenance and

investments

► Draw down or establish new credit facilities

► Cut costs through operational restructuring

► Scale back dividend and/or share

repurchases

► Sale-leaseback agreements

Challenges facing organizations today Key actions to address these challenges

Source: 2020 EY Global Corporate Divestment Study1 Sixty-five percent of executives are rebalancing portfolios as a result of the COVID-19 crisis.2 Ninety-six percent of activists shareholders recommend carve-outs of underperforming or non-core businesses.3 Fifty-two percent of companies say the need to fund new technology will make them more likely to divest.

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Companies that divested assets during the last economic recession generated excess shareholder returns compared to peers


9.3

8.58.0

7.77.4

7.6

7

8.08.2

8.3

9.1

10.0

10.8

11.0

10.8

10.6

9.8

8.8

8.1

6.66.5

7.27.6

8.99.3

9.6

9.09.0

10.0

1

12.0

11.0

11.010.6

11.011.2

12.1

11.411.0

10.2

10.710.3

10.2

6

7

8

9

10

11

12

13 Recession

While deal multiples were low, as there was considerable uncertainty in the market …

… companies that divested, using the downturn as a catalyst for change, saw their returns boosted.

Median deal multiples (2000 – Present)

Deal multiples greater than 30x and bid premium greater than 100%

have been excluded from the calculation of the median.

Included 354 companies with a market capitalization greater than US$1b located in

Europe and North America from the life sciences, consumer and industrials sectors

*Company TSR adjusted for currency and benchmarked against global sector indices to

calculate excess returns

63%

Divestorsn=266

Divestorsn=266

Non-divestorsn=88

Non-divestorsn=88

39%

Median TSR (2010‒18) for companies that made divestments in 2008‒10 vs. non-divestors

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A shifting activist agenda and recent economic conditions have increased demand for an accelerated divestiture timeline


Growing demand for an

accelerated time frame

2

13

1614 14

0

5

10

15

20

0-3 4-6 7-9 10-12 >12

DEA

L C

OU

NT

Deal duration: launch to closeSample: 59 carve-out sales

(2017‒19)

3% 22% 27% 24% 24%

Source: Analysis on EY Americas 2017 – 2019 carve-out sale closed transactions

Months

Median duration 9 months► Divestitures are complicated and can often

take nine or more months to complete.

► Pre-crisis, 36% of activists said the

expectation was that a divestment should

take place within six months.

► Today, 84% of activists expect a six month

divestiture timeline, with a focus on divesting

non-core and underperforming assets.

Companies must prepare for investor discussions that focus on how they are responding to the

crisis and proactively develop an approach to accelerate the deal timeline.

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Critical path activities across functions need to be understood and addressed to accelerate divestiture timelines and balance risks


Note: Illustrative and does not represent comprehensive activity set

Deal options and deal perimeter

Stand-alone, stranded cost analysis

Buyer due diligence

Obtain closing regulatory approvals

IT systems and infrastructure separation planning and execution

Day 1 readiness

Payroll and benefits setupEmployee transition strategy

Legal entity readiness

Dea

l p

rep

ara

tio

n

an

d f

inan

cia

ls

Financial results monitoring against forecast

Develop forecast and value drivers

Current state operating model Day 1 operating model

Separation planning and execution

Day 1 workarounds, TSA service delivery model development

Critical path activities

Le

ga

lT

ax

Sell-side financials

Accounts estimation and prep

Fin. statement alternatives

Data room population

Identify in-scope assets, liabilities, employees, etc.

Regulatory analysis

Negotiate definitive agreement

Determine optimal tax structure

Supplement and finalize TSA schedules

Contract separation and third-party consent

Prelim. purchase price allocation analysis Valuation analysis and prepare draft PPA

Transfer tax and other tax effect analysis

Post-close

Obtain remaining approvals

Wind down TSAs

Finalize PPA

Develop separation strategy

Sign to closeLaunch to sign

Op

era

tio

nal

rea

din

es

s

Page 11 Strategy and tools to accelerate divestitures

Critical path activitiesInterdependency

Levers to accelerate timelineOps Legal Tax

Consider deal options and define the deal perimeter early to avoid time consuming iterations.

✓ ✓

▪ Involve key decision-makers early to finalize and set deal perimeter▪ Select assets that are easy to carve-out and identify buyers with readily available

financing▪ Define the method of allocating resources to the deal perimeter early▪ Determine treatment of patents and other critical IP▪ Identify and assess treatment of shared assets, contracts and services early

Regulatory approvals can be time-consuming and complicated by seller and buyer industry dynamics.

✓▪ Selectively target a buyer pool that would limit antitrust concerns (e.g., due to

industry concentrations), work councils or other local jurisdiction concerns

Sell-side financials could be subject to time-intensive carve-out audit requirements.

✓

▪ Prioritize smaller, digestible assets to not trigger an audit; evaluate significant subsidiary test

▪ Prepare focused outside-in financials that support the value story around quality of earnings and key trends

Buyer due diligence requires significant time to understand business interdependencies, cost structure and allocations.

✓ ✓ ✓

▪ Invest time to detail out the operating model (shared vs. dedicated capabilities), cost allocations and a future state stand-alone cost model

▪ Consider reducing the pre-sign period by allowing post-sign flexibility, such as with a “grab bag” approach

Deal options and deal perimeter Regulatory analysis and approvals

Fin. statement alternatives

Dea

l p

rep

ara

tio

n

an

d f

inan

cia

ls

Critical path activities and levers to accelerate timelines and balance risks:deal preparation and financials

Critical path activities Note: Illustrative and does not represent comprehensive activity set

Post-closeSign to closeLaunch to sign

Buyer due diligenceSell-side financials

Stand-alone, stranded cost analysis Financial results monitoring against forecast

Develop forecast and value drivers Accounts estimation and prepData room population

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Critical path activities and levers to accelerate timelines and balance risks:operational readiness


Levers to accelerate timelineFin. Legal Tax

Employee transition can be delayed due to labor relations (e.g., European Works Councils) approval.

✓

▪ Initiate notice periods and negotiations as soon as possible▪ Utilize professional employer organizations (PEOs) or employee leasing

agreements to avoid delayed country closings ▪ Determine the stranded cost of severing in-scope employees not transferring to

buyer

Payroll and benefits setup requires significant lead time and is difficult for a buyer to merge into their own plans or outsource.

✓▪ Amend the employee matters agreement and enable the buyer to establish

programs

Creating step plans to form and operationalize legal entities requires cross-functional input.

✓ ✓ ✓▪ Prioritize setup of legal entities and identify legal regimes with long lead times▪ Establish Day 1 workarounds with incentives for prompt post-close transfer▪ Develop efficient acquisition structures to minimize transfer and other taxes

IT systems and infrastructure separation complexities can prevent business continuity.

✓▪ Minimize systems and infrastructure separation; use TSAs where necessary▪ Wall off the separated business from general IT access; establish security

protocols for employees

Day 1 workarounds and TSAs must be identified early and a delivery model planned to prevent disruption to business, as well as to limit ongoing entanglement.

✓▪ Identify potential TSAs as the operating model is developed▪ Leverage TSA inventory during buyer discussions▪ Assess buyer reliance on TSA support and required post-closing resources

IT systems and infrastructure separation planning and execution

Day 1 readiness

Payroll and benefits setupEmployee transition strategy

Legal entity readiness

Separation planning and execution

Op

era

tio

nal

rea

din

es

sPost-closeSign to closeLaunch to sign

Day 1 workarounds/TSA service delivery model development

Current state operating model Day 1 operating model


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Critical path activities and levers to accelerate timelines and balance risks: legal



Levers to accelerate timeline and balance legal risksFin. Ops Tax

Identifying and producing all in-scope assets requires cross-functional input.

✓ ✓

▪ Consider trade-offs in using categorical descriptions (e.g., primarily related or exclusively used in) vs. a specific listing approach

▪ Consider a “grab bag” approach to shorten pre-signing buyer diligence period ▪ Reduces certainty and creates an additional process; potentially impacts

stranded costs (e.g., procurement contracts)

Contract separation may not occur until post-close, but planning should start early to minimize post-closing entanglement.

✓▪ Contract terms can dictate the separation strategy and timing▪ Include proper incentives to minimize cost and burden of extended

subcontracting arrangements post-close (e.g., drop-dead date, tax gross-ups, liability transfer)

TSA scope negotiations should balance speed and certainty.

✓

▪ Avoid creating a backdoor closing condition by delaying TSA negotiations▪ Create a transition team to lead TSA negotiations with an escalation path that

allows disputes to be addressed quickly ▪ Allow buyer flexibility but negotiate “guardrails” upfront to protect the seller,

including a clear end date ▪ Ensure “at-cost” calculations are sufficiently broad to incentivize the seller ▪ Impose pricing increases for renewals and extensions

Note: Illustrative and does not represent comprehensive activity setCritical path activities

Le

ga

l


Identify in-scope assets, liabilities, employees, etc.

Negotiate definitive agreement

Supplement and finalize TSA schedules

Contract separation and third-party consent

Wind down TSAsDevelop separation strategy

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Critical path activities and levers to accelerate timelines and balance risks:tax



Levers to accelerate timelineFin. Legal Ops

Identify the seller’s optimal tax structure and calculate baseline tax savings.

✓ ✓

▪ Identify baseline tax cost for the seller’s optimal tax structure so that the seller can negotiate for additional consideration to compensate for any lost tax savings due to a buyer-preferred structure; consider NPV of the buyer’s basis step-up

▪ Allow the buyer flexibility to change the structure post-signing but provide for a tax-gross up for taxes exceeding the baseline

Identify asset and liability location to determine potential transfer tax and other tax costs of divestiture.

✓ ✓▪ Split transfer taxes 50/50 to incentivize parties to develop structures to

minimize transfer tax costs

Develop a mutually agreeable allocation methodology for purchase price allocation.

✓ ✓▪ Engage early on allocation methodology in complicated divestitures to limit

post-close disputes and significant changes to purchase price allocations

Determine optimal tax structure

Preliminary purchase price allocation analysis

Transfer tax and other tax effect analysis

Ta

x

Finalize PPA

Note: Illustrative and does not represent comprehensive activity setCritical path activities


Valuation analysis and prepare draft PPA

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Critical path activities

Deal

preparation

and financials

Consider deal options and define the deal perimeter early to avoid time-consuming iterations. ✓ ✓

Regulatory approvals can be time-consuming and complicated by seller and buyer industry dynamics. ✓

Sell-side financials could be subject to time-intensive carve-out audit requirements. ✓ ✓ ✓

Buyer due diligence requires significant time to understand business interdependencies, cost structure and allocations.

✓ ✓ ✓

Tax mattersTailor the transaction structure to account forall tax considerations. ✓

Operational readiness

Employee transition can be delayed due to labor relations (e.g., works councils) approval. ✓ ✓ ✓ ✓ ✓

Payroll and benefits setup requires significant lead time and is difficult for buyers to merge into their own plans or outsource.

✓ ✓ ✓ ✓ ✓

IT systems and infrastructure separation complexities can prevent business continuity. ✓ ✓ ✓ ✓ ✓

Creating step plans to form and operationalize legal entities requires cross-functional input. ✓ ✓ ✓ ✓

EY teams bring several accelerators to help divestors achieve faster timelines

EY Capital Edge

Op model workshops

Embedded data analytics

Managedservices

Functional cost baseline

tool

EY org and Talent Hub

Separation planning

workshops


2 Valuation as of 12-31-2013

EV 8.0% 9.0% 10.0% 11.0% 12.0%

Cash flows 14.8 0.0% 35.9 32.7 30.0 27.9 26.0

Terminal value 18.2 0.5% 37.4 33.8 30.9 28.6 26.6

TIC 33.0 1.0% 39.1 35.1 31.9 29.4 27.2

Debt 0.0 1.5% 41.0 36.5 33.0 30.2 27.9

EV 33.0 2.0% 43.3 38.1 34.2 31.2 28.7

2.5% 46.0 40.0 35.6 32.2 29.5

Revenue 132.3 3.0% 49.2 42.2 37.2 33.4 30.5

EBITDA 16.0 TV

Cash flow (1.6) 0.0% 20.5 17.5 15.2 13.3 11.8

0.5% 21.9 18.7 16.1 14.1 12.4

Rev multiple 0.2 x 1.0% 23.6 19.9 17.1 14.8 13.0

EBITDA multiple 2.1 x 1.5% 25.6 21.4 18.2 15.7 13.7

Cash flow multiple (21.1) x 2.0% 27.8 23.0 19.4 16.6 14.4

2.5% 30.5 24.9 20.8 17.7 15.3

3.0% 33.7 27.1 22.4 18.9 16.2

3 Income Statement 12-31-2013

Line Item in $'000 %

Revenue 132 100% 2013 - Payroll, SG&A, D&A, Restruct

Reimbursable costs and fees (30) (23%)

Revenue 102 77%

Payroll and related expense (60) (45%)

Selling, General and Administrative exp. (26) (20%)

EBITDA 16 12%

Depreciation & Amortization (8) (6%)

Restructuring charges (1) (1%)

EBIT 7 6%

Other Income(Expense) (9) (7%)

Corporate Tax Provision 0 -

NonControlling Interest in consolidated su 0 -

Net income (2) (1%)

4 Balance Sheet 12-31-2013

-30.0%

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

2009 2010 2011 2012 2013 2014 2015 2016 2017

EBITDA, EBIT and Net Income

EBITDA EBIT Net income

-63%

-28%

-8% -1%

2013 - Payroll, SG&A, D&A, Restruct

Payroll and related expense

Selling, General and Administrative exp.

Depreciation & Amortization

Restructuring charges

0.0

10.0

20.0

30.0

40.0

50.00.0%

0.5%

1.0%

1.5%2.0%

2.5%

3.0%

Value sensitivity

8.0%

9.0%

10.0%

11.0%

12.0%

15

33

18

0

-

10.00

20.00

30.00

40.00

50.00

60.00

70.00

Cash flowsTerminal value Debt EV

Value bridge 12-31-2013

2 Valuation - 2013

Brand 1 576 575.69 575.69 - - - - - - 575.69

Brand 2 33 608.70 575.69 33.00 - - - - 608.70

Brand 3 477 1,085.78 608.70 477.08 - - - - 1,085.78

Brand 4 336 1,421.74 1,085.78 335.96 - - - - 1,421.74

Brand 5 147 1,568.96 1,421.74 147.22 - - - - 1,568.96

Brand 6 11 1,579.97 1,568.96 11.01 - - - - 1,579.97

Brand 7 (71) 1,509.31 - - 1,509.31 70.67 - - 1,579.97

Brand 8 904 2,413.42 1,509.31 904.12 - - - - 2,413.42Total 2,413 2,413.42 2,413.42 - - - - - - 2,413.42

Value bridge - By Brand - 2013

3 Working capital - 2013

Brand 1 47 47.28 47.28 - - - - - - 47.28

Brand 2 28 75.28 47.28 28.00 - - - - 75.28

Brand 3 47 122.67 75.28 47.40 - - - - 122.67

Brand 4 22 145.16 122.67 22.49 - - - - 145.16

Brand 5 11 156.20 145.16 11.03 - - - - 156.20

Brand 6 3 158.83 156.20 2.63 - - - - 158.83

Brand 7 49 207.83 158.83 49.00 - - - - 207.83

Brand 8 111 319.04 207.83 111.21 - - - - 319.04Total 319 319.04 319.04 - - - - - - 319.04

Working capital bridge - By Brand - 2013

576

2,413

33

477

336

147 11

904

71

-

500.00

1,000.00

1,500.00

2,000.00

2,500.00

3,000.00

Value bridge - By Brand - 2013

0

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

EBITDA margin

Brand 1 Brand 2 Brand 3 Brand 4 Brand 5 Brand 6 Brand 7 Brand 8

47

319

28

47

2211 3

49

111

-

50.00

100.00

150.00

200.00

250.00

300.00

350.00

Working capital bridge - By Brand - 2013

82

104 101 99

94 91 88 85

-

20

40

60

80

100

120

Cash Conversion Cycle

DSO DIO DPO Cash conversion cycle

Pe

op

le /

P

roce

ss

Illustrative example: Finance94

Co

ntr

acts

Order tocash

Record toreport

Corporatetax

Buy to pay

Indirectsourcing

Consulting firm

Sy

ste

ms ERP

CDev tool Revenue system

C C

Video conference system

Billing systemHC C

CRM HomeSystemH

Visualization toolC

Office toolsC

Cash manage-ment tool

Visualization analytics

Backend tool

C

SH HC

Data visualization applicationS

Analysis toolsC

Business finance TaxFP&A8 6 1

Treasury

Tax planning Treasury vendor

Outsourcing vendor

Insurance

12 30

551215 N/ A

R

C G

R G

C

R

R

C

G

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Contacts


Doug CogenCo-Chair

Mergers & Acquisitions

Fenwick & West LLP

[email protected]

Bomi LeePartner

Corporate

Fenwick & West LLP

[email protected]

Adi MaheshwariPartner


Ernst & Young LLP

[email protected]

Shari YocumPrincipal

People Advisory Services

Ernst & Young LLP

[email protected]

Manish DabasPrincipal


Ernst & Young LLP

[email protected]

Ora GrinbergAssociate

Tax

Fenwick & West LLP

[email protected]

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Strategy and tools to accelerate divestitures

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