This week’s blog comes from Charles Honnywill, Transactions Partner and Divestiture Leader at EY
Disposals remain high on the UK corporate agenda and an active M&A market suggests that there’s no shortage of buyers. So far so good. But as recent high-profile examples highlight, many transactions don’t go to plan due to unforeseen regulatory issues. Too often, acquirers aiming to consolidate in their industry don’t get their desired outcome after coming face-to-face with competition regulation. They find out late in the process that they need to divest unexpected parts of their acquisition – frequently to the detriment of both parties.
In this week’s Capital Agenda Blog, I want to discuss what sellers can do to head off these risks to minimise the risk of ending up with only part of what they intended to buy.
Assets for sale
The UK edition of our Global Divestment Survey (GDS 2019) suggests that companies are still actively managing their portfolios and making portfolio adjustments remains at the top of their agenda. In the UK, 88% of respondents said that they intend to divest within the next two years — 72% in the next 12 months.
Thus far, there’s been no shortage of buyers. It’s interesting to note that 43% of UK respondents intend to reinvest disposal proceeds into acquisitions. Portfolio adjustment isn’t just about selling, but finding ‘better’ uses for capital, which includes investing to build market share or develop new competencies. Meanwhile, private equity remains exceptionally busy, fuelled – as we’ve recently noted – by record amounts of dry powder.
But, what GDS 2019 also shows is an increasing complexity in deal execution, especially where acquirers are consolidating already concentrated markets. Two-thirds of UK respondents to GDS 2019 said that Non-tariff barriers (i.e. regulation, product standards and ownership rules) would affect their plans to divest.
We’ve also seen recent high-profile examples in UK markets and beyond where regulatory issues threaten to scupper deals late-on, or acquirers have been forced to sell more assets than expected to achieve competition authority clearances.
How can sellers help mitigate this issue?
Create a clear perimeter
GDS 2019 shows that a significant proportion of “seller remorse” links back to creating a clear perimeter, the most difficult, but vital, part of the carveout process. This perimeter should be seen clearly through five “lenses”: financially, operationally, commercially, legally, and from tax and regulatory angles.
Too often tax and regulation have been perimeter afterthoughts; but US and European tax changes and the rise in protectionist measures have pushed both issues up the perimeter agenda. Almost half of our UK respondents said that their most recent closing was delayed by a lack of regulatory understanding. Lack of preparation in dealing with tax risk was cited as the biggest cause of value erosion in disposals, occurring in 71% of UK companies’ most recent divestments.
Hold that perimeter – but be ready to flex at the end
Sellers should set a firm perimeter, but stand ready to flex that boundary when absolutely necessary to meet a buyer’s regulatory needs. To maximize value, companies need to flex according to market conditions, tax efficiencies, timeline and anti-trust considerations. More than half of UK companies in GDS 2019 said that a lack of flexibility in the sale structure eroded the value of their last divestment.
The last-minute perimeter flex is an art, as much as a science. It is worth spending time to plan to get it right. Delayed closings pose operational and administrative burdens to sellers post-close and often delay their receipt of proceeds. They also delay the buyer from implementing the changes required to achieve value capture goals. Overall, these issues hit both buyer and seller.
Focus on buyer cases
It’s good practice for sellers to model potential buyers’ cases, a process that should flush out the synergies, but also the regulatory risks. Where regulatory issues are likely to arise, it can help to ‘war game’ how the regulatory process may play out for key buyers.
Regulatory requirement can include antitrust approvals, business licenses, capitalization of new legal entities, registration of products, labour requirements and achieving tax attributes (especially IP). Many of these activities must occur in a specific sequence, can be lengthy and can change based on rule-making bodies in each country and even locality. It pays to think ahead and predict likely scenarios.
Keep PE bidders interested
The best hedge against regulatory and anti-trust risks of corporate buyers could be to keep PE bidders in the process, who won’t face these issues. PE houses will be significant buyers in the next 12 months due to their significant war chest of capital available to invest and portfolio of assets for sale. In our survey, 81% of UK companies expect an increase in PE sellers in the next year, against 65% who expect more strategic sellers.
Working with PE buyers can be demanding. The biggest challenges picked out in our survey are the time taken to support lender diligence requests (68%) and the need to develop a realistic picture of stand-alone costs (64%). But the involvement of PE buyers also reduced the time to close in over half of cases and raised the multiple in 41% of deals.
Flush out risks
Early in the process, it’s helpful to use well-prepared “fireside chats” to flush out the risks before taking bidders beyond the first process phase. That may include identifying potential long lead-time regulatory requirements early and thinking about country-specific plans to be ready to work with the ultimate buyer.
The EY Global Corporate Divestment Study focuses on how companies should approach portfolio strategy, improve divestment execution and future-proof their remaining business.
Edited by Kirsten Tompkins