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Carve-out deals likely to increase after Covid-19

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Carve-out and spin-off deals are likely to accelerate as companies emerge from the Covid-19 pandemic. Increasingly, companies are looking at alternative strategies to boost their competitiveness, increase their profits and create value for shareholders.

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Not only does a carve-out or spin-off allow a company to do this, it also allows it to refocus on its core businesses and improve operational efficiencies without having to spend time and resource on non-core and/or underperforming business units.

2019 was the second busiest year of the last decade for spin-off transactions, and although deal volume was affected by the pandemic, we still saw some multi-billion dollar deals last year, such as United Technologies’ USD19.5 billion spin-off of Otis Elevator and Siemens’ USD18bn spin-off of its conventional power and renewable energy business.

PE funds were particularly active in 2020, with some of their largest acquisitions involving carved-out business units, for example EQT’s near EUR1bn acquisition of hand sanitiser producer Schülke from French industrials group Air Liquide and KKR’s GBP4.2bn acquisition of Pennon’s UK waste management business, Viridor.

We expect them to feature heavily in the months ahead as they look to deploy a surplus of accumulated dry powder.

But with a shortage of attractive standalone businesses coming to the market, it is likely that other financial buyers and strategic players will also contemplate buying carved-out business units.

Likely trends in the year ahead

Pre-pandemic shifts in key markets plus the direct impact of the crisis, for instance the way it has accelerated the adoption of new technologies, will reshape the priorities of big corporate players.

Businesses that have weathered the pandemic will be rethinking their strategies in order to rebuild and take advantage of new opportunities.

The impetus for change will vary from company to company and from sector to sector. For instance:

  • some companies, hard hit during the crisis, will need to increase liquidity and reduce debt. Distressed M&A deals, so far postponed thanks mostly to government support schemes, are likely to pick up as the year progresses
  • in Covid-resilient sectors with sustained and reliable cash flows, increased valuations could drive deal activity
  • environmental, social and governance (ESG) issues are increasingly driving boardroom decisions, including with regards to the units which no longer fit into the overall business portfolio

But other factors will play an important role.

For instance, we expect activist shareholders, key players in forcing business to spin off non-core assets in recent years, to step up their demands for divestments to increase shareholder value.

As we described elsewhere in this report, the massive proliferation of SPACs offers big corporations another way to divest themselves of business units for cash and for carved-out business to achieve a public listing.

Carve-out and spin-off deal breakers and complexities

Carve-outs and spin-offs are rarely simple to achieve and require careful planning and due diligence.

That’s particularly true of highly integrated companies where different business units may share premises, services, systems and personnel, and may have co-mingled supplier and customer contracts.

Deals can also flounder when quite far advanced, for instance if:

  • the spin-off proposal creates a large unmitigated tax liability
  • shareholder approvals and relevant antitrust clearances (including, increasingly, FDI regulatory requirements) are not secured ahead of signing
  • due diligence reveals that the unit to be carved out in fact contains elements crucial to the success of the remaining business and a change of course is not available

Planning for the initial separation and day one readiness, as well as for the long-term transition to operating as independent businesses, needs to start early and run concurrently. Both are equally important.

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