Divestments are on the rise, but increasingly difficult to deliver

Divestments are on the rise, as 70% of businesses now expect to make at least one in the next two years. However, a number of stumbling blocks stand in the way of companies looking to offload parts of their portfolio for large sums – particularly falling employee morale, which seven in ten executives see as a factor that could see deals falter.

Merger and Acquisition (M&A) activity in 2017 has seen a steady decrease in volume – pared with a general increase in value. During the first half of 2017, 8,553 transactions were announced – a decrease of 6.8% from the first six months of 2016, when 9,180 deals were closed. Compared with the second half of 2016, the decline is even greater, as 9,328 deals were closed in the last two quarters. Worldwide, the total value of transactions increased from €1,235 billion in the first half of 2016 to €1,405 billion in the first six months of 2017. One area of M&A that has seen an uptick in activity is that of divestment.

According to Deloitte's global M&A index there has recently been a significant recent increase in major divestment activity, with companies announcing nearly US$200 billion worth of global divestments in 2016 alone, compared to US$150 billion in 2014. This increase can be primarily attributed to three factors. First, there has been an increase in mega-deals and divestments are necessary to get regulatory approval. This has been coupled with organisational portfolio review and optimisation to focus on core growth areas; and activist pressure to shed assets, to deliver an environment in which the need for organisational ‘clear outs’ has become increasingly leveraged as a means to deliver increased value to firms, and free up a business’ strongest assets for growth.

According to a new survey, divestment activity will continue to increase in this manner over the coming years. The report took in the opinions of professionals from 123 global organisations who have recently been involved in divestment activity.

As markets enter a more guarded, ‘bear’ phase of long-term planning, over encumbered businesses offloading perceived dead weight to focus on long-term growth means that expectations for deal making across sectors are on the rise. A third of respondents for Deloitte’s poll said that their organisations undertook more than one divestment in the last three years, while 70% expected to make at least one divestment in the next two years, and a further 15% expect to undertake three or more.

Of the total survey respondents, 48% were CEOs, 22% were board members or C-Suite, and 19% were either heads of M&A or part of the survey respondents' corporate development team, while 80% of the organisations surveyed had over US$500 million of annual revenue.

Who is buying?

One striking result of the Deloitte Divestment Survey is that companies are more likely to market divestments to corporate buyers than to private equity firms, and more likely to market to domestic buyers than to cross-border buyers, despite private equity and cross-border buyers being statistically more likely to complete the deal. The European private equity industry expected a slower year in 2017, following a tumultuous 2016. However, those investors retained their rapid appetite for acquisitions, according to researchers.

Attempting to explain why these entities were still not preferred buyers, Mark Pacitti, Global Leader of Deloitte's Corporate Finance Advisory practice, said, "Everyone prefers to sell to a trade buyer because they can pay a synergy premium,” although Pacitti also questioned whether companies are right to prefer strategic buyers.

Further considering the phenomenon, Paul Lupton, Head of Deloitte UK's Advisory Corporate Finance practice, argued, "The advantage is the ability to drive performance from a business mentoring and incentivising management. They will look at the debt they can raise, and determine what they can pay in the light of that - and that may be more than a trade buyer. The speed of transaction in a PE purchase is also very attractive to a corporate buyer. PE does not have so many stakeholders to please, and they can act without worrying about fitting a complex business into an existing corporate system - so they can move faster."While speed and certainty to close were important values for firms looking to sell a part of their portfolio, at 32% of responses, money is ultimately king for sellers. When asked directly what the primary determinant for choosing a buyer was, unsurprisingly, the most important factor was which suitor offered the highest price –cited by 40% of respondents.

Whether the new owners would be a good fit for managers and staff after the sale was a distant third, at 20%. This potentially means that a number of sales are made to buyers who are a poor fit, leading to expensive failures subsequently cooling market sentiment. Interestingly, while this might be less of a concern for sellers in the short-term, in the long-run, such a lack of concern to find the right fit might well contribute to a growing difficulty in sell-side divestment.

Divestment becoming increasingly challenging

Risk sensitivity is already having a number of specific effects in the market for divested assets. Buyer demands are changing, deals are becoming more complex and involving more data and analysis. Indeed, this may exacerbate how the difficulty of divesting is increasing. According to Deloitte’s analysis, 54% of organisations expect that divestments will already be more difficult to deliver in the next 12 months due to external market changes. The sale process is often more costly and more drawn out than anticipated, and non-financial costs such as impacts on morale, reputation and customer perceptions can be significant.

The common theme is uncertainty. lain Macmillan, Deloitte Global Head of M&A, elaborated, “The decision to buy or sell is becoming more critical. It's not a question of do I pay or accept 5% more or less. The question is, do I want this level of uncertainty in my business? Pricing that uncertainty accurately is the key to divestment success.”

Also remarking on tightening divestment trends, Larry Hitchcock, Deloitte Head of Global Divestments added, “Divestments are now recognised as a core part of an organisation's priorities, yet the complexities how to identify and execute these successfully is changing rapidly. Sophisticated businesses are adapting their strategies to ensure they capture maximum value from these activities.”

What makes for successful divestment?

Delivering a successful divestment calls for proper planning and skillfully implemented execution. According to Deloitte’s research, the art of divestment is different from the art of acquisition (even though some of the same executives may be involved), and demands the ability to push through a clean separation without damaging internal morale or external reputation. Deloitte’s piece offers numerous measures to navigate the process.

1. Leadership and team clarity is key
The challenges of a divestment can be numerous and substantial, with the organisations surveyed stating that their biggest issue is managing employee morale, at 71% of respondents – as staff look for reassurances that their company’s sale will not lead to redundancies. In addition, 40% claimed that a lack of communication with the organisation about future plans for the business being sold was a major issue. The two are closely connected – and morale is obviously likely to flag when rumours surrounding the future of any company fill a vacuum left by the absence of official communications.For this reason, clarity and team capabilities are key to a successful divestment. According to Larry Hitchcock, companies need a defined process to give guidance to the deal team and the wider business. He added that, "It is also important to have the right capabilities in the team - and that means experience. Divestments differ from acquisitions - in order to successfully disentangle businesses you require operational knowledge. You need to be able to run a standalone business or know what it takes."

Effective change management is, therefore, a major boost to the hopes of any divestment. By communicating regularly and clearly with employees to keep them motivated and help them manage divestment-related cultural change, firms can offset labour-related stumbling blocks while working hard to identify the advantages of divestment to an owner that has strong belief in the potential of the business. For this reason, simply plumping for the highest offer may increase the possibility of a scuppered deal.

2. Preparation is paramount

Sellers will need to complete a readiness assessment to ensure that they have an effective plan and implementation team in place to manage this change. Those looking to divest should form a dedicated separation team and follow a robust, structured divestment plan to avoid negatively impacting employees' business-as-usual performance.

Firms should ensure that separation executives have operational knowledge of the business to be divested, and are ready to work with very tight deadlines. It is also important to know the divestment target well, as this will make subsequent integration easier.

3. Data and analytics can give insights
The use of analytics during the divestment process is becoming widespread, with buyers demanding greater access to data sources so they can perform detailed, bottom-up modelling. However, while the technique is commonplace among potential investors looking to ensure they purchase a quality operation, sellers can also leverage this tactic to add significant value to the asset being divested, by providing detailed workforce, commercial, and market data.

"This is a market that is changing rapidly," Andy Wilson, leader of Deloitte’s US M&A Seller Services practice, contended, "There is a huge increase in the amount of relevant information. There is traditional structured data, and there is unstructured data like web reviews or social media. Over the last 12 to 18 months we have seen the more sophisticated buyers looking at kinds of data that were never part of transactions before."

4. Use TSA’s
The use Transitional Service Agreement (TSA) has been proven to be a sting in the tail of divestments for many companies. TSAs are contracts that allow the purchaser to rely on continuing service from the vendor in areas like financing, supply or logistics during a limited period when the purchaser is building up ability to manage the acquired company – but the cost and complexity of negotiating and maintaining TSAs has often been underestimated. The growth of TSAs reflects the trend for diversified corporate groups to run more centralised shared services, and for acquired businesses to be fully integrated in the pursuit of synergies – while buyers seek to offset their purchasing costs and operational risks, easing an acquisition into their fold over an extended period – with over 22% of respondents stating a TSA lasts over a year.

"Companies make the mistake of thinking it is simple, thinking it involves only two or three functions," said Deloitte Partner Dan Beanland. "Also, the timeline may be under-estimated - although the vendors may expect and prefer a shorter time, purchasers often want a 12 month TSA with a possible 6 month extension!”

Unravelling these integrations is complex, time-consuming and expensive. Often, it is impossible fully to disengage a divested business from the original parent's corporate structure within a divestment timeframe. Deloitte advises that, rather than treating TSAs as a cost, it is better to enter into them as a commercial opportunity. There is potentially huge value in TSAs but corporates often fail to secure this, according to the researchers. According to the survey, the most frequently offered services in a TSA are finance and accounting, at 68%, which are particularly lucrative, alongside IT at 60%.

“The trend over the last ten to fifteen years has been for more companies to be integrated in order to create synergies," Maxine Saunders, Deloitte UK Head of Transaction Services said. "That creates a challenge when you come to sell. Part of the problem is that vendors may not understand the cost - the more centralised your functions are, the harder it is to see what the costs actually are."

5. The need for speed
Survey respondents reported that the time between executing purchase agreements and completing the transaction was over three months in 74% of their deals. Nearly 7% of deals take over 12 months to complete, while half of all those questioned said their divestments took more time than originally expected. Primarily, this time was  lost negotiating transaction agreements, in 58% of cases, and conducting buyer due diligence, at 45%.

"If you are going to have a successful sale, the first step is speed to market," Larry Hitchcock concluded, "The longer the deal takes to form, the more uncertainty you build in. You have to recognise that it is difficult to get a deal completed amid uncertainty."