Examining carve-outs in the current market

Equity carve-outs have tended to be popular strategies employed by CEOs as they look to sharpen their corporate focus by divesting non-core operations. While they can of course take many forms, one fundamental challenge remains for business leaders, especially those considering a carve-out in the current economic environment: the importance of creating value during the process.

Businesses are of course facing an economic environment unlike anything we have witnessed for half a century, with entire parts of the global economy effectively being turned off or placed into hibernation. As business of all shapes and sizes start to emerge from lockdown, the level of undeployed capital from private equity firms is at a record high, hitting a staggering $1.5 trillion as of April 2020.

COVID-19 has had a seismic impact on M&A activity but, according to Olivia Tyrell, Lead Cross Border M&A Partner at Baker & McKenzie, it will also lead to carve-outs undoubtedly proving more “complicated” in the immediate term. The pandemic has compelled more businesses to restructure their operations as a direct consequence of the new world we live in.

However, according to Marco Houscheid, a Partner at PwC, more deals will emerge after the crisis, driven not only by the high level of dry power but also by those companies undertaking a “strategic reflection” on their portfolio. This, Houscheid argues, will see carve-outs back on the agenda. Indeed, according to a recent poll of industry professionals carried out by Intertrust, a third (33%) said they intended to start looking for acquisition opportunities while 11% plan on initiating a strategic review of potential carve-out opportunities.

If carve-outs do begin to increase in popularity after the crisis, business leaders will face many challenges. Carve-outs can be extremely complex, depending on resource available to support the process, the integration of various businesses and whether the company operates in different countries and under different legal jurisdictions.

To create value during the process, management should undertake a readiness assessment in conjunction with its senior advisers to ascertain a better understanding of the deal hypothesis, transaction parameters, key stakeholders and their needs, availability of financial information and resourcing.
There are typically three phases during the carve-out process: preparation, execution, and separation. It is the first phase that is critical through the carve-out process and, as the deal progresses to the execution phase, good preparation means leaders can more easily side-step expensive pitfalls. Conversely, a badly prepared deal can lead to all sorts of problems, ultimately resulting in the buyers dropping out of the transaction.

During due diligence buyers will come to the table with many questions, but there are arguably three fundamental ones that need to be answered:

• What am I buying? And what am I not buying?
• Do I have a good understanding of the financials?
• How complex is the separation going to be?”

As businesses start to emerge from lockdown and better appreciate the economic and operational implications of COVID-19, M&A activity will tick upwards as corporates look to “rationalise their portfolios in response to the pandemic,” according to Tristan Nagler, Managing Director at Aurelius Equity Opportunities.

COVID-19 has created challenges to completing carve-outs, especially in the context of a cross-border setting. However, with activity levels expected to increase over the next few months, Intertrust remains committed to working with new and existing clients to help navigate the choppy waters ahead.