Magazine Article | December 24, 2014

Salvaging Value In Divestitures

Source: Life Science Leader

By Fred Olds, Contributing Writer

The unfortunate truth is that most business divestitures are characterized by value destruction from inception to close. That’s PwC’s conclusion about divestitures according to Glenn Hunzinger, a partner at PwC Transaction Services. “Selling a business is probably the hardest thing a company can do,” he says.

Business leaders underestimate the detailed planning required. Sellers often end up in front of a buyer unprepared to answer many of the buyer’s questions, and the process begins to linger as the seller scrambles to answer those questions. The longer a divestiture takes to close, the greater the risk to the seller’s value proposition.

Unless a company has participated in a divestiture previously, it’s not uncommon to have the misconception that the effort will be quick and easy with leadership providing inadequate time and resources to the process. “People have day jobs. Divestiture is just what they do after 5 p.m., and it gets second-class attention,” says Munzoor Shaikh, senior manager of healthcare transaction services at West Monroe Partners. Consultants such as Hunzinger and Shaikh say divestiture plans often lack a clear strategy and will present with an overly brief diligence that doesn’t have an objective valuation or a clear definition of what’s being sold, or include encumbrances that may be linked with the business or asset being sold.

Hunzinger says that leaders should conduct regular reviews of their business and evaluate whether divisions meet the long- and medium-term visions for the company. It’s at this point that divestiture becomes a consideration. “When opting for divestiture, the critical question to answer is the ‘Why’ of the strategy,” says Shaikh. Answering this question affects the process. For instance, if the strategy is purely to generate cash to dedicate to the core business, the guiding principle may be speed. The guiding principle becomes risk, however, in a situation in which Company A is divesting itself of a subsidiary that happens to be a supplier of critical compounds. Shaikh says Company A might need to take more time to mediate risk and ensure there is no interruption of critical supplies during and following the divestiture.

When a company chooses divestiture, says Hunzinger, it has to answer two questions: What does the end business look like? What is the right process to achieve that end point? Consideration has to be given then to the type of divestiture. “Selling to a large corporate entity is a lot easier than selling to private equity or creating a spinoff,” says Hunzinger.

Spinoffs, he says, leave no slack time for acculturation; they have to be up and competitive on day one. Creating the right culture and structure are critical. Leadership needs to look at the market to analyze the competitive environment and corporate structure that succeeds there.

Using this knowledge, the mother company has to structure the spinoff to compete in that market. Hunzinger says, “Often leadership just mimics the structure of the parent company. There has to be a more strategic view.” After all, the needs of a small biotech or device company are very different from those of a large multinational.

Divesting to private equity carries many of the same considerations because equity companies usually don’t have the infrastructure to support a new business. The seller may have to provide some support systems until equity can contract or hire resources to fulfill those needs. The nature of the resources, the duration they will be provided, and the expense need to be fully detailed in the contract.

“You cannot plan enough,” says Hunzinger, “Up front, set a defined perimeter regarding the transaction object [what’s being sold], have all the data, and complete a detailed diligence. The more you do on the front end, the faster the back end goes.”

Divesting a business unit or asset requires a high degree of detailed oversight and planning. “Even something as seemingly simple as wanting a file from the regulatory system can be complicated,” says Shaikh. Proprietary information can be hidden in documents, emails, and various programs. All of these have to be reviewed and vetted by the people or business units responsible for their generation.

Too often companies fail to leverage the positives or address troublesome issues associated with the business. Leadership has to provide supporting evidence of the positives. “And you must be prepared from the outset to put all of the issues — good and bad — on the table,” says Hunzinger. “Then you will be able to tell the buyer what you are doing to address them.”

“The more you prepare up front, the more you understand the business,” says Hunzinger. “This preparation will provide the data to construct a well-designed sale offer and will enable you to handle any situation during the sales process.”

“In a divestiture there are the ‘knowns’, ‘unknowns’, and ‘unknown unknowns,’” says Shaikh, “and you have to prepare for all of them. In other words, expect the unexpected.” He explains that a common “known” is that an inventory system will have to be converted from Company A to Company B. This is handled routinely. Or, perhaps, Company A’s quality program needs to be implemented at Company B. But how these conversions and implementations are conducted is an example of an “unknown.” Planners need to estimate the time and steps necessary to align the programs and allocate that time into the divestiture plan.

In every project, however, situations arise that are completely unanticipated (“unknown unknowns”). Shaikh says you have to schedule time into the divestiture plan to account for these situations. IT debt is a common occurrence. Companies buy customizable ERPs (enterprise resource planning) to manage business processes. The more customized they become, the more difficult the divestiture. Over time, layers of customized technology are applied to one another. Artifacts and unauthorized workarounds from previous editions may remain and cause dissonance in expected outcomes.

For instance, a company may say its average market price (AMP) is computed in the I-many program. Yet AMP printouts don’t match expectations, because seven years ago a portion of the AMP computations was switched to the finance system. Untangling these situations becomes an exercise in forensics. These irregularities in IT can compound over time and be difficult to untangle.

"You must be prepared from the outset to put all of the issues — good and bad — on the table."

Glenn Hunzinger, Partner, PwC Transaction Services

Hunzinger says a company must allocate resources designated specifically to guide the divestiture. This includes oversight and direction from a leader appointed to drive the project. A dedicated unit/ section should be created, composed of interdisciplinary teams representing all of the functional divisions of the company. These teams must understand how their work relates to that of others and how all of them relate to the divestiture.

IT and the business units must all work together throughout the process, says Shaikh. Tech is the foundation of communication in most enterprises. It is the sinew that links the parent company to the business units. Slicing off a unit or product will require some restructuring of the enterprise, the unit, and the IT system.

Company leadership is often too close to the business unit to have an objective understanding of its value. Leaders need to look at the unit through the eyes of a buyer.

“Often leadership is looking at its business and product lines without all of the associated costs/expenses. So, the offer doesn’t have a measure of true profitability,” says Hunzinger. “That leads to a disconnect between the seller’s perception and what an outside party perceives the value to be.” Examples of these oversights include pension obligations, tax exposures, indemnifications, and debt.

There are other expenses that may detract from the value of the sale. A buyer may ask to subtract the costs they will incur to provide infrastructure and support to the new division business. Sellers may find they are left with personnel or systems that are no longer needed, now that the divestiture has been completed. Associated transaction expenses such as lawyer fees, filings, consultant fees, and banker fees should be considered in the value proposition.

To substantiate the potential profitability of a company, sellers must convince buyers that their forecasting methodology is reliable. In today’s business climate, it may be difficult to convince a buyer that historical forecasting is a good prediction of future revenue production. Sellers must develop and validate models that produce convincing results.

An offer to sell has to be explicit. Shaikh says, “An offer might say, ‘The seller retains no right to the existing assets, and the buyer gains all rights to the existing assets.’ The question then becomes what are the existing assets?”

It’s very difficult to conclude a divestiture if, during the process, the seller is ambiguous on what’s being sold. “Defining a transaction object is one of the biggest places companies fall short. They don’t set parameters up front,” says Hunzinger. Sellers sometimes add or retract assets, personnel, or entities to or from the sale during negotiations. This muddles the sale and extends the process.

A primary goal in divesting has to be the reduction of ambiguity. The seller should present an offer that leaves few questions and increases confidence on the buyer side. That speeds the sale and salvages value.