Value creation through carve-outs: Fail to prepare … prepare to fail

1. Introduction

After another strong quarter of deal-making activity, the M&A outlook for the remainder of 2021 looks buoyant. As countries emerge from lockdown restrictions and vaccine rollouts reinvigorate consumer confidence, the extraordinary “standstill” of twelve months ago appears to have been banished.

This economic re-awakening presents a huge opportunity for business leaders to strategically recalibrate their portfolio to focus more on core offerings, while also carefully considering acquisitions that could accelerate strategic growth.

With such significant rewards up for grabs on both buy- and sell-sides, carve-outs are likely to be a dominant feature of the M&A landscape for some time to come. This makes it all the more important to ensure that nothing is left to chance when executing a carve-out strategy.

2. Be aware

Carve-outs are a significant undertaking from so many perspectives, ranging from defining the ideal carve-out perimeter over designing the optimised legal entity setup, considering cross-border governance and tax implications, to developing a communication concept ensuring that no stakeholder feels excluded from the carve-out process, to name just a few.

However, combining all elements into a single clear plan from the outset – refined as new information becomes available – and having it delivered by an experienced, “battle-tested” project team can give leadership teams the greatest chance of unlocking the highest value in the shortest possible time.

3. Don’t underestimate complexity

Any assumptions that carve-outs are anything but highly complex are delusional. The levels of entanglement within large entities from brand, customers, shared services and technology perspectives, to name just a few examples, will present myriad challenges.

Businesses subject to a carve-out have often suffered from a lack of HQ focus, investment or just general love and attention for some years. But that’s not to say that they aren’t tightly integrated within a portfolio, with the best intentions of forging productive collaboration and realising other business synergies.

There is always a path to separation through such complexity – but this will require rigorous assessment and diligent implementation – with continuous learning and the need to update strategies along the way.

Much depends on the quality of the preparation. A swift and comprehensive planning process, driven by a dedicated core team, including experienced carve-out project managers and affected front- and back-end key functions, will deliver a clear Target Operating Model (TOM) for the carved-out business and a suitable implementation plan. This includes the identification and transfer of affected resources, assets and headcounts to achieve operational effectiveness on Day 1. In addition, Transitional Service Agreements (TSAs) need to be negotiated to guarantee continued support from the parent company (e.g., access to ERP systems and maintenance, use of shared office space, brand licenses) for a pre-defined period of time.

Other critical factors to achieve a successful carve-out include the regular testing of Day 1 readiness, the evaluation of risks and mitigation measures, and the development of a robust communication program to all stakeholders, in particular to affected employees. This is often underestimated, but crucial in preparing a smooth transition for the separation, to ensure an energetic start for the separated business post-Day 1.

4. Create value

As carve-out assets have typically been neglected or at least de-prioritised, they are particularly attractive to certain private equity firms, including funds focusing on turnaround situations. Such assets frequently offer significant performance improvement opportunities, either as standalone businesses (possibly as a buy-and-build platform) or as integration targets for an existing portfolio company. So, after the route of entanglement has been identified – how will the business be optimised once again?

While carving out a business and moving it to a standalone state will benefit from speed over elegance in terms of reaching Day 1 readiness, this doesn’t mean that the analysis and the assessment of the business is negligible – value creation begins from the outset.

From establishing the initial deal perimeter in terms of people, products, systems and customers to building a robust value creation plan, this up-front attention to detail will pay off once the process is under way – and ensure that sellers don’t leave value on the table.

From a buyer perspective, the plan to realise value from any asset forms a key part of the investment thesis and is usually split into two distinct phases – Pre-Deal Due Diligence and Post-Deal 100-Day Implementation Plan.

• “Pre-Deal DD”:
  The challenge for most buyers in the Pre-Deal Due Diligence phase is the inherent limited access to management and data. Having deep business/sector/functional expertise, combined with a proven track record of performance improvement delivery, is vital to develop and validate a set of initiatives through a combination of experience-based hypotheses and data analysis. The due diligence phase is primarily used to stress-test initiatives, reflecting not only a refined set of prioritised activities but also the risks and issues associated with them that must be addressed post-deal.

• “Post-Deal” 100-Day Implementation Plan:
  It’s only after the deal completes that greater management and data access is available and the picture becomes clearer. Initial Pre-Deal Due Diligence initiatives can be validated and detailed (unfortunately in some cases, where haste or lack of sufficient preparation has prevailed, initiatives may finally be disproved). In addition, new initiatives can also be developed based on a clearer understanding of the true state of the asset. These will form the Post Deal Value Creation Plan, which should precisely outline and prioritise initiatives. Here the application of the 80/20 rule is vital, focusing attention on the initiatives that deliver most of the value. The initiatives should be actionable, measurable, and pragmatic with a relentless drive and focus on cash and EBITDA generation. To deliver the value, it is fundamental to address the key drivers that have the greatest impact on the business first.

5. Drive implementation through strong governance

Ensuring all the above elements are in place requires meticulous preparation and execution, if the catalyst of a carve-out is truly to deliver the value it first promised.

However, having the right Separation and Value Creation Plans alone is not enough. A strong governance model to drive implementation is equally important. The Challenge Project Management Office (PMO) should not be a checklist PMO. Carve-outs are complex transactions and the Challenge PMO must be led by strong operations professionals who have a deep and proven track record in delivery. It should also be content-rich, solutions-driven and proactively challenging of every workstream involved, rather than a reporting and escalation mechanism, as time will be of the essence and any delays translate to significant additional costs.

6. Don’t stop – Reaching Day 1 is only the start

Successfully completing separation and reaching Day 1 on schedule, with a set of TSAs that all parties are confident can be worked through without unexpected delays, will of course be cause for celebration.

However, a value creation plan on paper is just that. Day 1 brings the need for a relentless obsession with implementation, to get a business fighting fit and agile enough to be ready for growth.

The operating model must be established quickly to facilitate that transformation, from process optimisation through to appropriate legal structures and everything in between. For private equity funds, it may feel like a race against time to optimise a business to a point where the strategy that was invested in in the first place can finally be shaped to start delivering returns.

Here, it is people that will come to the fore – the right management on board with the vision, track record and relevant experience to reinvigorate the carved-out entity. With careful planning up front, those leaders should have been identified and secured, and be prepared for implementing a success story that includes employees, customers, suppliers and other key stakeholders.