- Sellers averaged 9.5% year-on-year growth in earnings after two years, 3.1% after three years and 5.3% after five years
- Carved-out entities saw average share price growth of 16.3% after one year, 45.1% after three years and 40.5% after five years
EY conducted a detailed study of 200 transactions covering carve-outs with a deal value of £100m or more, by companies that are currently, or have in the last eight years, been a part of the FTSE 100 or FTSE 250 indices.
On average, share price value increased for both the vendor parent and their carved-out entities following divestment, the EY study reveals. The long-term value of vendors increased significantly, with average growth in share price after three years and five years of 4.2% and 7.2%, respectively. After five years, the average share price growth of vendors exceeded the relevant index.
For the carved-out entities, the picture is even more positive. After one year, carved-out companies that remained separately listed saw average share price growth of 16.3%, 45.1% after three years and 40.5% after five years.
Charles Honnywill, Partner, Divestiture Advisory Services at EY says: “There has been a wholesale change in market dynamics since the credit crisis. In many lower-growth economies, executives are divesting parts of their companies to redeploy capital and/or reduce debt levels to improve share performance.”
“Divesting selected businesses allows a group to refocus its attention on its core business and drive higher rates of growth either organically or by acquisition. A timely, well-executed carve-out increases confidence that the group is focusing its energies on the most profitable parts of its business.”
Profitability analysis
According to the EY findings, both vendors and carved-out entities showed a long-term increase in earnings following divestment. Sellers averaged year-on-year growth in earnings after two years (9.5%), three years (3.1%) and five years (5.3%).
Divested entities achieved an 11.1% year on year increase in earnings five years after a carve-out. Such growth is typically achieved after the business has “settled” as a stand-alone entity; this takes, on average, three years. The first three years as a carved-out standalone entity are critical to the success, or not, of the business. An operational focus on key business drivers, notably revenues and margins, typically makes the difference.
Honnywill adds: “The costs of running the business as a stand-alone entity can increase as it loses the benefits of scale that it enjoyed when part of a group. However, this does not have to be the case. Many functions such as IT, financial reporting and management information systems may be simplified or become more efficient on leaving a larger more complex organisation. As a result, there will often be scope for cost savings and efficiencies in the medium term, which can offset the costs of separation experienced in year one.”
With four transactions representing 40.5% of the total deal value during the period, the telecommunications sector saw the highest value deal activity, followed by the financial services, energy and materials sectors accounting for 16.6%, 14.8% and 12.2%, respectively. In terms of volume, the financial services sector saw 46 deals, followed by energy with 36 deals and materials with 35 deals, with the remaining 83 deals across various other sectors.
He continued: “In more and more cases, carve-outs can be an attractive prospect and a workable solution to a company’s search for growth. They can increase shareholder value in three areas: retained group, carved out business growth and the redeployment of the capital proceeds. Companies operating in the Eurozone and other countries with sluggish growth rates should seriously consider whether a carve-out could increase total shareholder returns. Likewise, private equity firms should consider whether a carve-out could boost value in an underperforming portfolio company.
“However, there are complex considerations for businesses considering a carve-out. There are many factors that typically divide the successful from the failed carve-outs. But without the top three, you usually suffer.”
The top three considerations are:
- Presenting a clear equity story with evidence as a stand-alone business; not just showing carved-out data from a group
- Clear perimeter – focusing on five angles: operational, commercial, financial, tax/legal and regulatory
- Having three roles done well – IT carve-out, financial data consistency, and planning for “Day 1” readiness
Concluding, he said, “Getting the preparation and due diligence right is key. Most carve-outs involve multiple workstreams that need to deliver without unduly disrupting the day-to-day operations of the group/vendor and the carve-out business. The devil is not just in the detail.
“However, done well, a successful carve-out can create significant value in excess of that delivered by “just growing with the market” – and that value can accrue to both the vendor and the carved-out entity. EY predicts that those businesses that will achieve profitable growth in the coming five years are already planning how they will divest to grow.”
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Hannah Forrester
EY Media Relations
+44 (0)121 535 2997
+44 (0)7931 491 342
HForrester@uk.ey.com
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