Carve-out Management as a Success Factor for Value Enhancement and Growth Strategies

1. Introduction

Global M&A activity has been on an upswing since 2008. In 2019, there was a slight downturn of 3% ¹ compared to the previous year, but the total volume and number of deals remain at a historically high level.² While the number of deals has declined, the volume of deals, especially megadeals over USD 10 bn.,³ has increased steadily. The drivers of this growth are technology-oriented transactions.⁴ Thereby, in particular, the increasing volume of PE-supported transactions in the mid-cap (18%⁵) and the relatively high proportion of carve-outs with approximately 40% stand out.⁶ In the DACH region, three of the top five deals were carve-outs in the first three quarters of 2019.⁷ Other assets, such as TK Elevator or BASF’s Construction Chemical division, are or were in the process and attract the interest of PE investors in particular.⁸

At present, global uncertainties continue to cloud the positive outlook. The trade dispute, Brexit, the situation in the Middle East, increasing political and regulatory intervention, as well as a general economic downturn are creating uncertainty and thus promoting general caution among investors and financial institutions.⁹ For the key players in M&A – the banks –, this behaviour is reflected in the restrictive lending policy, which in turn has a negative impact on M&A activity.¹⁰ In the fourth quarter of 2019, we are seeing this reluctance among companies, especially in the market approach. However, it is interesting to note that preparatory activities for deals, especially carve-outs, spin-offs and IPOs, remain robust.

Active portfolio adjustments and the associated divestment are trending in many companies. Carve-outs have thus become an essential component of successful M&A activity.¹¹ This is underlined in a recent Deloitte study, with more than 80% of participants (+10% on the previous year) stating they plan to sell individual divisions or portfolio companies next year.¹² The high liquidity, especially by PE investors in the market, on the other hand, acts as a fuel for future global M&A activities.¹³ In the private equity sector, in particular, this upward momentum was shown in the growth of platform and add-on deals in recent years.¹⁴  For example, financial investors assume the role of industrial consolidator, using economies of scale and investment in technology to reduce costs and create value.¹⁵ Despite all the uncertainties, the multiples in the German market have remained relatively stable in 2019.¹⁶

These current market developments reinforce the need for divestments and carve-outs, as they enable a strategic reorientation and revitalisation of secondary business activities or divisions. ¹⁷ The focus is on the replacement and disposal of non-core activities in order to generate capital for acquisitions or investments, particularly in new technologies. Antitrust regulations and activist investors also drive this trend.¹⁸ In terms of content, transactions are thus becoming more transformational and complex.

Properly managed, carve-outs offer sellers and buyers far-reaching potentials for value enhancement. The early development of exit strategies is not only relevant in the PE environment, but also for corporates. We expect Buy & Build scenarios and strategic realignments to become increasingly relevant in the coming years in an inherently unsteady environment characterized by increasing volatility, uncertainty, complexity, and ambiguity.¹⁹

On the seller’s side, carve-outs support the streamlining of the portfolio in order to be able to focus limited resources on the core/growth business. Successful portfolio streamlining therefore involves defining a strategic direction for the target before the carve-out. Not only to be able to market it optimally later on, but also to ensure the target’s own requirements, such as continuation or long-term cooperation.

On the buyer’s side, outsourced parts of the company are often the appropriate link that enables the company to expand inorganically in terms of breadth, depth, but also complementarily.²⁰ For example, companies that bought spun-off business units in the first half of 2019, outperformed their industry benchmark.²¹

The interests of both sides place high demands on the efficient design, planning and implementation of carve-outs. Extensive preparation is essential to achieve the highest possible process reliability for all parties involved. An experienced project team, management focus on the core business and the correct use of agile and digital tools is essential.²²

This article aims to highlight the common success factors that lead to an increase in the company’s value during the carve-out and acquisition process by drawing upon case studies. The case studies include selected acquisitions and divestitures of Aurelius Equity Opportunities²³ and demonstrate the authors’ best-practice experiences.

  

2. Aims and challenges of the carve-out

The conflicting aspiration of sellers and buyers in acquisitions are well known. However, the buyer can design the deal to keep strategic options open, while simultaneously incentivising the seller to enter the deal in their favour.

Successful carve-out management involves the balance of reliability, delivery capability, and efficiency of the process, on one side, and high degree of flexibility of the buyer on the other. The expectations of potential buyers should be flexible concerning scope, development opportunities, and standalone capabilities in the strategic design of the carved-out business.²⁴ Only this way the buyer can be granted sufficient freedom to implement strategic goals. An experienced deal and carve-out management team can identify, understand, weigh, and influence these factors (see figure 1).  

Source: own presentation

To achieve a high degree of flexibility, a vital part of the preparation process includes considering as many realistic deal scenarios as possible. These may regard the definition of the carve-out scope, deal process, and operational carve-out before the buyer/market approach. Depending on the strategy and course of events, the parameters can be adjusted, reaching from a full standalone to a minimal standalone approach.. ²⁵ A modular approach also facilitates the communication with the buyer regarding mutual expectations, timelines and costs (see figure 2).

  Source: Own presentation

Challenges in carve-outs often arise from underestimating the operational complexity and lack of experience of the deal and management team.²⁶ This is reflected in a lack of preparation and miscalculating timelines. A sales process once initiated, but insufficiently prepared often leads to the termination of deal negotiations with correspondingly high costs on all sides and lasting negative effects for the carve-out asset. In the course of the carve-out process, underestimating the complexity can lead to the operational business being neglected.²⁷ Often human factors are undervalued²⁸, such as the commitment and multiplier function of the management team and continuous transparent internal and external communication.

  

3. Carve-out process

The carve-out process can be divided into four phases: the strategy and design phase, the preparation, the implementation, as well as the transformation and integration phase.²⁹

The involvement of the buyer(s) typically starts in the preparation phase and varies in intensity depending on the strategy and competitive situation. In individual cases, however, an unnecessarily strong reluctance of the buyer to actively participate in carve-out planning and thus promote an optimized takeover and integration can be observed before closing. If competition law and other company-specific interests are safeguarded, an early open discussion should be sought. This helps to realize values on both sides.

  

  Source: own presentation

A carve-out management office (CMO) or a corresponding carve-out management team should ensure continuity and knowledge transfer throughout the entire process.[30. Joy (2018). Divestitures and Spin-Offs: Lessons Learned in the Trenches of the World’s Largest M&A Deals. Springer: 23ff.] 

Strategy and design: In the strategy and design phase, the essential cornerstones for the carve-out process are laid.³⁰ In addition to the selection of potential buyers and the way the process is conducted, the guidelines regarding the definition of the carve-out object, the timeline, and the carve-out approach (full vs. partial standalone) are defined.³¹ Further results of this phase are a complexity analysis and a rough concept for the future operating model. As a rule, the circle of people involved in this phase is kept as small as possible. ³² Digital tools such as data analytics and process mining help to maximize transparency with low personnel input. The definition of an optimal sales strategy today benefits by default from the use of consistent carve-out tools. Such tools visually support the scenario discussion regarding the definition of the carve-out object and the financial perspective, especially when core parameters such as product segments, geographical footprint or customer groups change. ³³ In practice, the establishment of a CMO and the development of initially lean project structures have already proven to be successful in this phase. A dedicated carve-out manager supports the M&A team with operational carve-out experience and transports strategic goals into the next phases without any losses.

Preparation: The preparation phase serves to create methods and structures, depending on the chosen approach (full vs. minimal standalone), in order to finally put theory into practice. ³⁴ In the first step, a project team is established. The focus is on creating a clear organisational structure and communication channels for the project and all parties involved in the carve-out.³⁵  These structures are defined during a kick-off meeting with the management. A key priority of the CMO/ project team is to relive the management during the carve-out, so that it can keep the focus on the daily business. Typically, the project team is extended to the second management level during this phase. In addition, depending on the approach and complexity of the carve-out, employees from relevant functions will be included on an individual basis.

In this step, the results and thus the main points of the complexity analysis are analysed in more detail and processed in a structured manner. In this phase of the carve-out it is essential to eliminate the last white spots so that they do not disturb the course of the project or even become deal breakers. Then a detailed carve-out concept is developed along with the operating model and the value chain (starting with primary and secondary corporate functions).³⁶  The aim is to develop a detailed carve-out concept that describes the transformation from the current situation (“as-is”) to the target situation (“to-be”). This also includes any TSA requirements, potential staff build-up or outsourcing solutions including the associated cost changes and one-off costs. This concept is not only the foundation for all further phases, but also serves as an information basis for a financial factbook and other sales-related documents. An operationally feasible carve-out plan based on the detailed concept is the result of the planning phase and the starting point for the implementation phase.

In this phase, the CMO ensures that a consistent methodology and baseline is used. Further, it manages dependencies between subject areas and workstreams and may use its experience to ensure that potential points of no return are shifted as far back in time as possible in order to maintain flexibility and design options and to avoid potential sunk costs.

The remaining part of the company should also be considered in the preparation phase. Here, structures and processes usually need to be reorganized to adapt them to the new circumstances.

Implementation: In this phase, it is important to effectively put planned steps into practice. At the time of implementation, the carve-out intention is usually known within the company and among the employees. This communication must be carefully planned and employee representatives must be included in this process at an early stage. It is crucial to accompany employees through the entire implementation process and to inform them transparently.³⁷ Thereby, the meaningfulness of the carve-out process, especially the personal future perspectives, must be highlighted.

Also in the implementation phase, care must be taken to ensure that day-to-day business is not affected. One to two months before closing, a Day 1 check should take place to identify whether all areas are prepared, all TSAs are defined and ready, and the necessary communication with suppliers, customers and other service providers has been completed.³⁸ This period usually offers the chance to eliminate any problems in a more focused manner. The cut over to Day 1 must be planned in detail and, depending on size and complexity, rehearsed. If the complexity exceeds a certain degree, phase models with staggered implementation have proven to be successful in practice. Despite thorough planning, there will be no 100% certainty that all eventualities have been taken into account – in some cases, general conditions will change during the process. If problems or new circumstances arise, it is fundamental that quick and clear decisions are made on how to proceed and, above all, that potential effects on the overall process are taken into account. An experienced CMO is often the key to success in bringing any tactical discussions that may arise to a factual level.

The buyer should be involved in this phase in a meaningful way and according to the approach. As long as timelines and effort are not negatively influenced, a lot of value can be maintained and created through open and transparent communication. It is particularly important here to ensure the Day 1 capability of the host organization or integration team.[40.Deloitte (2014). It’s not easy to say goodbye: Perspectives on driving divestiture and carve out value. Deloitte M&A Institute: 155ff]

Transformation and integration: The seller concludes the essential project work with a successful Closing. ³⁹ It must be ensured that TSAs start off correctly, are effectively managed over the term and that there is efficient ramp-down planning of the TSAs.⁴⁰ In addition, technical tasks such as Closing accounts must be created. The CMO should be maintained at least for a short period of time after closing in order to coordinate these activities and to hand over longer-term activities to the organization in an orderly manner and without loss of knowledge – also for subsequent carve-outs. Not to be forgotten is also the optimization of the remaining part of the company and the application of knowledge gained from the carve-out to this very part of the company.

On the buyer’s side, comprehensive preparation for the operational and organisational takeover is critical to success.⁴¹ In the following case studies, we show how elementary the first 100 days after the takeover are to set the right course and what relevance an experienced team of experts and the early exchange between buyer and seller have for value enhancement. No change process on the scale of corporate transactions can be planned 100% in advance. Unplanned developments have to be managed in addition to the fundamentally high complexity by new processes, systems, organisation and cultures and the resulting additional costs.⁴²  This additional expenditure must be sensibly cushioned so that planned synergies or turnaround measures are not endangered.

  

4. Carve-out Case Studies

4.1 Carve-out Med-Tech 

The first case study is a classic carve-out of a business unit of a DAX30 company that no longer belongs to the core business. An initial market approach was made without professional carve-out consulting and sufficient description/planning of the carve-out in the sales documents. The process was ultimately not pursued further. After another strategic review, a new attempt was made. This time, an appropriate carve-out management team was involved from the very beginning and was instrumental in steering the process.
This carve-out related to only one product group, a manageable turnover and a few production sites. The complexity was caused by a high degree of interdependence within the parent company (no separate division), globally distributed development and production as well as a large number of systems.
Critical to success in the first phase was the commitment to a narrow group of buyers (strategic) and a corresponding definition of the carve-out object. In the preparatory phase, reliable financial figures were prepared before the market approach was made. Also, the carve-out concept showed very clear areas that the buyer had to take on, and a corresponding TSA and SLA catalogue was drawn up. Through a cross-functional workshop, a very resource-saving process was chosen with the low time commitment of only two days for the relevant stakeholders, leaving the focus on the daily business. Based on the high level of transparency, a short deal process was possible. Likewise, the buyer was integrated into the project structures directly after Signing, within the scope of what was permissible. This reduced the phase between Signing and Closing to just under three months. The carve-out team was able to create transparency for all parties in the shortest possible time due to its experience and methodological competence, thus ensuring a short and successful sales process.  

4.2 Carve-out IT-Services

A similar situation can be described from the buyer’s perspective in the case of an IT service company. Here it becomes clear how, in addition to the early involvement of the buyer, the carve-out and transformation process should also be continued on the buyer side by an experienced operational integration team.

Aurelius acquired the company in the IT sector as part of a carve-out from a listed Dutch telecommunications group in 2012.

The target company was active in ten countries at the status quo, but did not have a holistic group strategy. Nor did it have an IT infrastructure separate from its parent company, independent financing or its brand. In addition to these operational challenges, the company operated in the low-margin workspace management segment with a declining customer retention rate. Missing financial transparency with a lack of standardized reporting and controlling functions on the part of the target made the tight due diligence phase of two months challenging. Aurelius was prepared to execute such a transaction, as they have an operational team ready to drive and ensure the repositioning and transformation from Day 1 at the latest. After the carve-out of the IT infrastructure and brand from the parent company, the first step was to set up a separate financing line. Key operational measures included the introduction of new controlling and management systems, the standardization of the tool landscape and group-wide performance tracking. A new cost-cutting program (outsourcing of logistics and reorganization) led to a general improvement in performance. With the help of the operating team, the service portfolio was streamlined and it focused from traditional workspace services to promising higher-margin products such as next-generation workspace, applications and cloud-based services as well as industry-specific solutions (airport management and healthcare). The key success factors for the transformation to an independent company were the additional support of the operational experts as well as the speed and relief of management in day-to-day business. Through five add-on acquisitions, the business was expanded sustainably alongside organic growth and was able to expand geographically as well as extend its product portfolio.

In particular, the most recent add-on acquisition, a leading European provider of cloud and hosting services, not only revitalized a business unit that was to be closed, but also expanded the product portfolio to include the strategically promising cloud market. This led to successful cross-selling activities with existing customers.

The seller, a European IT and telecommunications service provider, had previously announced a closure of the business unit. Consequently, the add-on transaction required close conceptual cooperation and rapid execution in order to stabilize the business and counteract initial trends of churn among customers. The complex transaction structure in the context of an asset deal in 12 jurisdictions also required the early and active involvement of the buyer in order to set the framework for the transfer of customers, suppliers and employees. In addition, previous core functions (in addition to back office functions such as finance, HR and IT, sales and business development) also had to be redesigned – this could not only be done from the buyer’s existing structures, but also required the expansion of a forward-looking sales force. Clear TSA and transparent agreements regarding the carve-out requirements were fundamental to implementing the business requirements in a future-oriented manner. Joint workstreams between buyer and seller supported, among other things, compliance with the deadlines set. In terms of communication, the buyer and seller needed to reach close coordination in order to make it both internally (future-oriented change management) and externally (customers and suppliers) effective.

After successful repositioning as an ICT ⁴³ partner for medium-sized and large companies, the company was successfully sold to a private equity-based strategist in 2017.

  

4.3 Carve-out Packaging Solutions

The case study of the transaction described below illustrates how the carve-out of parts of a company outside the focus area offers positive contributions for both sellers and buyers and, with the right approach, can establish sustainable competitive business concepts.

In 2015, Aurelius took over the solid board and printed cardboard division of the European market leader for corrugated board. The divested cardboard factories and packaging plants belonged to different units in the parent company and did not have their management team. Furthermore, essential group functions were not part of the transaction. The close coordination between buyer and seller was an important prerequisite for developing an independent company from the once non-priority peripheral area. The carve-out included the development of own IT infrastructures, the migration of existing data and the implementation of new financial and payroll systems. At the financing level, the company needed to set up new bank accounts, liquidity planning and its cash pool at short notice. In addition to new reporting structures and the implementation of a new pricing model, the company was also supported in building its brand. The parent company logos originally used had to be replaced, and new communication channels with customers were established. The specific carve-out issues in this transaction show that buyers in complex corporate spin-offs should already be actively involved in carve-out planning to ensure a smooth takeover and subsequent standalone capability.

In the further process, the operations team initiated the following measures: the carton board mills and packaging plants were bundled into one organization through vertical integration. The establishment of a company-owned service centre, improved performance management tools and new KPIs led to a long-term improved cost structure. The establishment of central support functions and regionally networked teams laid the foundation for the new organizational unit. With a new management team, the company was able to lay the foundations for further organic growth in the next step. Three strategic add-on acquisitions with high synergy potential enabled geographic expansion and a sustained increase in operating efficiency. In 2019, Aurelius sold the company, a growing and established European producer of packaging solutions, to a private equity fund focusing on growth capital.

  5. Conclusion and outlook

The degree of professionalization of carve-out processes and management has continued to increase in recent years. However, resource and time requirements and complexity are still frequently underestimated. In our experience, a lack of communication and transparency between the parties involved and a lack of experience are the main obstacles to efficient carve-out processes and prevent the (timely) realisation of value potential. An early exchange between seller and buyer is often underused and efficiently managed, taking into account the legal and competitive framework.

In order to overcome these challenges, the interaction of an experienced deal and carve-out management team is a key success factor on the seller side. On the buyer’s side, a clear strategy, effective implementation of key measures in the first 100 days, and a focus on optimization and growth are critical to success.

In the case studies discussed, the combination of a realignment of the business model (operating model), potential restructuring and sensible expansion through further acquisitions proved to be a particularly successful model for the further development of outsourced parts of the company, often as part of a buy & build strategy. Experience and speed are essential, along with clear communication. Major integration activities should be completed after the first 100 days or so to free up resources for further add-on acquisitions.

Carve-outs and divestments have shown that they are suitable for revitalizing divisions and creating and expanding value. If properly managed, divestments as an instrument of active portfolio management are a valuable option for sellers, buyers and the affected part of the company.

We expect that a further deterioration of the economic situation will attract more and more specialized investors, so that well-managed carve-out processes are a sensible option for all parties involved, even in a tense economic situation.