M&A Outlook 2022: The rising popularity of multinational carve-outs | Factors for success and failure

2021 has seen M&A-activity at its highest ever levels notwithstanding multiple disruptive trends, the pandemic, supply chain disruptions, geopolitical risk and increasing inflation. It is fair to say that these trends are likely to continue in 2022.

Pressure on businesses to keep their business models resilient and at the same time to focus on innovation remains unchanged. Business leaders focusing on innovation will need to continuously look out for attractive acquisition targets in an ever more competitive environment. Keeping their business resilient will force business leaders to review their business comprehensively to assess each business unit’s strategic fit, growth prospects and profitability.

For those businesses with a multinational footprint this review will likely reveal variation in growth and profitability within the same company. In earlier times, such findings would probably not automatically have meant a need for immediate board attention. Today, however, this has changed dramatically. Business leaders’ agendas have been accelerated by the pandemic which has come hand–in-hand with multiple disruptive trends such as sustainability regulation, digital transformation and disruptive technology. In this environment businesses now need to address inconsistent growth and profitability promptly, particularly so for listed companies in light of increased activist investor activity.

Typical carve-out scenarios

Two scenarios can be observed: Firstly, strong performing business units may be carved-out by a subsidiary IPO or trade sale, for example. Secondly, underperforming business units may be declared non-core and, in where restructuring is not an option, will subsequently be put up for sale. It comes as no surprise that in today’s time of disruption this prompts a disposal of non-core or old-tech assets. This is particularly true for traditional industrial businesses such as natural resources, automotive or mechanical engineering, which are acutely affected by this disruption.

Common pitfalls

There are a number of pitfalls dealmakers should be aware of when considering the disposal of a non-core business. Common hazards are:

• Blindness: Ignoring the signs of an underperforming business for too long will dramatically reduce exit opportunities and the market of potential buyers.
• Unrealistic timescales: Carve-outs are significantly more complex than straight-forward M&A deals. The more integrated the carve-out business is, the more jurisdictions involved and the more complex customer and supplier relationships are, the longer the preparation time will be need to be prior to formally kicking-off a sales process.
• Lack of design: Carve-out business with an inadequate operating structure will result in an unpackaged deal with a buyer certainly wanting to cherry pick the most valuable elements. Creating a pre-packed structure instead (e.g., prior to signing or, most common, prior to closing) will address that.
• Lack of resource: Carve-outs concern the entire value chain of a business unit which may generate millions in turnover, spread across multiple jurisdictions, employ thousands of employees, and have different levels of integration into the core business. Identifying the assets, employees, and liabilities pertaining to the carve-out business is a major task that cannot be managed without an experienced and sufficiently staffed project management team.
• Weak stand-alone capability: Neglecting the carve-out business’ need for stand-alone capability from closing will typically result in serious disruption for the carve-out business and increase the potential for disputes with the buyer. Choosing the right buyer, securing that buyer’s commitment to the business plan alongside agreeing the appropriate set of transitional services required for an agreed interim period will be key for the success of the carve-out (and buyer’s reputation).

Features of success

Whilst not losing sight of the common hazards, it is also important to assess the key hallmarks of successful carve-out deal-making, such as:

• Structure: Where there is time to pre-pack the structure, a well-designed target operating model will facilitate easy deal-making. For example, a single share deal in a pre-packed holding structure would be more favorable compared with multiple direct share and asset sales under different laws to the buyer in an unpacked structure.
• The buyers’ market: Kicking-off the sales process at the right time, i.e., not during or shortly before the carve-out business enters a period of distress, will create room for buyer selection even if the business is destined to decline over the next few years as a result of external factors, for example, regulatory change. To the extent that the carve-out business is in, or is close to, distress, alternative scenarios such as shareholding as a service (ShaaS) with a trustee structure to facilitate a restructuring might become relevant.
• Paying attention to employee matters: Various jurisdictions have strict procedures that give employee representatives far reaching consultation and information rights. These typically come with mandatory timelines meaning that the deal must not be signed prior to expiry of those timelines. Also, compliance with these rights will require additional preparation, e.g., in terms of information packages, consultation procedures and Q&A-sessions.
• Purchase price: The level of disruption currently seen across markets may negatively impact purchase prices (even to the extent the seller may need to pay a negative purchase price to the purchaser). Alternatively, the seller may be forced to agree payments of consideration linked to completion of identified financial milestones so that the buyer can focus its financial resources on the target business. 
• Using W&I: Using W&I in the carve-out transaction will certainly limit seller’s exposure to risk and facilitate negotiations. However, the appetite of W&I insurers may inevitably by affected by the level of distress a target may be in. Further, , seller and buyer both need to be aware that insurance cover depends strongly on the geographical footprint of the carve-out business, whether the carve-out is taking place prior to signing or, as is customary, between signing and closing, and the level of buy-side due diligence.

As multi-national companies strive to keep their businesses focused and innovative, carve-outs will continue to be an important feature of the corporate landscape. How such transactions are managed and conducted will impact the value to both sellers and investors, as well as the on-going viability and growth of the carved-out business and so planning and good execution will be key to the success of these deals.