Corporate divestments fuel European buyouts

Francesca Veronesi
13 January 2020

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Carve-outs and spin-outs accounted for a larger proportion of European buyouts last year, although the challenges associated with the deal type continue to daunt private equity players. Francesca Veronesi reports

An increase in the number of buyouts in which corporates sell a subsidiary has been noticeable in the past year; such transactions represented around 14% of all buyouts in 2019, up from 11.5% the year before and 10% in 2017, according to Unquote Data.

This ties in with market sentiment. The volume of corporates looking to sell some of their European assets was predicted to be higher for 2019 than for the previous year, according to 65% of participants in the Aurelius Equity Opportunities corporate carve-out survey, published in June last year.

The lion's share of PE-backed corporate divestments in 2019 were located in the UK (around 23%), followed by France and DACH (16% each) and the Netherlands (10%), according to Unquote Data. Respondents to this year's Aurelius survey predicted that the UK will see the most divestment activity, driven by continued uncertainty around the outcome of the Brexit process. However, even in France, a region in which such deals have been historically less plentiful than elsewhere in Europe, a carve-out come-back has been apparent, as reported by EY's Corporate Divestment study, published in 2019.

Asked what the biggest catalyst for divesting is, 63% of respondents to the Aurelius survey picked the need to focus on core business areas, 14% the need to free up capital, and 9% came from opportunistic or unsolicited approaches from potential buyers. Says Aurelius Equity Opportunities' UK managing director Tristan Nagler: "Divestments allow the parent business to reduce its debt, as well as free up capital and time to dedicate to its core and higher-performing businesses. Moreover, activist shareholders are encouraging the spin-out trend."

In the current environment of high multiples, PE firms are also more willing to enter auctions for non-standard deals, such as corporate carve-outs and other primary deals: "Auctions for peripheral or unloved divisions of larger businesses can be less competitive, and the valuations less aggressive, than those for whole standalone businesses," says Nagler.

Hard work pays off
The complexities connected to the strategy explain why carve-outs are not for everyone, and why their statistical prominence has declined in Europe over the past two decades despite this latest revival.

Having previously been part of a larger group, a divested business is not always structured to operate on its own. The easiest acquisition from a corporate is of a division that operates independently from its parent for the most part, though this is less common – usually at the time of sale these businesses are highly integrated with their parent.

Steve O'Hare, senior partner and UK country head at Equistone, says: "Divestments are in most cases sourced via auctions orchestrated by the parent company. The management team of the subsidiary may not be used to or even have been previously anticipating PE backing."

The human factor in these transactions can indeed be challenging to navigate. A GP needs to assess whether the management team will have the capabilities to deal with the change of running an independent business. Says O'Hare: "Even management teams who are suitable are not always complete; hence many carve-outs require the GP to leverage their network and help with additional senior appointments."

Aurelius's Nagler adds that a transitional service agreement needs to be put in place, so the former parent company can provide some support for months or years to ensure continuity following a deal. "As a result, assessing the overall cost of the acquisition is in some cases difficult and due diligence takes longer," he says. Finally, Nagler explains that a consequence of these kinds of buyouts is that the carved-out business needs to be rebranded, as it can no longer use its former parent's name, which is a tricky process to get right.

These deals are more complex, require greater support after acquisition, and the investment can be riskier. "However, when carve-outs are executed properly, the value creation opportunities and returns on exit can be considerably higher than buyouts and SBOs," says Nagler. "A number of advisers have specialised in supporting spin-out transactions, which is very helpful for GPs when conducting due diligence."