Podcast Eight on Air : Deals & Disruptions !
29 Dec 2022
29 Dec 2022
The political and market conditions have drastically changed over the last nine months. In this episode of our podcast we are reviewing how much of an impact this will have on the world of carve-outs, transactions in which certain parts of the business are separated and mostly sold to a third party. Furthermore, we are debunking some myths about carve-outs, as if done well, employees should love carve-outs. Also carve-outs don't need to be lengthy and there are certain reasons why the future of a carve-out entity does matter to the seller. We are also providing many real stories of carve-outs that are literally thriving in post-COVID economy.
To listen the podcast 👉 https://eight-on-air.podigee.io/4-new-episode
Valerie Haller: Welcome to the podcast of Eight Advisory “Deals and Disruptions”. My name is Valerie Haller, great to have you all with us. Today, we will talk about carve-outs. With me are two men who in their jobs both have been around the block for some time: Curt Oliver Luchtenberg, Partner at Eight Advisory, an expert in transformation who has been a consultant for more than two decades. And Maximillian Schwab, Partner in the Corporate and Financial Services Department with Willkie, Farr and Gallagher. He advises financial investors, private equity houses and corporate clients on cross-border and national mergers and acquisitions. One of his specialties: carve-outs.
The political and market conditions have drastically changed over the last nine months. Today we want to review how much of an impact this will have on the world of carve-outs, transactions in which certain parts of the business are separated and mostly sold to a third party. Furthermore, we want to debunk some myths about carve-outs. I think we dare say that if done well, employees should love carve-outs. Carve-outs don’t need to be lengthy and there are certain reasons why the future of a carve-out entity does matter to the seller. We will also provide many real stories of carve-outs that are literally thriving in post-COVID economy. So please stay with us until the end of the podcast. It’s going to be worth it. Now let’s get started with our first question. Let’s start with the basics. What is a carve-out?
Curt-Oliver Luchtenberg: A carve-out is a legal and operational separation of a clearly defined business activity or business unit, which is then disinvested by the owner via an IPO, a spin-off or a trade sell. The post-carve-out entity is characterized by the fact that – with the exception maybe of some TSAs – it has to operate fully standalone after the separation. In a broader sense, we can also see entities that have been simply separated and put aside in the operating business of a larger conglomerate as a carve-out. This is often done to see how the business develops over time, for example, if it is uncertain whether it will grow or has any chance to survive. Therefore, I put it in a legally separate entity and watch how it is developing. Later on, you decide whether to re-integrate or sell it.
Valerie Haller: There are quite a few different types of carve-outs. Could you explain them to us?
Maximillian Schwab: First of all, there’s a difference when you look at the approach for that carve-out. As Curt-Oliver mentioned, there is the classical trade sale where the business unit is divested to a third party either by a share or asset deal. Then there may be an IPO where the business unit is brought to a stock exchange and hence fresh money is raised to a certain extent. There is also the spin-off, where a business unit is brought into a legal, separate entity and is initially still held by the same shareholders or within the corporate conglomerate, it always involves the parent company. However, that may be with a completely different view, because with an IPO as well as with a spin-off, it is merely or mainly done on the side of the current shareholder. Whereas in a trade sale, there is basically a third party involved very early on, sometimes even from day one, who will take over the company as the new shareholder. Hence the dialogue and the exchange are a different path than if you would see it as an internal measure in the first step. And that leads us to the second differentiator on the side of carve-outs, which is the situation the business that is earmarked to be a carve-out finds itself. One driver can be focus on the core business. We often hear about publicly listed companies, which find themselves forced to do something because they face conglomerate discounts, which have a commercially detrimental impact on a business. Although you believe in the carve-out business, you see, that fresh and additional liquidity is required that you cannot facilitate within the existing structure. Therefore, you would do something to get new investors and new money in. Last but not least, is the not so well performing carve out aka a distressed carve out where the business unit itself is not performing financially positively. As a current shareholder, I don’t see myself in a position, be it strategically or commercially, to turn that around. For that reason, I look for someone who has the expertise and the means to do so.
Valerie Haller: If we had to choose the approach to disinvest, which one is better right now?
Maximillian Schwab: Looking at the uncertainties that we are all facing these days it is hard to say what the drivers are. In the first instance, one would say that a spin-off as an internal measure where you do not have to deal with a third party may be favorable. However, this is something that creates a tremendous workload within the organization. So, leave aside the IPO, which in the current market conditions, everybody has more question marks than answers about. In my view, the typical favorable way would still be the trade sale as this can be achieved on rather short notice and requires fewer internal measures which often prove to be conducted in vain.
Curt-Oliver Luchtenberg: In my experience, it’s actually the case that very often they go dual tracks now. When they were planning for an IPO or spin-off, they were also having a Plan B, and the plan B was always a trade sale because it could very well happen that it’s not possible to place it at the stock exchange.
Valerie Haller: One would think that companies are keeping their feet still in these highly uncertain times, but they’re making portfolio adjustments, including carve-outs. How many have there been in the last 12 months in the German-speaking countries and how is the number developing?
Curt-Oliver Luchtenberg: The last exercise we’ve done was from 1st of June last year until the end of June this year. We accounted for about 400 carve-outs in the GSA or D-A-CH region. This is a number which has been very high, certainly in these 12 months. It seems to be slowing down a bit currently. But it’s hard to say because many carve-outs that have been initiated in the last 12 months still haven’t been completed or closed. So that is still going on. And on the other hand, we might experience an increase in distressed carve-outs very soon. We haven’t seen much of them yet, but the longer the inflation stays up or the crisis continues, the more we will also see distressed carve-outs in the future.
Valerie Haller: Should carve-outs always be on the agenda of business owners and managers, regardless of market conditions, because there is an astonishing level of activity despite these challenging times we’re seeing right now?
Maximillian Schwab: The short answer is yes. I think it’s a very important topic to talk about because there are a lot of misperceptions of carve-outs still in the market. Carve-outs are picking up again, and the different drivers of it are always a reasonably good opportunity to at least analyze the possibility of divesting the nonperforming business unit as well as to improve a financing position of a performing unit that needs access to free liquidity for further growth or to utilize a business that has not been in the focus of a large conglomerate. And especially nowadays where I guess it’s fair to say that today’s normal is not normal at all. Carve-outs, as they are always different and tailor-made, are a very attractive alternative route for growth in a post-COVID global economy, which, after we have digested those tasks to a certain extent, is facing a new and common economical world order.
Curt-Oliver Luchtenberg: Carve-outs should always be on the agenda of a CFO or CEO because there are so many different situations where you want to sell part of your business activities, even driven by growth stories. Or you might have a situation where you’ve got a very interesting business, but you don’t have the financial means currently to grow it yourself. Then, in the first step, you have to carve it out and afterward would bring it into a joint venture. Carve outs can therefore also mean growth, not only growth for themselves but also growth for the company that sells it because it then would keep a stake in the company.
Valerie Haller: Let’s have a look at sectors: where have most carve-outs been happening in the last 12 months?
Curt-Oliver Luchtenberg: Unsurprisingly, industrial manufacturing was leading the pack with around 25% of all carve outs because that’s the most precise sector description of them all. Next was TMT, including IT, which is a high growth market and where PEs are also very active buying portions which have been carved out. Energy transition is next and we all feel it day by day: companies active in this sector are certainly under high pressure. Take companies like Staerk for example, which is in the press currently. They need to put refocus on their business, which leads to carve-out activities. There are other important sectors like automotive, which need to refocus very much on electric vehicles. Then there are life sciences and healthcare services, which are split up and specialized. Additionally, there is the chemical sector where a lot of non-core businesses are carved out or portfolios are realigned between the different players. We actually expect many more in the future. In my perception, there might be a slight increase in automotive and chemicals in the future, but this ranking will remain very much unchanged.
Maximillian Schwab: I fully agree with Curt-Oliver and interestingly enough that you mentioned automotive and chemicals. because if you look at carve outs, it’s often an interesting look at the economic history of Germany. When chemicals come to carve outs, you remember the large chemical parks that were built around a plant of German chemical players dating back to the 19th century where they operated to park themselves all the infrastructure. If you look at chemicals ranging from food to very particular special chemicals, there are things in the portfolio that are so far abroad from each other that at a certain point in time people looked at the portfolio identifying areas that they are not really doing anymore. On the other hand, in the automotive sector, there was a large tendency in the seventies and eighties to integrate every supplier into the large corporate universe. Now companies are facing different challenges on a global scale which are putting all that to test again. Whereas there are other sectors that have only grown over the last two decades, for example IT, which again takes a different approach. So of course, it’s thrilling to be around that industry and learn a lot about how all that developed over the past partial 120/130 years.
Valerie Haller: So interesting, you look at the development of carve-outs and you understand a lot about the whole economy and how it’s developing and changing.
Curt-Oliver Luchtenberg: Actually, different sectors are often interlinked and not separated activities: For example, chemicals are very interwoven with the automotive industry. A lot of divestments have taken place in the chemical industry where chemicals were later used for automotive. Polymers, for example, are one area where you saw these divestments taking place in chemicals because of the change in the automotive landscape.
Valerie Haller: Isn’t it difficult to get everybody convinced that a carve-out is really a good idea?
Maximillian Schwab: The answer is yes and no. Obviously, the beauty of a carve-out in the first instance is that you get a business without a fully fresh start, but you can develop and build a lot of things from scratch while still having a core operating business model behind it. The great challenge, in our experience, is that you need to identify, either on the side of the one who is conducting the carve-out or at the company considering the investment, who needs to be involved and who is the knowledge bearer. This ranks from a separate corporate wise organised business unit in a separate legal entity to the worst thing I’ve done in my life in terms of nitty-gritty work: to buy a mere line item in the balance sheet. Of course, one of the main tasks is to identify who knows what about the business, what needs to come, and what needs to stay behind. But if you are able to foster and cultivate such dialogue in the first instance in the organisation that is carving something out, but then in a dialogue of the transaction, it may look like it turns out to be a very good exercise for all parties involved. That’s obviously where reasonable advisors can add some value as it’s often hard to moderate that dialogue with external sources and to ask the right questions while not getting lost in the woods because you focus too much on a particular item.
Curt-Oliver Luchtenberg: I think it’s not that difficult to convince somebody that a carve-out is a good idea. As mentioned before, there’s always a strategic situation in a larger corporate where a carve-out could make sense. For example, if you’ve got a business to grow and you cannot finance it yourself or if you have too many different businesses and want to really put a focus on your core businesses, then it’s good to carve out certain businesses and put them as a potential venture capital activity aside. Let it get new financing. Deutsche Telekom has started to do that very early to see how it develops and then later on they could either reintegrate or sell it. It’s always a strategic consideration. If you plan the strategy for your company, you need to consider carve-outs as one of the core strategic measures. It’s a part of the portfolio strategy you’re having.
Valerie Haller: We used to have a trend when companies used to be large tankers and they couldn’t be big enough. But the large tanker is not so much what we need or it’s not so much the trend anymore. Now we have small speedboats.
Curt-Oliver Luchtenberg: True. Although I think it’s kind of a fashion trend. I’ve seen a huge trend toward diversity. Then it was flashing back and a focus on core competencies emerged. Then we had diversity and diversification. Now, the trend is clearly toward focusing on core competencies again, which means having small and large boats. If you look at large conglomerates like Siemens, we see that they are already building a corporate holding structure for quite a while now. It’s not like the business is always about Siemens AG, but there are holding companies below Siemens AG. Take Siemens Healhtineers, for example, which has been separated, then brought to the stock exchange, but the majority is still held by Siemens AG.
Valerie Haller: Well, now that we’ve managed to convince everybody that it’s a good idea to go ahead with a carve-out, what’s next?
Curt-Oliver Luchtenberg: This is f the part where Max and us are interacting. First of all, it’s very important to identify the carve-out target and to set the guidelines for the game if you want so. Furthermore, you need to perform an exit readiness assessment in order to find out how complex it will be to do the carve-out. There are a few instances in which we had to stop a carve-out because it was too complex to separate it. Then we rethought and re-scoped. Scoping is a very important element to certainly defining what I want to sell. If that hasn’t been defined clearly, it is all going to be a mess. Afterward we need to design a carve-out story. Why are we selling it? The seller and the buyer will always ask for that. It’s even more important if you do a spin-off or an IPO, because then it’s an equity story. We need to analyse the impact on the remaining business, but also take a close eye on the situation of the business that’s being sold. After that, we typically design a blueprint, a selling document for the due diligence. Then we perform the due diligence and prepare the legal documents. Afterward the detailed planning of the execution in the end market follows. Max, what is your legal view on that?
Maximillian Schwab: I think the most important point that you stretched is maybe unlike the typical transaction scenario where the different groups of advisers work to a certain extent within their specific experience and then align at a rather later stage in a carve-out. Again, on both sides, it is an absolute necessity to have a strong interaction between the advising parties and the client from day one. Why? Because again, it’s great to identify what is required to have the business on a standalone basis. If you don’t prioritize the key factors that you need in the agreed form, or at least in agreed terms as soon as the carve-out is signed, or at least as soon as it is closed, what can be done in a transitional phase afterward? You’ll have to decide on that basis what needs to be papered when and what the drivers on the timeline are: When can you have it? Whom do you need? Let’s leave aside boring legal or technical matters like regulatory impact, antitrust, and assessment of whether liabilities can actually be assumed or not. Pensions are always a big issue. Can you take on the obligations of large corporate pension funds? Is it worth the same if you have, “Bayer AG Pensions Kasse” vis a vis a newly set up pension fund entity of an investor? That’s where we need to work together and pool all available in it. I like to call it working in swarm intelligence because that’s what gets you over the goal line.
Valerie Haller: There are a few myths around carve-outs – Eight Advisory even created a white paper on them. Let’s have a look. Myth number one: The seller doesn’t care about the future of a carve-out entity. True or false?
Curt-Oliver Luchtenberg: We have seen very often that the seller didn’t really care about the future of the target entity. That can be a big mistake for several reasons. We’ve seen quite a lot of companies who have performed after they had been standalone in a completely different direction. Others have performed well, but actually caused some trouble in the news because they were doing some business that the former seller wasn’t doing – but the former seller was still identified with that business. Everybody knew that this business was carved-out by the former owner. It was a negative reputation spillover now. Therefore, it’s very important to take a little bit of influence on the direction the carve-out entity is going. There are also situations in which you had a business that was very much interlinked with your business, meaning that you had cross-selling agreements, joint customers, and so on. It is very important to keep these links alive. Moreover, it can imply that there are a lot of redundant costs sitting with the seller – so why not do a joint venture in order to keep the synergies for both at a low level? We will come to that later when we speak about IT. There are a lot of reasons why the seller should take care of the future of the business that he’s selling.
Maximillian Schwab: I guess the myth here comes from a time when a carve-out was seen from a corporate perspective merely as a way to divest something that is not desired anymore and even benefit from the opportunity to get rid of some additional liabilities or the utmost liabilities at least. And on the other hand, purchasers came rather with the focus on getting their hands on the silverware whilst caring about the rest later, which has often caused negative media attention in terms of site closures, layoffs, and so on. This has tremendously changed as corporates do not want to have bad media behind them when they do that. On the other hand, the investor landscape has changed as well. Corporate raiders are not as present as they used to be on a global basis – especially in Germany as it may have been the case in the Wild West days of private equity in the late eighties and early nineties.
Valerie Haller: Myth number two: Carve-outs lead to significant dis-synergies.
Curt-Oliver Luchtenberg: Well, in principle, I have to agree. Dis-synergies are a natural thing to happen once I have a carve-out, but what’s often forgotten and why carve-outs often have been stopped is that you have got a lot of room for improvement. On the one hand, when you do a carve-out and you are not simply taking over the old processes/ systems, you’re reinventing the wheel to a certain degree by not using a huge SAP program anymore, but an easier program. On the other side, you can redesign the sales approach. I’ve seen it often that I had to really think with the management over how to sell the products. Now, after we established a huge network all across the globe, we had to find completely new approaches which in the end were much simpler, much more effective, but also much cheaper. There are a lot of reasons why dyssynergies can be avoided. In the context of PEs, what we have to see is that value creation measures can be taken because old structures from corporates still remain with the entity, and hence, we have a lot of potential for synergies.
Valerie Haller: Let’s talk about myth number three: Employees have good reasons to be afraid of carve-outs.
Maximillian Schwab: That’s still sort of a heritage myth coming from the early days that we just touched upon. I believe the opposite is the case. Obviously, it is a bit much to expect all employees to sing and dance once they learn about the carve-out.
Valerie Haller: Especially change.
Maximillian Schwab: Especially change. And as we are all Germans at this table, we are free to say that especially Germans have a certain reluctance to embrace change. Nevertheless, in all that I have seen personally, especially working for private equity investors on the buy side, it always brought along great opportunities for employees, namely people that may have never gotten such an opportunity throughout their regular career had it continued within a large corporate organization. You may ask why. First of all, it’s a chance to bring a startup spirit to a business unit. Think it new. Look at it new. Like Curt-Oliver said, rethink the distribution, rethink sales, rethink sourcing and get people on board. Maybe give them the chance to change the things that they had always thought will never be able to change because the chain of command is too high, and the level of attention is not there for merely operational matters that may bring a significant difference for a specific business unit because it doesn’t matter as much in a large corporate. If you really convey that message from the seller and the investor side early on, there’s a great opportunity to give people, a new way of looking at their job. Change is not as harsh as you think it may be because you can stay within the environment with which you’re comfortable. You know the business, you know the animals, know your friends, and know your enemies. Based on that, you can think of things new and approach them in a new way. My favorite example was a private equity client acquiring a chemicals business. There was a gentleman at the age of 55 who had been with the company for 40 years. He started as a blue-collar and was the site manager handling all the operational processes. The gentleman became CEO of the new business and, through a management equity program, co-shareholder. I think it’s prudent to say that by a mere change of employer from corporate to corporate, he would never have found a comparable opportunity. I guess it’s reasonable for employees to question the carve-out when they are confronted with it, to identify their personal role in it and ask specific questions as well as to make sure that they can play a role within the process. When I’m asked by people from my network whose business unit is getting divested, I tell them: Great, you don’t need an employment lawyer – you need to get into business and think about what’s on your wish list.
Curt-Oliver Luchtenberg: You need a career manager, right? Often when we are arriving, people are completely disappointed. They’re sad and feel anger towards their current employer. But actually, it’s one of the best career boosters you can have. I’ve seen so many people being promoted, and Max gave a good example. It’s just simple logic. If before I had just one CFO, then after I’ve got two now. If before I had just one HR manager, afterward I have two. There are a lot of new positions and for other employees, that means that they might move up the career ladder. In the end, some people get newly hired, because some synergies might always remain. In this respect, carve-outs even create new jobs.
Valerie Haller: There’s a lot of chances for employees, as you say. Let’s look at myth number four: Carve-outs take a very long time to be done with.
Maximillian Schwab: There are obviously a lot of examples from the past that would prove this myth to be true. But I would strongly object because this again leads down to what Curt-Oliver explained beforehand. It’s all about scoping and analyzing the scoping from an acquirer site because not everything needs to be there from day one. You need to identify what really is core, and what is something that I really need to have in the business to be standalone. And there are maybe other things that for that specific business are rather commodities and in the worst case could be sourced from a third party somewhere else. You really need to prioritize and have a list of things that you want to set in stone at the latest as of closing. For the remainder, we can identify terms and agree on certain time periods until we finalize that. If you approach it that way, you will be able to do it in a normal transaction time frame, meaning typically you will have merger clearance required, and then it’s three to four or five months between sign and close anyways, leaving you a lot of time to do the mere boring paperwork, assuming that everybody has done a proper job beforehand, discussing, agreeing and aligning on what needs to be there at what point in time.
Valerie Haller: Let’s get to myth number five, our last one: IT separation does have to be ready at closing. True or false?
Curt-Oliver Luchtenberg: This myth goes very much along with the last question we had because IT seems to be driving the length of a carve-out, but it actually doesn’t have to be ready at closing. We’ve seen several cases where joint ventures have been formed and for eg. shared services functioned as a separate legal entity. So not much had to be changed except for new company codes and some rearrangements of the services, which was a much quicker process. There was a large energy provider some years ago, that never would have made it to the stock exchange that quickly if he hadn’t separated IT as a shared service for the future. We spoke about the German attitude, and perfectionism: I’ve seen numerous discussions where the IT heads were debating on how to separate emails in order to find out what portion of the emails should go to the target and what should remain with the seller. In this ridiculous situation, we have to focus on the important stuff: There will always remain a certain legal risk that the other party gets some legal content. But if they still have an interest in working together, they will never use it against the other one. If it’s sold to a competitor, you have to be a little bit more careful. But if it’s sold to private equity or it’s a firm or a management buyout, then we don’t have to be perfect.
Valerie Haller: Okay, so a little pragmatism is helpful. Maximilian, anything you want to add to it?
Maximillian Schwab: I think the one thing that proves around IT is to think out of the box as every carve out is different. As a Partner of an American-based law firm, it’s often funny to see when German perfectionism hits the American approach. Let’s kick the can down the road or let’s cross a bridge once we get there. The list of pictures is long. The truth lies, as always, in between. And the task is to identify that jointly and not get lost in detail where you have a bigger fish to fry. Again, the standalone ability doesn’t have a list of checkboxes that are identical for every carve-out, but that need to be set up by all players involved. And then it’s actually fun work to do if you have that basis.
Valerie Haller: As I understand, carve-outs are quite a heavy task, especially in the current market conditions. What would you say? Is it harder now?
Curt-Oliver Luchtenberg: It’s clear that it is not an easy job because there are a lot of complex details and time pressure. You don’t apply German perfectionism. That is certainly increasing now because if you need to generate fresh money or free up your capital, you have to do it as soon as possible. I expect that the time available for carve-outs will shrink in distressed situations. Therefore, it is going to be a lot tougher and tighter for all of us.
Maximillian Schwab: I guess it’s important as well, that the mindset of the people that are potentially addressed as a carve-out investor is open beyond the request to really know everything about the industry and the business because you can be a successful investor post-carve-out if you have a reasonable and good understanding of the industry that you’re looking at. Someone approaching an industry he has never been in but always wanted to because it looked attractive shouldn’t probably start with a carve-out. Everything beyond that can be set up individually, be it with advisors or the help of the seller. That is a large opportunity, especially in the difficult market conditions we’re facing right now. I’m still an opportunist and try to see my glass half full, where we are not looking at a changing economic landscape for the next 20 years and a persistent downturn, but a situation where those that address challenges and take the opportunity have a great chance to thrive, inter alia, through well managed and advise covered transactions.
Valerie Haller: Thank you.
Curt-Oliver Luchtenberg: Valery, one question to you? Have you experienced any carve-outs in your professional career? Or have you ever come across the word carve out before?
Valerie Haller: I’ve been reporting on business news for way over 20 years. So, yes, I did. I did report on carve-outs, but I never named them carve-out because I just can’t get too technical. I’m not reporting for the business news channel of a large TV network. And obviously, the people who are listening to us, they are not experts. And therefore I have to sort of talk around it a little bit and explain it without calling it carve-out and making it too technical. But I talked about RWE, I talked about Siemens and yes, I’ve seen quite a few of them.
Valerie Haller: Thank you, Max, thank you Curt-Oliver. I really did learn a lot and can’t wait until I report the next time on a carve-out. We’re coming to the end of our podcast. If you, dear listeners, have any questions, you’re more than welcome to get in touch with Curt-Oliver and Max. You find their contact details on our website. Thank you for being with us Curt-Oliver and Max. Dear audience, thanks for listening to our podcast “Deals and Disruption”.