Selling, Not Just Buying: How CFOs Can Spin Off Assets at Premium Prices

When people think of M&A, it is typically from the perspective of the buyer. After all, M&A stands for mergers and acquisitions. But in fact, there are two sides to a transaction, and the CFO is likely to be on the selling side at some point. 

In a recent report, EY has chosen to focus on divestments because, writes Steve Krouskos, Global Deputy Vice Chair, Transaction Advisory Services, “the divestment of non-core or underperforming businesses is now widely seen as a key way for companies to fund the next phase of growth.”

Shareholder activists tend to get involved when the market perceives that a company does not appreciate the inherent value in its portfolio of businesses and is slow to act”

The Big Four accounting firm cites its survey of 900 global corporate C-suite executives as evidence. According to Global Corporate Divestment Study: Learning From Private Equity, nearly half of respondents said their company plans to divest in the next two years, with 46% open to the possibility.

But many of these companies “will struggle to generate maximum value from their divestments,” says Paul Hammes, EY Global Divestiture Advisory Services Leader. One way to fix this is to study the leading practices of organizations that excel in finding value.

He means private-equity firms, which Hammes describes as “serial buyers and sellers, expert at locating hidden upside in companies . . . [and] often exit at a multiple that many times the original purchase price.” As well as the 900 corporate leaders, EY also surveyed 100 private equity executives and analyzed external data on nearly a decade’s worth of divestments.

The researchers concluded that CFOs can ensure divestment success with the following action steps:

  • Assess portfolio of businesses regularly
  • Compile accurate and comprehensive data
  • Make sure analytics provides critical answers
  • Improve information sharing
  • Develop consistent execution procedures

Assess your portfolio regularly

“Our survey shows a clear link between frequent portfolio reviews and divestment success,” write the EY researchers. Analyzing how frequently companies that had high-performing deals (measured by impact on valuation multiples) reviewed their portfolio of business, they found that 48% conduct quarterly reviews. Only 29% does so every two years.

The researchers also found that more than one quarter of private equity firms carry out portfolio reviews every quarter – compared with just 7% of corporates. “In all, nearly half of PE firms conduct reviews at least twice a year as a matter of course,” they report.

EY suggests that corporates should conduch an in-depth portfolio review once or twice a year. They should also carry out a quarterly performance review to get a detailed understanding of their portfolio’s performance against plan, against macro market dynamics and against competitor actions. The findings should then guide them on whether any changes are required in their capital allocation and structure.

“There are other implications of infrequent portfolio reviews,” the EY researchers warn. “Shareholder activists tend to get involved when the market perceives that a company does not appreciate the inherent value in its portfolio of businesses and is slow to act.”

Indeed, 78% of the corporate executives surveyed say they expect the same or an increased number of unsolicited or hostile bids within the next year.

The importance of accurate data

Eight out of ten of corporate executives surveyed say poor-quality data makes it difficult for them to use analytics effectively. This is a big concern. Four out of ten of private-equity executives say lack of confidence in information is the most significant factor that causes a PE firm to reduce its offer price or walk away from a deal.

The EY researchers suggest that CFOs should work towards:

Producing more granular data. This includes gross margin, cost of sales and working capital, which are of course basic data that every company has, but not always in real time and easily broken down to their components. “PE firms empower their information systems to provide a deeper dive into business unit financials,” EY observes. “The costs of this effort are not inconsequential but should be recouped through incremental shareholder value over the long term.”

Setting benchmarks like an outsider. CFOs should align the key performance indicators they use for portfolio reviews with those that external investors utilize. This will help them value their assets as a potential buyer (or hostile bidder) would and ensure they price a divestment at market value.

Stress testing the data. CFOs should empower a portfolio management team drawn from different functional areas (not just finance) to run stress tests and make sure data is accurate and supportable.

Understanding business complexity. CFOs should consider the extent to which each business is integrated with the remaining company. This has implications on valuation and whether or not the business or some of its assets should be monetized. One example is overlap in customers, vendors and facilities.

The use of analytics is not just about tools. Companies should also take advantage of the massive amount of data that both they and third parties can now easily access

The critical role of analytics

In assessing business unit performance, corporate respondents say the most important types of analytics are predictive modeling (e.g., price elasticity, workforce analytics, sensitivity to market changes), commercial analysis (customer segmentation, market share, size and growth), and model multiple scenarios.

The researchers report that 42% of corporate executives say they need to apply more sophisticated analytical tools to their process. To their credit, says EY, 63% plan to invest in commercial analysis capabilities within the next two years. The majority plan to invest in model tax footprint and tax rate (53%) and predictive modeling (51%), while 48% intend to invest in model multiple scenarios.

But the use of analytics is not just about tools, EY reminds CFOs. Companies should also take advantage of the massive amount of data that both they and third parties can now easily access. A shareholder activist or a potential buyer may be able to uncover something that the company’s leadership did not know because they had not fully considered all potential sources of data.

These sources of data include social media, such as the opinions, comments and suggestions posted daily on Twitter (totaling a staggering half a billion every day) and “countless more” in reviews, blogs and other online forums. “These real-time, unfiltered opinions contain a treasure trove of intelligence that can help companies track market trends and extract insight for portfolio reviews,” write the researchers.

How does the CFO know that the company’s analytics tools and sources of information are adequate for divestment purposes? According to EY, they should be able to answer the following critical questions:

  • What are the true drivers of historical and forecast performance (financial and non-financial)?
  • What are the probable future outcomes for the portfolio under various assumptions, and how could this affect a deal as well as the remaining organization?
  • What strategic options offer the most value-creation potential?
  • What are the risk and return characteristics of each business in the portfolio, and what is the overall effect of their relationships and interdependencies?

Improving information sharing

It goes without saying that poor information sharing is a negative for divestment success. EY points to the case of a company that publicly announced the timing of a spin-off, but failed to consider alignment among the deal team.

Because of poor communications, the company discovered too late that there were several regulatory hurdles in numerous countries. The transaction was delayed by six months and the stock lost more than 20% of its value post-announcement, recouping its losses only after the business was finally spun off.

In making purchase decisions, 56% of private equity respondents say growth potential is the financial factor they prioritize, followed by the potential EBITDA and internal rate of return

The action steps that companies can take to improve communications include:

Making sure the M&A team has an open line to the strategy team and the board. Portfolio review protocols should be established so it is clear which businesses are on a watch list. Appropriate models, timelines and milestones should also be developed relative to pending transactions to allow for value enhancement.

It is also important to develop related stakeholder communications, including communiques to equity analysts, and align internal functional work streams with those of the company’s service providers.

Appointing a project leader to manage the portfolio review process. Enlist someone who is sufficiently senior and experienced to have the C-suite’s ear, suggests EY. This project leader should be empowered to mobilize the smartest functional leads, who are not always readily available, and make them accountable. “No external advisor can do that,” the researchers point out.

Managing internal conflicts of interest. Overcoming emotional attachments to assets and other conflicts of interest can be a significant challenge to reviewing the portfolio of businesses. EY has some suggestions.

  • During the portfolio review process, define objective evaluation criteria and discuss the review findings regularly in board meetings to support objective decision-making
  • Involve the business stakeholders in the process so they understand performance expectations and they feel it less like an event – or a threat
  • Once the decision has been made to divest, listen to employee concerns and explain the vision for the separated business. Involve business stakeholders in discussions with external advisors so they understand the potential opportunities for both the parent company and the separated business
  • Provide incentives to key executives to help ensure a successful transaction. For example, they can be granted retention payments, stock options and performance bonuses

And now to execute

So you’ve done the portfolio review, identified the asset or business that should be monetized, won buy-in from key executives and other business stakeholders, and clearly communicated to equity analysts and the markets your intentions and the expected gains. What next?

You should be able to make the asset easy for others to buy and also create competitive tension, says the EY report. “The value story should clearly articulate the future value of the separated business, which often deviates from the current operating model under the current corporate umbrella.

Companies should also develop consistent execution procedures across their divestments, which only 36% of corporate respondents say they have done. These include continuing to create value in businesses that are intended to be sold, providing credible information to buyers, and valuing and communicating the potential synergies of the divested business.

In making purchase decisions, 56% of private equity respondents say growth potential is the financial factor they prioritize, followed by the potential EBITDA and internal rate of return. “It is therefore incumbent upon sellers to employ data analytics (e.g., social media, predictive analytics) as well as traditional commercial diligence to help buyers understand the growth potential.”

Finally, even before a successful divestment, the CFO should also consider how to use the proceeds. “Seventy percent of our respondents used the funds from their previous divestment to grow their core business,” report the EY researchers, “through investing in new products/markets/geographies or acquiring a complementary business.”

For Asian businesses still spooked by the 1997 financial crisis and the 2009 global crisis, the temptation may be to simply add the proceeds to their already massive reserves, on the theory that cash is always king. That may be true, but in today’s volatile and globalized business environment, we at CFO Innovation think an overly healthy cash flow can be counterproductive.

It can attract hostile bids and stakeholder activism like a swarm of bees to honey. The best course includes returning some of the proceeds to shareholders and utilizing the rest for growth – and anticipate the next round of divestment.

About the Author

Cesar Bacani is Editor-in-Chief of CFO Innovation.

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