May 2022 Issue
Although the appetite for spin offs and carve outs has been adversely impacted by market turbulence and a challenging macro environment, investors remain focused on using divestment to increase their cash resources and shore up their balance sheets. Those with large amounts of ‘dry powder’ have played a particularly active role, as have special purpose acquisition companies (SPACs) – adjusting portfolios and charting new strategic paths, while ultimately unlocking value for shareholders.
FW: How would you describe the current environment for corporate carve out and spin off transactions? What level of appetite are financial and strategic buyers demonstrating for these opportunities in the current market?
Hensel-Roth: There is strong appetite out there among investors to look at carve outs and spin offs. What we see is that the underlying make-up of many industries and therefore linked value chains are changing. There are various factors driving this. Most prominently, the impact of decarbonising entire industries and supply chains is significant. Think large steel production and other heavy industries, automotive, and of course energy. Also, the world is still coming to terms with a new form of post-pandemic globalisation. All of this has people busy trying to identify what known business models will disappear, and what future value pools will emerge. Focusing on the energy industry, we see this across almost all sectors. For example, power supply markets, where high and volatile prices, low margins and the importance of being able to maintain significant hedge positions, are driving consolidation. Even before the current price crisis, we saw companies spinning off some of their books, carving out IT systems to reposition in the market and create leaner growth platforms. Also, integrated utilities that own assets across renewable and fossil generation, distribution and storage have been trying to position themselves for success against the backdrop of the energy transition with spin offs and carve outs, by separating dirty from clean assets, future from legacy businesses, growth from declining businesses and so on. Finally, there is a lot of capital in the market. Combined with shifts in industry and against the backdrop of the outlined trends, it makes sense for buyers to look at carve outs where one believes value can be created.
Bonnie: At the present time, the appetite for corporate carve out and spin off transactions, along with equity capital markets activity more generally, has been adversely impacted by market turbulence and a challenging macro environment reflecting concerns over inflation, energy and commodity prices, rising interest rates and, most immediately, uncertainty from the war in Ukraine. Although it is not an ideal time to go to market, these are transactions that tend to be driven by long-term strategic and competitive rationales rather than a short-term market opportunity. Given the significant lead times involved, present market conditions should not dissuade businesses for whom a spin off or carve out is strategically compelling from beginning to prepare for such a transaction and to be ready to execute whenever conditions improve. Companies and their boards will always regularly engage in portfolio review and seek strategic options that can create value for their owners, and a carve out or spin off is a proven way to do this where the embedded value of a particular business does not seem to have been given appropriate credit by public markets.
Katz: There has been a significant uptick in corporate carve out and spin off transactions in recent years. First, a number of companies are spinning off businesses, either in response to, or in an effort to avoid, demands by shareholder activists for companies to restructure their businesses. Generally, this is done to increase the company’s market valuation by spinning off a business where the full value of the spun-off business is not reflected in the market value of the entire company. The second reason that we are seeing more spin offs are the headwinds in the current initial public offering (IPO) market. Rather than selling 20 percent of a part of the company in an IPO, it may be more efficient to spin off 100 percent of the part of the company to the company’s current shareholders, which can address both timing and liquidity considerations. There is a robust market for carve outs today as private equity (PE) funds have significant firepower to deploy and many assets are eagerly sought.
Greenberg: We saw a pickup in corporate carve out and spin off transaction activity in 2021 compared to 2020, as the economy recovered from the pandemic, and early signs in 2022 indicate continued interest in these transactions. Companies with diverse businesses have looked to carve outs and spin offs as a way to unlock value and focus on their core businesses, while increasing their cash resources and shoring up their balance sheets. In addition, the appetite of financial and strategic buyers to acquire carve out businesses continues to be strong, and competitive auctions are common for attractive businesses. Financial investors with large amounts of ‘dry powder’ have played an active role as buyers in carve out transactions, and to a lesser extent, we have seen some special purpose acquisition companies (SPACs) show interest as well. At the same time, strategic investors continue to look to acquire carve out businesses as a means to bolster their existing businesses, generate growth and create value through synergies.
Glover: The market for carve out and spin off transactions, like the market for M&A transactions generally, was very active in 2021. Large numbers of companies used these deal structures to adjust their portfolios and chart new strategic paths. At the beginning of 2022, practitioners were optimistic that carve out and spin off volumes would remain high for the foreseeable future. More recently, inflation concerns, supply chain woes, uncertainty regarding the extent and duration of the coronavirus (COVID-19) pandemic and the military conflict in Ukraine have dampened this optimism. But deal activity is likely to continue at a strong pace. On the sell-side, companies continue to review their strategic plans and consider whether to sell or spin off non-core assets. Activists continue to stir the pot, encouraging companies to generate value by streamlining their business portfolios. And on the buy-side, both companies and PE firms continue to look for good acquisition opportunities.
“If the spin off cannot be completed on a tax-free basis, companies will often decide to sell the business rather than create a headache for their shareholders.”
FW: Could you explain some of the main reasons why companies might consider carving out or spinning off parts of their business?
Bonnie: A trend in public equity markets over the past decade has been the increased preference for so-called ‘pure play’ issuers over more diversified companies. Carve outs and spin offs allow a parent company to divest an ancillary business line so that both companies can focus on their core businesses. Management may conclude that separating an ancillary business line would maximise shareholder value because the separate parts of the larger business would be valued higher than the combined enterprise. This can be the case particularly where the businesses have different growth rates for which the equity markets are not providing enough credit or if the businesses attract divergent investor bases. The parent business and the carve out may also differ in their relative capital intensity and separation can allow both to implement balance sheet strategies and access to capital resources that are tailored to their respective needs. The separation may lead to top-line growth potential by eliminating operational or regulatory conflicts currently existing between business units.
Katz: Many spin offs occur because the parent company’s stock is undervalued. For example, if the parent company’s market valuation is $1bn and subsidiary A is projected to have a market value of $500m and subsidiary B is projected to have a market value of $800m, then if subsidiary A and B each trade separately, the parent company’s stockholders would recognise or ‘unlock’ an additional $300m in value. Another important driver of spin offs or carve outs is when a particular business of a company may be constrained by operating as a wholly owned subsidiary of the parent company if potential customers will not purchase goods or services from the subsidiary if it is owned by the parent company because they view the parent company as a competitor. Companies may also undertake carve outs or spin offs to attract employees who want to be paid using the separated company’s stock, rather than receiving the parent company’s stock as a consideration.
Greenberg: The principal reason why companies consider a carve out or spin off is to divest noncore or underperforming businesses and unlock value by allowing the separated businesses to be run independently and enable their management teams to be more focused on their own separate businesses and strategies. Investors generally have been supportive of divestitures as a value-enhancing action for companies whose operating results or market valuations are held back by businesses that are not achieving their full potential or are no longer are aligned with the company’s go forward strategy or priorities. In addition, the cash proceeds from a divestiture can provide the parent with needed liquidity to reduce debt and fund the growth of retained businesses. Spin offs and split offs have the added benefit that they can be accomplished on a tax-free basis, subject to meeting certain tax requirements. We are also seeing carve out sales being pursued to address regulatory concerns in larger M&A transactions.
Glover: A company often decides to divest a business unit because it concludes that continuing to operate the business no longer fits with its strategic plan. It may determine, for example, that the business offers fewer opportunities for growth or less profit potential than its other businesses. Or it may determine that the business does not fit well with its other businesses because it has different capital needs, serves different types of customers or requires a different workforce. A company may also decide to divest a business unit for financial reasons. If the company feels pressure to generate cash, selling a business unit to a third party in a carve out transaction can help provide a solution. Alternatively, it can structure a spin off so that it produces cash for the parent. For example, the parent might cause the subsidiary being spun off to incur new debt and distribute the proceeds to the parent. Finally, a company may conclude that a divestiture will help bolster a faltering stock price. In the past, the stock market has responded positively to carve outs and spin offs.
Hensel-Roth: There are several reasons driving decisions to carve out and spin off parts of a business – but at the end of day it is about focus, or better, refocusing where a business or shareholder thinks value can and should be generated and to raise or free up capital to do so. Policy and market regulation can be another underlying reason for carve outs and spin offs, just think about changes in taxation or unbundling requirements for specific industry sectors. Clearly, there are corporates that go through a refocusing exercise at times of distress, spinning off assets as a defensive move to focus efforts on core businesses. For others, carve outs have a more strategic nature to strengthen areas of the business that they believe will drive value and turn these into growth platforms. Additionally, there are often simply better owners and operators for a spun-off business outside the current corporate structure. Coming back to energy and the challenge of decarbonising our industries, a key driver for carve outs is to offload carbon-heavy assets and businesses that are difficult to turn into profitable and clean businesses. Additionally, chief executives are under increasing pressure to ‘green’ their portfolios and to comply with shareholder requirements around environmental, social and governance (ESG) ambitions and targets, as well as with increasing public pressure.
“Carve out businesses do not have a history of operating on a standalone basis and often are deeply integrated with the parent prior to the sale.”
FW: What are some of the common challenges and dealbreakers that tend to surface during carve out and spin off deals? What steps can buyers and sellers take to resolve or avoid such problems?
Katz: Spin offs and carve outs can face several challenges, the biggest of which is often tax driven. If the spin off cannot be completed on a tax-free basis, companies will often decide to sell the business rather than create a headache for their shareholders. One of the requirements in the US for a tax-free spin off is that there be an acceptable business purpose for the separation, which is not usually that difficult to find. These rationales can include an enhanced ability to attract employees, better ways to operate the business, and so on. Another challenge that can get in the way of a spin off or carve out is if covenants in the parent company’s debt documents prohibit or limit the spin off or carve out, particularly if the parent company is highly leveraged.
Greenberg: At the outset, parties must clearly define the perimeter of assets and liabilities included in the transaction. This can be challenging if there are shared assets or contracts that are important to each of the separated businesses. Parties may need to negotiate licences, service and supply agreements or other commercial arrangements to address these issues. In addition, while sellers typically seek to limit their retention of legacy liabilities of the divested business, buyers often want to limit their exposure to pre-closing risks. These differences can be overcome through negotiated indemnities and through the use of representation and warranty (R&W) insurance, which has become increasingly prevalent in carve outs. In addition, we are seeing increased focus in carve out negotiations on the allocation of risk related to obtaining regulatory approvals, particularly in light of recent regulatory challenges to announced deals. These concerns may be addressed through negotiated regulatory conditions, efforts covenants and reverse termination fees.
Hensel-Roth: From a buyer’s perspective, there are myriad things that can go wrong, but there are many steps that buyers can and should take. Most of it is common sense, such as the right level of due diligence, having people on board who not only understand the market, industry and ideally the target asset, but have active experience in the field. Depending on what and where you buy, regulatory risks can also be considerable. Take regulated infrastructure assets that can be subject to pricing or revenue controls and are often in the spotlight of regulators – who, in turn, are influenced by wider economics, what is going on in electorates or broader geopolitics, as we are currently witnessing. Underestimating the relevance of IT and digital capabilities is something we see as a particular hurdle. Where previously systems were important in enabling business operations, they are increasingly a core capability for businesses in most industries, often directly driving underlying business models. However, both management structures and due diligence approaches too often do not reflect their relevance accordingly and treat them as something of an inconvenient side issue.
Glover: The most common deal breaker relates to value. If a parent company that wants to sell a business in a carve out sale concludes that it will not receive an acceptable price, it will probably terminate the transaction. If a parent company that is planning a spin off concludes that the market will not value the newly spun off company’s stock at an attractive level, it will likely change its plans. One of the biggest deal execution challenges relates to the development of a clear definition of the business being carved out or spun off. What is the perimeter of the business to be divested? Can the assets and liabilities associated with the business be readily identified – and is the parent willing to part with all of them? Will ancillary businesses be included? Another execution challenge relates to the question of how to separate the business to be divested from the parent company. As a practical matter, the business is likely to be entangled in a variety of ways with other parent businesses. For example, the parent and target business may share intellectual property (IP), manufacturing facilities, employees and various liabilities. In addition, assets and liabilities may be housed in different subsidiaries around the world. Until the transaction planners have defined the perimeter and developed a separation plan, they will not be able to complete financial statements for the unit being divested.
Bonnie: Spin off transactions present management with a variety of challenges. These are transactions that require substantial time and management focus, diverting attention away from operating a company’s core businesses, and they involve substantial one-time costs. Carve outs and spin offs both require the functional and operational separation of a business that has been embedded in a larger enterprise. Operational entanglements and shared services, such as IT, accounting, legal and HR, must be identified and addressed. Legal entanglements, such as contractual relationships, licences, IP and branding, shared liabilities and credit support, must similarly be worked out. In addition to untangling and separation challenges, a spin off also involves the issues inherent in an initial IPO. The spin off company must gain the ability to operate independently as a standalone public company, with its own senior leadership and board and its own public company corporate functions, including accounting, financial planning and analysis, investor relations and Securities and Exchange Commission (SEC) reporting. Most spin offs involve support from the parent company in some or all of these functions in the first year or two after separation through a transition services agreement (TSA) until the spin off company has the wherewithal to function unaided. Unlike a spin off, where most aspects of the transaction are within the parent company’s control, a carve out sale implicates the challenges that come with any M&A transaction – the need to negotiate mutually agreeable terms with the prospective buyer and uncertainty about whether the parties will be able to reach such an agreement, as well as the need to address other matters such as corporate governance requirements, satisfaction of each party’s tax objectives and arranging bidder financing if applicable.
“A primary driver of spin offs is their tax efficiency. Unlike a carve out sale, a spin off represents an opportunity for a parent company to divest a business in a transaction that is tax-free to its stockholders.”
FW: How important is it for buyers and sellers to establish appropriate protective rights, warranties and indemnities in these types of transactions? What options are available to manage associated risks?
Glover: In carve out transactions, it is common for buyers to demand a full set of representations and warranties regarding the assets and liabilities of the business being sold. They are likely to focus in particular on a ‘sufficiency’ representation to the effect that they are receiving everything they will need to operate the business, and an absence of liabilities representation to the effect that they are not assuming unknown liabilities. They will further request that the representations be backstopped by an indemnity with generous caps and baskets. Sellers will vigorously resist these requests, and negotiations regarding the scope of R&W and indemnity coverage can become quite heated. In a hot deal market or a competitive auction, the seller may insist that the buyer rely on R&W insurance coverage rather than expansive indemnification provisions. They will tell buyers that they want a ‘public company’ style deal, in which the selling stockholders have no post-closing liability. More and more often, buyers are agreeing to this request, in part because they have become comfortable that R&W insurance policies provide adequate coverage.
Bonnie: The contractual agreements in the transaction will define the assets, liabilities, employees and obligations that are intended to be separated and those that are intended to remain. Demarking this division becomes more difficult the more closely integrated the carve out business is with its parent company. Dedicated resources and collaboration across functions, including with specialists in areas such as tax, IP and environmental and employee benefits, are necessary in order to ensure that the contractual agreements work as intended and to establish appropriate protective measures under circumstances arising prior to, at and after the separation. Further, although separation agreements can define the relative rights and obligations of a parent company and a carve out business as between each other, they may not be effective to bind a third party. For instance, a parent company might agree with its SpinCo that a particular litigation or other contingency is the spin off company’s responsibility, but frequently this will not stop litigants, creditors or other claimants from seeking recourse against the parent company anyway.
Hensel-Roth: Establishing appropriate protective rights, warranties and indemnities is important and provides something of a safety net. We have seen the need for these kinds of rights increase in the last few years. With COVID-19 resulting in a lesser ability to get into the nuts and bolts of an asset, we have seen examples of potential misrepresentation, and no matter how good the due diligence, there is always some level of uncertainty from a buyer’s perspective. It is hard to find all the skeletons. There also significant value in knowing what to look for in different asset types and how to best incorporate a robust set of warranty and indemnity (W&I) policies. Some key considerations include getting capable and sector-experienced risk advisers for the W&I, incorporating early W&I advice into the due diligence process, conducting a detailed and thorough due diligence effort, and starting W&I drafting early in the transaction process and not waiting until the last minute.
Greenberg: It is very important for buyers and sellers to establish clear protective provisions in transaction agreements to avoid unexpected issues in a carve out. Carve out businesses do not have a history of operating on a standalone basis and often are deeply integrated with the parent prior to the sale. Buyers may seek detailed representations and warranties about the divested business and interim operating covenants to preserve the value of the business. Sellers typically want to limit their exposure to retained liabilities related to the divested business and may seek a no recourse or limited recourse construct and require buyers to obtain R&W insurance to protect themselves. Given the limitations in insurance, buyers may seek specific indemnities for known or unknown risks, which may be in addition to insurance. In any event, buyers will need to conduct a thorough due diligence of the carve out business prior to signing to identify and assess these risks.
Katz: In a spin off, there are usually no buyers – it is generally the shareholders who hold the stock of the spun-off entity. However, it is very important that in the agreements regarding the spin off transaction, it is very clear which entity is responsible for which liabilities and to make sure that each company is indemnifying the other company for the liabilities that company is assuming. If there are no clear indemnities, one party may not be able to recover from the other party if it must pay off the other company’s liabilities. Moreover, when the spin off occurs, each company needs to be solvent; if there are insufficient assets available to cover the liabilities, the spin off may be unwound as a fraudulent conveyance, depending on the specific circumstances. In a carve out transaction that is structured as a sale, it is also important to be clear as to which liabilities each company is responsible for. In carve out transactions, it is more common for there to be representation and warranty insurance available instead of an indemnity, although this would need to be put in place at the closing of the carve out transaction.
FW: What role can tax liabilities play in making the deal more or less attractive for the parties involved? In your experience, what can companies do to structure a spin off or carve out in a tax-efficient manner?
Bonnie: A primary driver of spin offs is their tax efficiency. Unlike a carve out sale, a spin off represents an opportunity for a parent company to divest a business in a transaction that is tax-free to its stockholders. The rules in the US tax code that govern tax-free spin offs are exceedingly complicated and the preconditions for tax-free treatment can limit the candidate businesses for a spin off, as opposed to a sale. The parent in a spin off may ask the US Internal Revenue Service (IRS) to provide a private letter ruling that supports the desired tax-free treatment of the transaction based on its particular facts and plan for separation. Even if such a ruling is received, the parent almost universally receives an opinion of counsel confirming certain requirements for tax-free treatment, upon which the IRS will not rule.
Hensel-Roth: In almost all transactions, tax considerations are a high priority. This can relate to firms that want to move IP rights, functions or departments or IT assets and licences from one tax jurisdiction to another, which is something that happens frequently when businesses are carved out, restructured and subsequentially integrated into something else. There is also the use of deal-specific holding companies, which comes with its own set of considerations. All of this can trigger tax payments or liabilities and has implications for how a deal could be structured. It can further relate to looking at whether shared services in the previous parent company have historically been priced appropriately, which changes the underlying economics significantly, impacting the valuation of a deal.
Greenberg: Tax considerations can play a critical role in how a transaction is structured and its attractiveness to parties. Sellers typically seek to structure these transactions in the most tax-efficient manner possible consistent with business objectives, while buyers may place a value on acquiring the business in a manner that provides a step-up in basis of the assets acquired. Careful planning with outside advisers at an early stage of the transaction planning is key to obtaining the best possible result. Advisers can assist with the step plan for the transaction, identifying the tax implications and interdependencies of different steps and avoiding pitfalls. A key benefit of spin offs or split offs is that they can be accomplished on a tax-free basis. The tax requirements for effecting the internal and external separation steps are often complex and will need to be carefully planned for, including an assessment of the need for tax rulings and tax opinions.
Katz: Tax liabilities are important to consider when structuring a spin off transaction and tax liabilities need to be appropriately allocated in connection with any carve out transaction. Tax planning for these matters is an essential component to structuring the transaction in an appropriate manner. In some circumstances, the parties may want to pursue a tax ruling from the IRS to assure that the proposed transaction will be accorded the appropriate tax treatment. However, tax rulings can require a significant lead time and if not considered early, may impose significant delays on proposed transactions.
Glover: Tax liabilities and tax benefits can make or break a transaction. Carve out transactions are generally taxable to the seller, but parties may be able to structure the deal so that the buyer receives a step up in the tax basis of the target’s assets, for which the seller may seek additional compensation, either upfront in price or via a tax receivable agreement. In spin off transactions, deal planners will ordinarily take steps to ensure that the spin off qualifies as tax free to both the parent and its stockholders under Internal Revenue Code (IRC) section 355. When the parent plans to couple the spin off with a cash generating event, such as the incurrence of new indebtedness, it may be able to take planning steps that put cash in the hands of the parent company on a tax-free basis. Tax experts can also evaluate the feasibility of a so-called ‘Morris Trust’ or ‘Reverse Morris Trust’ transaction, in which the parent spins off a subsidiary and a third party then combines with the parent or the newly spun off subsidiary, respectively. If certain tax requirements are satisfied, the spin off and the combination can be completed on a tax-free basis.
“In a world that is changing rapidly, and in which companies feel constant pressure to respond to evolving conditions, carve outs and spin offs will remain a very useful tool.”
FW: When structuring the deal, what change of ownership considerations need to be made? What kinds of complications can arise when licensing agreements or asset distribution contracts are involved, for example?
Glover: Spin off transactions generally do not require antitrust approval. In a carve out transaction, by contrast, the buyer and the seller may need to make antitrust filings around the world. Because the US, the European Union (EU) and other countries are taking a much more aggressive approach to antitrust enforcement, obtaining the necessary merger clearances can be challenging. In cross-border carve outs, the buyer and the seller may also have to address increasingly difficult restrictions on foreign investment under the Committee on Foreign Investment in the United States (CFIUS) and similar regimes outside the US. Spin offs and carve outs that involve regulated businesses may trigger rules requiring the parties to obtain new licences from relevant regulators. In both types of divestitures, transaction planners may also need to obtain consents from counterparties under IP licensing agreements and other important contracts, as well as counterparties to other contracts that need to be split between, or shared by, the parent and the business to be sold. These consents may be difficult to obtain if the counterparties realise they have significant bargaining leverage.
Greenberg: Transacting parties will need to carefully assess the transaction’s impact on change of control and anti-assignment clauses in contracts, licences and permits. In the case of shared contracts, licences and permits, parties will need to consider how best to split, partially assign or replicate such contacts or address them in a licence or services agreement. In addition, there may be debt or guarantees in place that need to be addressed. It is therefore important for the divesting party to conduct self-diligence at an early stage to identify potentially problematic areas and determine how best to address them. The parent will also need to consider the steps needed to prepare the divested business to be ready to operate on a standalone basis and whether it will require ongoing services or other commercial arrangements from the parent to operate independently. In some cases, the parent may need reverse services from the divested business post-closing.
Katz: In spin offs and carve outs, IP rights and ownership must be carefully considered. For example, if the parent company is licensing a specific technology, can it transfer that licence to the new company? Will the spun-off company have all the permits, IP and licences it needs to operate its business in the ordinary course once the transaction is completed? These issues must be considered when the transaction is structured as it may not be possible to remedy a problem after the fact. In addition, if the parent company is licensing technology or IP to the spun-off company, the circumstances under which the licence may be further transferred should also be considered.
Hensel-Roth: There are a whole host of complex ownership changes that can arise when carving out or spinning off a company. With large corporates, large procurement contracts, for example, are often centralised, as are commodity trading or hedging services. These contracts often need splitting, novating or renegotiating completely. In the interim, services provided by the parent can continue to be provided to the carved out entity under a TSA. These allow both parties to go through necessary steps, such as providing sufficient time to unwind positions. The negotiation of a TSA, however, requires upfront understanding of the services in-depth, as well as commitment to a plan for the final separation. Brand and customer relationships also require careful consideration, as these can often be shared with the sell-side business temporarily.
Bonnie: Significant attention is required to craft the agreements governing the separation to effectively allocate assets, rights, liabilities and operations and to design principles and mechanisms that can address unforeseen issues, such as bankruptcy or termination risk for each party. Parties will need to undergo a careful diligence exercise when structuring the deal to uncover potential issues, including each party’s needs after closing. Existing proprietary assets should be diligenced to determine their rightful owner, which is ordinarily the primary user, and existing contracts will need to be reviewed carefully to determine whether a divested or retained entity is the counterparty and whether assignment, change of control provisions or other key provisions would be triggered by the transaction. For example, depending on the language in each contract and the applicable governing law, sometimes when a business that is a licensee or party to a contract is being divested, the transaction may be deemed an impermissible assignment due to the change in the owner of the carve out or spin off business, notwithstanding that the identity of the contractual counterparty did not change. Further, a partial assignment may not be permitted so as to permit the divested and retained business to share the contract.
“Establishing appropriate protective rights, warranties and indemnities is important and provides something of a safety net. We have seen the need for these kinds of rights increase in the last few years.”
FW: Looking ahead, do you expect to see more spin offs and carve outs in the M&A market? What underlying drivers are likely to continue or emerge?
Greenberg: I expect to continue to see spin offs and carve outs as an important part of the M&A market in the year ahead. The fundamental drivers for these transactions continue to be in place, although increased market volatility, macroeconomic uncertainty and geopolitical developments in 2022 may present headwinds for future activity levels. Companies with diverse businesses will continue to see divestitures as a way to unlock value, improve liquidity and enable greater focus on core businesses and strategies. In addition, we can expect to see a continued push by shareholder activists in support of carve outs and spin offs as a way to improve shareholder returns. Further, the strong interest of financial and strategic buyers in acquiring these businesses should continue to fuel carve out activity.
Katz: I see no reason why there will be fewer spin offs or carve outs for the foreseeable future, especially if the M&A market remains robust. Inflationary pressures should not impact these types of transactions. Companies with Russian business operations may find it more difficult to successfully structure these transactions in light of recent events, but this should not be an insurmountable impediment. In addition, as long as shareholder activism continues unabated, there will be a push for companies to split their business in order to create greater value for the activist, and hopefully the shareholders. Only if there are significant tax changes that it would make it more difficult to spin off companies on a tax-free basis, is there likely to be a significant diminution in these types of transactions.
Hensel-Roth: I expect to see more spin offs in carve outs, especially in sectors undergoing significant changes, such as industries where value chains and their underlying asset bases are starting to reshape, break up, and where new value chains and business models emerge. Transport, shipping and mobility, energy, critical infrastructure, heavy industries, steel, cement and chemicals are all industries impacted by various mega trends, such as the challenge to decarbonise entire systems. At the less asset heavy end, consumer-facing businesses and digital services are being reshaped by changes in customer trends and expectations, again testing existing and spawning new business models. All of this is a fertile ground for smart investors to look for the best deal to generate value, build a growth platform, but also for smart boards to refocus their strategies and divest businesses and assets that divert cash and focus on what is core to their own value proposition.
Bonnie: If US corporate tax rates return to levels closer to where they were before tax reform in 2018, the tax drag of carve outs and other strategic options will increase. This this may lead to companies utilising spin offs more frequently as the potential comparative tax advantage associated therewith will increase. In addition, a more restrictive posture by antitrust and other regulators may reduce the number of viable strategic buyers in carve out M&A. On the other hand, the recent proliferation of SPACs, which compete for transactions alongside traditional buyers, such as PE firms and corporates, may tend to increase the bid for attractive assets and make a separation transaction compelling to sellers even if it is taxable. Both carve outs and spin offs will continue to remain options that companies will consider when evaluating which potential strategic alternative can deliver the most value in each specific circumstance.
Glover: Notwithstanding near-term uncertainties, spin offs and carve outs should continue to be a prominent part of the deal making environment. Transaction volumes may go up and down, tracking the M&A market generally. But in a world that is changing rapidly, and in which companies feel constant pressure to respond to evolving conditions, carve outs and spin offs will remain a very useful tool.
Tilmann Hensel-Roth is a vice president in the energy practice of Charles River Associates. He specialises on the energy and infrastructure sector, specifically utilities, renewables, energy services, customer solutions and oil and gas. Mr Hensel-Roth advises on corporate strategy, M&A and transaction support, large scale transformation, as well as value optimisation and operational excellence. His work often focuses on challenges relating to the accelerating energy transition and the shift to renewable and low-carbon technologies. He can be contacted on +44 (0)20 7664 3649 or by email: thensel-roth@crai.com.
Stephen I. Glover is a partner in the Washington, DC office of Gibson, Dunn & Crutcher and recent co-chair of the firm’s global mergers and acquisitions practice. Mr Glover has an extensive practice representing public and private companies in complex mergers and acquisitions, joint ventures, equity and debt offerings and corporate governance matters. His clients include large public corporations, emerging growth companies and middle market companies in a wide range of industries. He can be contacted on +1 (202) 955 8593 or by email: siglover@gibsondunn.com.
Joshua Ford Bonnie is co-head of the firm’s global capital markets practice and co-managing partner of the firm’s Washington, DC, office. He is one of the preeminent initial public offering (IPO) lawyers in the US and regularly counsels public companies on spin offs and other significant strategic transactions, capital markets offerings and general corporate and securities law matters. His transactional experience also includes business combinations involving special purpose acquisition companies (SPACs). He can be contacted on +1 (202) 636 5804 or by email: jbonnie@stblaw.com.
Thomas W. Greenberg is a corporate attorney whose practice focuses on M&A, both negotiated and hostile, private equity investments, securities transactions and other corporate matters. Mr Greenberg represents public and private buyers, sellers and target companies, private equity firms and investment banks in a variety of US and cross-border acquisitions and dispositions, investments, joint ventures, restructurings and financings. He also counsels companies on shareholder activism, securities law compliance and corporate governance matters. He can be contacted on +1 (212) 735 7886 or by email: thomas.greenberg@skadden.com.
David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz in New York City, an adjunct professor at New York University School of Law and co-chair of the board of advisers of the NYU Law Institute for Corporate Governance and Finance. Mr Katz is a corporate attorney focusing on mergers and acquisitions, corporate governance, shareholder activism and complex securities transactions. He can be contacted on +1 (212) 403 1309 or by email: dakatz@wlrk.com.
© Financier Worldwide
THE PANELLISTS
Charles River Associates
Gibson, Dunn & Crutcher
Simpson Thacher & Bartlett LLP
Skadden, Arps, Slate, Meagher & Flom LLP
Wachtell, Lipton, Rosen & Katz