Selling a Non-Core Asset That will be Relied Upon For Future Service
Corporations continually re-evaluate their strategy to focus on the services and products they provide. Oftentimes this exercise results in a need to divest certain non-core assets; owning them is not key to achieving the corporation’s mission. In rare instances, divesting these non-core assets can have profound consequences for the remaining business. We will focus on instances in which the Seller (“Parent”) owns a business that provides services to its existing clients, and those services are non-core to management’s long-term strategy. This situation can present several dilemmas, but the focus of this post will concentrate on considerations related to the economics of the divestiture.
Typically, maximizing value is a main deal objective for a Parent when divesting a non-core asset. In the case where a Parent is a significant client of the divested subsidiary, buyers will be focused on this relationship and the impact it will have on the value of the business. In order to maximize the value of the asset, the Parent must clearly define its intentions to remain a client of the business. The manner in which this is done should give potential buyers confidence that the Parent will not terminate or reduce its business with the business.
One potential dilemma that may arise for the Parent involves maintaining the ability to shift business away from the non-core asset to get less expensive, and/or higher quality service. The buyer, of course, will be focused on maintaining the deal economics, especially when the Parent makes up a majority of the revenue. The buyer is interested in locking the Parent into a long-term contract or an exclusive provider arrangement, or both, so that the revenue stream is guaranteed. While there is typically not a perfect solution for this dilemma, the following are some solutions and some things to consider.
When the Parent makes up the lion’s share of the subsidiary’s revenue and the buyer is keen to keep revenue from the Parent around for a while -- and possibly grow it -- the buyer will want a long-term revenue commitment or an exclusive provider arrangement from the parent, or both, to protect the deal economics. We will assume, for this example, that the Parent needs the flexibility to pursue lower cost or higher quality alternative service providers. Given these dynamics, a solution to this dilemma is tenuous as the buyer and seller may be at odds over a key deal issue. We will assume that the Parent will require some level of service from the subsidiary over the near to medium term because of existing service requirements; signing up to a medium-term contract extension or a minimum revenue commitment that declines over time should bring the buyer and seller closer to an agreement. At this point, it may not make sense for the buyer to keep its demand for an exclusive provider arrangement with the seller unless the buyer expects to be unable to grow the business with external clients.
A different dynamic may arise when the non-core asset has value to external clients, but is designed and operated to solely serve the Parent. In this situation, the buyer will likely be an entity that has the ability to unlock value within the asset by expanding the client-base of the subsidiary beyond the Parent. In this scenario, it is likely that the parent would be interested in signing a long-term contract and potentially an exclusive provider arrangement (with appropriate service level agreements) in order to take advantage of the lower cost, or higher quality, the buyer’s expertise would provide.
Prior to bringing an asset to market, it is important for the Seller to thoroughly evaluate its position with regard to its ongoing commitments to, and future expectations of the non-core subsidiary. This evaluation process may lead to other questions not covered in this blog post, such as, “How do we find a buyer that can meet our transaction hurdles, as well as our commercial needs?” Furthermore, the seller may want to contemplate how transaction value may be affected by commercial needs, define a set of prioritized goals, and set internal stakeholder’s expectations accordingly. If the Seller has taken the steps to do these things, it should be better prepared to work with a buyer, satisfying the acquirer’s economic expectations and asks within the framework of the transaction, and achieve a successful outcome with the most appropriate owner of the business going forward.
About the Author:
Scot Bailey was most recently the Vice President of Mergers & Acquisitions at Conduent, Inc., a $6.5 billion leader in the business process outsourcing space. In this role, Scot was responsible for working with senior business executives and the corporate strategy teams to evaluate the strategic and financial fit of potential acquisition candidates. Other responsibilities included valuation of potential acquisitions, negotiation of transaction related documents, management of due diligence teams and maintaining relationships in the investment banking and deal intermediary community to ensure consistent acquisition deal flow.
Additionally, Scot was responsible for internal investment theses and the creation of approval documentation for potential acquisitions. During his nearly 14-year tenure at Conduent, Scot assisted in the completion of more than 50 transactions with a total enterprise value of more than $2 billion, across multiple business lines.