Divestitures: look before you list

Selling a company is a big step for anyone, be it a family business owner or a private equity firm. So what separates deals that succeed from those that fail? Often, it’s the planning that’s done before taking the business to market
By Robert Olsen
With Adam Brown and Brian McKenzie

Whenever we see articles on M&A, the typical focus is the number and dollar value of successful deals closed versus the previous year. However, much less is written about the number of divestitures that are planned but don’t close, or the ones that close but didn’t achieve the expected purchase price.

The year 2007 set the record in this regard, when deals worth US$933 billion failed to close, according to Dealogic. Volumes in 2008 were almost as high, when the credit crunch hit. Now, half a decade later, they’re rising again (see first chart). But why? Sure, weak commodity prices in the energy market are not helping matters and perhaps economic weaknesses in the BRICs are contributing as well. Failures tend to rise with overall M&A volume, too, and 2015 was a record year for M&A. But what else? Could it be inadequate planning prior to sale?

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The first rule for a successful divestiture is to plan, plan and plan some more, and then take meaningful action well in advance of a transaction. This is how you will ensure your business is appealing to the right set of buyers, and that you will receive top dollar. It will also ensure that your business is ready to stand alone or be integrated with another company. Listed below are three areas that sellers should pay close attention to prior to launching a sales process.

1. Maximize EBITDA before sale. Maximizing EBITDA (earnings before interest, taxes, depreciation and amortization) prior to sale will directly translate into a higher sale price as most often sales prices are anchored by a multiple on EBITDA. The key to maximizing EBITDA is to adopt a mindset of relentless value capture. That starts with performing a detailed business review and identifying areas where value can be captured, then developing and executing an implementation plan. A typical review uncovers opportunities to enhance EBITDA by improving customer and product profitability, SKU and service mix, organizational capabilities and processes, and reducing general and administrative costs. While opportunities could be guided by benchmarks of sector-leading businesses, improvement initiatives should be designed in the context of each business’s unique circumstances.

A notable example of successful EBITDA optimization was the increase in Gillette’s EBITDA from US$2.2 billion in 2001 to US$3.7 billion in 2005, leading up to its sale to Proctor & Gamble. Much of the credit for Gillette’s optimization was given to CEO Jim Kilts, who was parachuted in just a few years prior to the sale. While much attention was paid to Kilts’ accomplishments on the sales side—he grew sales of the personal care giant by 9% year-over-year from 2001 to 2005, it was his relentless focus on taking out costs, reducing working capital and instilling financial discipline that led to a 15% compound annual growth rate in EBITDA during that same time period. Warren Buffett aptly praised Kilts’ successes in his 2005 Berkshire Hathaway annual report by saying: “Upon taking office at Gillette, Jim [Kilts] quickly instilled financial discipline, tightened operations and energized marketing, moves that dramatically increased the intrinsic value of the company.” The benefits were reaped in spades when P&G paid $56 billion, or more than 15 times EBITDA for the business.

2. Sustainable revenue. Revenue quality is one of the most critical factors that both financial and strategic investors will scrutinize before buying any business, particularly those in cyclical sectors such as manufacturing, where sales cycles can be lumpy. A prospective buyer will look for a strong pipeline of sales from diversified sources, and clear data-driven evidence to demonstrate a loyal customer base and a high level of certainty in collecting revenue.

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Performing preparatory work well in advance and building capability to substantiate your revenue base are critical to building confidence amongst buyers. Accurate data provided in an easy to digest, highly visual format, such as a dashboard, will go a long way to achieving that end. Many investment banks and investors are now encouraging owners to provide their own vendor due diligence (VDD) package alongside the marketing materials that go out to investors as a way of providing third-party validation that the financial situation of the company is secure and revenue is sustainable. In short, convincing buyers of the quality and sustainability of revenue gives them the license to pay top dollar for your business.

3. Optimize working capital. Working capital is another critical area often overlooked, but can drive significant value for sellers. There is far less attention paid to collecting receivables and paying vendors correct amounts—and on fair terms—than on other areas such as sales or EBITDA growth. However, these are often the focus of financial investors in particular during due diligence and can be a significant source of value when divesting a business.

Measures to optimize working capital can be put in place rapidly, starting first with a maturity assessment, followed by a focus on both internal areas such as day-to-day cash cycles and external areas including strategic relations with customers and suppliers. The path to working capital improvement requires buy-in from management, including the finance, sales and marketing, and procurement functions. Rigorous processes should be in place to ensure accounts receivable is collected in a timely manner and in the correct amounts and that payment terms are stretched out. Inventory turns should be maximized by eliminating obsolete and redundant stock and improving inventory forecasting.

Changing the tide on failed deals starts with these three actions. Doing so will ensure a competitive sales process that yields top dollar for your company and give it the greatest chance for success after the transaction is closed.

Robert Olsen is Deloitte’s national Corporate Finance leader. E-mail: robolsen@deloitte.ca. Adam Brown is Deloitte’s Performance Enhancement Advisory leader. E-mail: adbrown@deloitte.ca. Brian McKenzie is a senior manager in Deloitte’s Performance Enhancement Advisory Group. E-mail: bmckenzie@deloitte.ca.

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