VLRE-15-05-01-Cover_Journal covers 6/5/15 5:49 PM Page 1 May/June 2015 After the Breakup— Valuation of Corporate Spinoffs and Divestitures Bret Tack VLRE-15-05-04-TACK_Layout 1 4/20/15 3:17 PM Page 22 pinoffs and divesti- ness strategy.2 Other reasons for spinoffs tures comprise a and divestitures include: large portion of the • The parent’s need to reduce debt or overall deal market.1 raise capital (this was a more preva- Independent valuations lent reason during the economic are often required in recession than it is today). these transactions, • Jettisoning an underperforming busi- for purposes that ness. include corporate • Monetizing a business that has planning, fairness strong growth prospects but whose and solvency opin- current capital requirements are a ions, tax strategies, drain on the parent’s mature, prof- fair value reporting, itable business. option pricing, and litigation. Yet despite • Regulatory considerations. their prevalence, the valuation literature is practically non-existent when it comes to addressing the potential dangers for Relationship with Parent valuation professionals in performing The specific valuation considerations to spinoff and divestiture valuations. This be addressed largely depend on which of article seeks to draw on the present the following categories the spinoff or author’s experience in order to high- divestiture candidate falls in, relating to light some of the challenges associated its relationship with the parent compa- with these engagements, and suggest ny and their anticipated future dealings appropriate valuation treatments. following the transaction: A spinoff is a transaction in which a • Standalone. A corporate subsidiary, company distributes shares in a sub- division, or business unit that has sidiary to the shareholders of the parent. always operated autonomously from In a full spinoff, ownership of the spun- the parent company. off entity is identical to ownership of • Dependent. A corporate subsidiary, the parent company immediately after division, or business unit that has the transaction. However, in most spin- historically been dependent on the in the present author’s experience the offs it is expected that ownership of the parent company for services, sup- majority of spinoff and divestiture can- parent and the former subsidiary will port, or financing and will continue didates do not fall into this category. diverge on a going forward basis. This to require some level of support from Most have historically received some usually requires that any post-transac- the parent post-transaction. level of support from the parent. tion business dealings with the former • Transitioning from dependent to Dependent Businesses. It is common parent be on an arm’s-length basis. standalone. A corporate subsidiary, for a spinoff or divestiture candidate to A divestiture is the sale, liquidation, division, or business unit that has continue to receive services or use the or spinoff of a subsidiary or portion of historically been dependent on the assets of the former parent post-trans- the parent company’s business. Thus, a parent company for services, sup- action, at least for a period of time. When spinoff is technically a form of divesti- port, or financing but will need to this is the case, the following issues need ture. However, divestitures are typical- transition to full autonomy once it to be addressed in the valuation: ly referred to in the context of a full or has been spun-off or divested. • Which services will continue to be partial sale of a subsidiary, division, A standalone business will pose the provided by the former parent and business unit, or product line of the par- fewest spinoff or divestiture-specific val- for how long? ent. Such sales are also commonly uation issues. If the business already has • Are agreements in place between the referred to as carve-outs. its own dedicated management team; subject business and the former par- has its own general and administrative ent that spell out the terms by which infrastructure; owns its own intellectu- the parent will provide such services, Reasons for Spinoffs al property; occupies its own facilities; including management and general and Divestitures is self-financed; and has always had its and administrative (G&A) services? There are many reasons that a compa- own standalone financial statements, it These agreements are typically ny will spin off or divest a business unit. is possible that no valuation adjustments referred to as either shared services The number one reason is that the busi- specifically related to the spinoff or agreements or transition services ness is not part of the parent’s core busi- divestiture will be required. However, agreements (TSAs). In some cases they are temporary, though there are BRET TACK, ASA, is a managing director at Cogent Valuation and currently manages its Los Angeles office. transactions in which the shared ser- He has provided business valuation and related financial advisory services since 1985, managing over 1,500 valuation engagements involving businesses ranging in size from small closely held companies to multina- vices arrangement is expected to con- tional, publicly traded companies with revenues in the tens of billions. tinue indefinitely. 22 VALUATION STRATEGIES May/June 2015 SPINOFFS VLRE-15-05-04-TACK_Layout 1 4/20/15 3:17 PM Page 23 required to reflect changes in the finan- cial and operating characteristics of the subject business resulting from the transaction. The transaction may also affect the subject business’s risk profile and growth prospects. These factors will be reflected in the valuation profes- sional’s selection of market multiples and required rates of return. Finally, val- uation indications from the market and income approaches may need to be adjusted for non-operating assets and liabilities, working capital shortfalls (or surpluses), and contingent liabilities. In order to identify specific valua- tion considerations relating to the spin- off or divestiture, the areas of in- vestigation discussed below should be covered in the valuation professional’s due diligence. Intellectual Property. Often the busi- ness being spun-off or divested will have been using intellectual property owned by the parent. This may include trade- marks and trade names; patents and technological know-how; copyrights; software code; or proprietary data and content. During the time that the busi- ness was a subsidiary or division of the parent, there may not have been any • Are license agreements in place for rely on it for services and support. This license agreements in place covering the the subject business to use intellectual poses a different set of issues that must usage of the intellectual property by the property ownedIt byis the parentcommon com- be addressed for in the spinoff valuation, including: business and no license fees being pany? • Is the management of the subsidiary charged by the parent. The valuation •candidates Are TSAs and license agreements to atcontinueor division capable to of runninguse the professional must first assess who will market rates? What are the relevant business on a standalone basis? own the intellectual property used by terms?the former parent’s• Will the subject assets. business be ade- the subject business post-transaction. • Will the former parent provide quately capitalized? If ownership will be retained by the par- financing and, if so, on what terms? • How will services formerly provided ent (as is common when the parent also • How does continuing to be reliant by the parent be obtained? uses the same intellectual property), he on the former parent affect the risk • What is the likely business impact of or she should determine whether license profile of the subject business? the transaction, including on rela- agreements will be in place post-sepa- • Will the divested business use the tionships with customers? ration from the parent and, if so, on former parent’s facilities? Are there what terms. lease agreements in place? While the subject business may Clean Break Scenario. An alternative Valuation Considerations receive a royalty-free license from the scenario is one in which the subject busi- Like all businesses, spinoff and divesti- parent as part of the spinoff or divesti- ness will be expected to make a clean ture candidates are valued based on con- ture, often it will be required to pay a break from the parent and no longer sideration of three distinct valuation license fee for the use of the parent- approaches, each of which has multiple owned intellectual property. The valu- variants or derivative methods. These ation professional may be called on to 1 According to Global Finance magazine, spinoffs and divestitures accounted for 47% of world- are the market approach, the income determine a market royalty rate for the wide M&A activity in 2012. See Platt, “M&A: approach, and the net asset or cost intellectual property if establishing an Record Spin-Offs Boost Global M&A,” Global Finance (February 2013). It has been estimated approach. Primary emphasis in the val- arm’s-length basis for the license fee is that almost $600 billion worth of spinoffs and uation of operating companies is usually important. If the subject business’s his- divestitures were completed in the U.S. in the first nine months of 2014. See Dealogic, M&A given to the market and income torical financial statements do not Review (September 2014). approaches. include a license fee, historical earnings 2 This was cited as the number one reason for In spinoff and divestiture valuations, should be adjusted to deduct agreed divesting a business by 62% of respondents in Deloitte’s Divestiture Survey 2013. specific earnings adjustments may be upon license fees (typically as a per- SPINOFFS May/June 2015 VALUATION STRATEGIES 23 VLRE-15-05-04-TACK_Layout 1 4/20/15 3:17 PM Page 24 centage of revenues) when calculating representative earnings.