There is typically an ebb and flow to the corporate divestments market. But the market departed from its traditional cycle in 2017 when multinationals, private equity funds and other investors drove transaction activity to record levels.
“The deal market is on fire at the moment,” says Paul Hammes, EY Global Divestment Leader in Chicago. “Usually the year gets off to a slow start, but in 2018 there’s been no respite.”
The 2018 divestment study, “How can divesting fuel your future growth?” shows that 87% of corporate executives are expecting to sell a subsidiary or spin off an asset in the near future. That’s more than double the 43% response in 2017’s version of the same poll.
Corporations sold off $2.3 trillion in assets in the first half of 2018, according to our calculations, up 66% from the same period a year ago.
If anything, the pace is likely to intensify for the balance of the year. The reasons range from $628 billion in unallocated private equity funds, increased clarity on tax implications and corporations turning peripheral units into capital they can redeploy. That capital could be spent buying digital businesses that complement traditional economy activity, or on acquisitions that boost the bottom line in case the pace of global economic growth isn’t sufficient to grow profits from existing units.
Our survey results indicate that readiness is crucial. Offers are likely whether solicited or not, and realizing a premium price for a corporate asset requires advance preparation, especially on the tax implications. Some 61% of executives who responded to the survey said that, for their last divestment, they felt better preparation of the tax factors for prospective buyers would have delivered a higher price.
Worldwide, long-standing questions about the future of tax are being answered by the completion of the US tax reforms and greater clarity over global tax norms through the Base Erosion and Profit Shifting (BEPS) action plan. BEPS, a series of coordinated changes to countries’ laws that more closely align multinationals’ profits to the locations of their sales, workers and production centers, was initiated by the Organisation for Economic Co-operation and Development (OECD) following the G20 Summit of 2012. As of May 2018, 116 countries were members of the BEPS inclusive framework.1
“While deals are primarily about commercial strategy, we’re increasingly seeing buyers make tax a key due diligence point,” says Bridget Walsh, an EY Global Transaction Tax Leader in London.
Current market conditions demand a proactive approach, both for companies actively looking for transactions and for those that are open to offers in a seller’s market. That means companies need to understand which assets or units could be sold and be ready to articulate the tax attributes of the particular business before any potential buyer emerges.
Macro issues make tax a strategic consideration in any divestment
Global changes have elevated the importance of tax factors in any potential divestment. The 2018 divestment study indicates that 80% of companies consider tax policy changes worldwide as a key geopolitical driver of divestment plans following the 2017 Tax Cuts and Jobs Act in the US and the OECD’s BEPS action plan. The study also revealed that 86% said labor or immigration laws may affect divestment plans, a topic you can read more about here.
In both cases, says Hammes, the market is responding to an injection of clarity after several years of uncertainty. Tax reform was long-awaited in the US and came with significant incentives for multinationals to boost activity in the US, such as the lower overall tax rate for corporate income, which dropped from 35% to 21%.2 BEPS, meanwhile, is a series of country-level tax-policy changes that attempt to reduce artificial tax-planning strategies that allow profits to be claimed in countries regardless of where sales, workers or factories are located. It was approved in 2013 and, now that implementation is underway, taxpayers have fewer questions about how it will work.
However, in some specific cases, such as in the UK, uncertainty is driving deals. There, a survey by the private equity firm Aurelius found that European divestment activity is expected to be driven by a lack of clarity on how Brexit will affect UK corporations and their non-core holdings, particularly in the financial services sector.3
”Recent experience shows that the legislative changes coming into play in the tax landscape are starting to make a real difference, both in terms of divestment activity, as well as in deal modeling and pricing, both on buy side and sell side,” says Walsh. “By thinking about tax up front, sellers can ensure their tax assets and liabilities are priced appropriately, and buyers can be more competitive by being able to accurately model their potential future returns.”
Tax — dealmaker or deal-breaker?
While current conditions denote a seller’s market, corporations won’t maximize profits by waiting for offers to come in. In our 2018 survey, 62% of executives said they lost the ability to realize the highest possible valuation in a divestment by not preparing diligence materials. The results showed executives believe that one way to elicit the highest potential offers is to understand the tax-based risks and opportunities that specific units or assets present and to customize a narrative for potential buyers that wards off any lower bids based on tax concerns. But just 56% of the group reported doing this work ahead of time. Getting the best deal requires specific and detailed preparation, says Hammes, starting with anticipating potential buyers.
The most important specific task in this preparation process is to complete a tax assessment for a unit or asset that could be sold and present it to any potential buyers before they come up with their own version, as well as being cognizant of the tax drivers and profiles of potential buyers, including the difference in focus between a private equity buyer and a corporate buyer.
“By being aware of your suite of buyers and considering their tax structures and tax priorities, you can ensure you put your assets in the best possible position, both from a tax and a commercial perspective,” says Walsh.
In the 2018 divestment survey, executives reported that doing this allowed them to highlight tax benefits to potential buyers, but only 35% of them had done this to date, so nearly two-thirds of sellers are not yet thinking about tax up front and therefore are not able to bring these tax benefits to light. The process should include analysis of the unit’s supply chain, cash flow and effective tax rate, and how these factors could change after a transaction for both income taxes and indirect ones.
It should also consider relevant tax jurisdictions and whether a sale should be structured as an asset sale or a stock purchase, always taking into account the likely structural desires of your buyers.
“We are increasingly seeing the more sophisticated buyers ensure that tax synergies are baked into their pricing, so if a seller ignores how it should present its tax profile, they could be missing out on the best deal,” adds Walsh.
Tax can provide clarity as deals get more complex
Complicated deals can become even more so because the range and types of divestments are expanding. In addition to the sale of a whole unit, companies are carving out elements of them for sale or forming joint ventures for them.
In this scenario, finding the right deal structure is crucial. In our divestment survey, almost two-thirds of executives said they could have achieved a better price in a transaction by being more flexible about matters such as whether a deal is based on cash payment or equity shares, for example.
Clients often opt for transaction forms that are consistent across all relevant legal jurisdictions, says Hammes. “By working with operations and the legal department on the optimal transaction form in each specific market you can drive value, minimize the time to close, and lower risk for both sides,” he says.
Supply chains also stand out as an area for scrutiny. An asset for sale may need to be incorporated into a different supply chain, and working with a buyer to highlight variables that impact the effective tax rate is advised, says Hammes.
“You start by looking at the deal through the eyes of the buyer,” says Walsh. “Companies help maximize exit value when they focus on how tax makes a positive or negative impact and then communicate that in a coherent way to the buyer community.”
- Interest in global divestments is at a record high, in part because tax reforms in the US and elsewhere have boosted certainty after a period of ambiguity. Even corporations that aren’t looking to sell assets have something to gain from a review of what could be sold.
- The volume of potential buyers worldwide creates significant opportunity for corporations that prepare in advance. Achieving the highest possible valuation for an asset requires creating transaction plans for specific types of buyers before actual ones emerge, and making certain that those plans identify value drivers and communicate them clearly.
- It’s a mistake to leave tax to the latter stages of negotiations. Tax factors are rarely a primary rationale for any given transaction, but can drive sale prices higher when spotted early.