6 Ways to Maximize Value Creation for a Carve-Out

SOURCE: RKON

There are many challenging opportunities and deal structures in the mergers & acquisition market, but perhaps none as complex as the carve-out. Though complicated, these deals provide many benefits which justify their increased effort. For buyers, these acquisitions can lead to higher gains and therefore better return on investment. Sellers, on the other hand, eliminate a less strategic piece of their business enabling them to focus on the company’s core strengths.

In order for the portfolio to benefit from these advantages, the deal must be analyzed beyond the financials to understand the inherent challenges associated with a carve-out. The pieces being sold will rely on the parent company for key business operations that are not part of the sale. Conversely, the buyer will require post-deal support from the seller for an agreed upon period of time covered under a transitional service agreement (TSA). Though these challenges are not new, they are often the elements that cause the most pain.

The speed to execute a deal leaves little time to proactively develop a strategy to separate the purchased entity from the mothership. Without this plan the carve-out may risk disappointing results, business disruption, unbudgeted cost and unforeseen delays, all of which adversely affect the portfolio value. A major component of a successful carve-out strategy is the IT plan, which sets the stage for the migration of legacy systems and develops the platform for stand-alone business systems and processes for the newly formed company. This slide show explains how to successfully craft the IT plan in order to maximize value creation for your portfolio company.

1)      Look Before You Leap

It is now a common practice to evaluate cloud platforms as part of the IT plan, which is a great leap forward. The only drawback may be the use of the term “cloud,” which has now become so overused, it includes a multitude of services, some of which differ drastically in scope, yet are compared on cost alone. But beware; it’s imperative to understand that not all clouds are created equal. Demand the cloud provider support legacy systems because there will be some, inevitably. Expect not only compute, storage and backup capabilities but mature process, change control and fully integrated monitoring and management services. The magic—and where value is created for your company—is in these later services, rather than in commoditized compute and storage.

2)      Start Generating Value Sooner

A looming issue for carve-outs, or any of your portfolio companies, is to hit projected value creation targets within the portfolio’s life span to ensure a successful financial return. This pressure increases when investors require shorter return periods such as three years. It is not uncommon for a carve-out to spend one to two years building its core operation, leaving just one year to focus on value creation or revenue generation. This disproportionate effort is a major reason for the failure of many carve-outs. It is clear the focus of the carve-out must be aimed at value creation much earlier in the life cycle, and no later than end of the first year.

3)      Outsource, Don’t Buy

Information technology and associated compliance are major components of business operations. The decision to buy—in this case outsource—versus build these capabilities is becoming a viable, and in many cases, smarter choice. Outsourcing IT to a partner that not only brings the technology and ability to manage it, but also the processes, change control, monitoring and continuous improvement, can enable a new company to reach mature operations within months. Add to this the compliance and security requirements being imposed and companies have no chance of building the breadth of knowledge or budget to accomplish this all in-house in a timely manner to allow the carve-out to successfully generate value within a three-year period.

Outsourcing enables a solid foundation to be constructed quickly enabling the focus to shift to value generation much earlier in the carve-out’s lifecycle. All this leads to a much higher chance of success and financial reward for your portfolio.

4)      Create a Strategy and Hire with that Mentality

It is very important to create a strategic plan for the transition and the growth beyond. Part of this strategy encompasses IT. Though the trend is moving towards outsourcing many of the facets of IT, there will still be a handful of jobs that are retained internally. For these roles, it is very important to have the IT strategy mapped out beforehand and then hire people who buy in to the plan. One of the biggest potential carve-out setbacks is when six months is spent moving along a plan and then new internal people are hired with their own agenda, often in direct opposition to the current strategy. This completely derails progress and in many cases sets back the accomplishments of the prior six months.

To avoid this dilemma, create the IT strategy in the beginning, hire people that buy in to the strategy to keep the progress clock ticking. This will also minimize turnover, which can stifle progress. In addition, having an IT strategy from the onset ensures that cohesive solutions build on one another versus a hodge-podge of disparate systems.

5)      Pick a Partner not a Provider

The typical process for finding an IT provider is through a request for proposal (RFP). The RFP is sent to a handful of providers, proposals are generated and the lowest price is usually selected. These RFPs are also typically created for each phase of the process, such as the migration of systems from the parent company to the new entity as well as the hosting of the new company’s data center.

Though this process delivers a low cost provider, the same provider usually does not win all RFPs so there are multiple partners involved in the migration, hosting and management of the end solution. While this method may return the lowest cost, and that is open to debate, it most certainly does not deliver the best solution.

6)      Consider Costs

There are many “costs” which do not show up on an RFP. For example, what is the cost of downtime? One provider may have a 99.999% uptime and another 99.9%. That’s the difference between your systems being down for 8 hours and 45 minutes a year versus 5 minutes and 15 seconds. This reality will not be caught if price is the only consideration. It’s also important to consider what efficiencies are gained when a single provider performs migration services, hosting services and full management of the systems versus having to manage three or more providers to do the same work. Having multiple disparate vendors involved can lead to finger-pointing when IT doesn’t work correctly.

The point is that there are hidden cost savings, possible efficiency gains, and that time can be spent more productively if you choose a single partner capable of providing full services from migration to hosting in a price effective manner. A provider that can grow with the carve-out’s needs and requirements is generally much more efficient and effective than piecing together multiple vendors to do the same.

Overall, Understand The Risks

New ventures are risky and carve-outs push that to the limit. Buyers and sellers may have opposing motives. Buyers want continuous business operations and outsourced services from the seller for as long as possible and often impose ridiculous service level agreements. The seller wants to provide outsourced services for as short a period as possible with little or no agreed upon service levels, and may impose penalties if project milestones are not completed on-time. By leveraging these six tips, your portfolio company can meet its goals faster while creating a more synergistic relationship with the seller, leading to a much more effective transition period for all.