What Buyers Should Assess When Acquiring A Spin-Off
Companies everywhere are constantly seeking ways to remain competitive. Divesting noncore or underperforming assets remains a popular and effective strategy for doing this. During the decade from 1993 to 2003, the annual number of divestitures or spinoffs from public and private corporations in the U.S. averaged 1,700, or approximately 40%, of total middle-market transactions, defined as those with a disclosed transaction value of $1 billion or less, according to Thomson Financial and Robert W. Baird & Co. This volume of transactions indicates that there are plenty of potentially untapped investment opportunities for financial or strategic buyers.
Buying a division of an established company, even if it is underperforming, is likely to be less risky than starting a new business venture. At the very least, there will be an established and proven business model.
Crucial to post-transaction success however, is the ability to quickly establish an appropriate infrastructure to run the business as a standalone or integrated entity. Once the deal is finalized, there will no longer be any support from the original parent company.
Buyers should therefore evaluate and plan for the following issues:
- Institutional knowledge—Buyers usually undertake cost-reduction programs, particularly employee layoffs, almost immediately after buying an underperforming asset. This tactic often results in the loss of important knowledge about the company’s processes and systems, customer and vendor history and other vital knowledge. The buyer should be judicious in his approach to evaluating the knowledge and experience of all staff, regardless of their position in the company. Oftentimes, lower-level staff are overlooked, on the assumption that higher-level management alone understands implicitly the workings of the company.
- Seasoned management—The manager charged with turning an underperforming asset into a performance driver or integrating a noncore asset into an existing business must possess a unique and crucial set of skills. She is a strong executor, able to construct a short-term plan to make the asset profitable and then quickly and deftly act on that plan. A seasoned industry veteran, she is an accomplished performer and is comfortable in the role of change agent. If a buyer, particularly financial, does not have such a manager at the ready, he would be well advised to walk away from the deal.
- Hidden corporate charges—Generally, large corporations have centralized support functions. The operating division pays the parent company a corporate charge for the use of these central services. Because the components of the charge and how it is calculated are often nebulous, it is imperative that the buyer scrutinizes the charge in detail. In the majority of cases, allocations of corporate expenses do not reflect the true cost of running a company outside of a large corporate environment. Additional costs to implement new or stronger support systems should be calculated before an offer is made.
Two areas in particular require careful consideration:
- Information systems—Is the division using software licenses that have not actually been paid for by the company? In many instances, the IT divisions of large corporations, both public and private, are unable to keep up with user demands. Many times, new software applications are installed before approval to buy the license has been obtained. During diligence, the buyer should complete an inventory of software products in use and compare this with payment records to ensure there are no hidden liabilities.He should also evaluate whether all workstations are operating on the same platform. If not, the cost to implement a standardized operating system should be calculated, as its existence will facilitate smoother upgrades in the future.
If the division has been relying on the disaster recovery plan of the parent, some consideration should be given to how a standalone plan can be implemented and the estimated cost of doing so.
Finally, the buyer must assess how well the computer system is serving existing user needs and whether it can adequately serve future needs. Telltale signs of ‘Band-Aid’ systems include core modules operating offline or management reports being generated using a myriad of separate spreadsheets and Crystal Reports.
- Additional people costs—The buyer should carefully assess the functions being carried out by the corporate parent that need to be replicated in the standalone or integrated entity at an additional cost. These could include marketing and selling, payroll, tax compliance and planning, budgeting, information technology, risk and treasury management, purchasing and certain accounting functions. The buyer needs to assess the costs and benefits of outsourcing these functions or, alternatively, hiring the necessary executives.
In the current market, where capital is plentiful and multiples are escalating, identifying opportunities that have not been ‘shopped’ to death is increasingly difficult. Some buyers are identifying noncore or underperforming assets in larger companies and approaching the seller before they become available in the marketplace. The big question remains: Having identified a unique opportunity, do you have in place what it takes to maximize your return on investment?
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