Getting divestment done

With research showing that divestments are proving increasingly difficult for energy companies to complete, Rob Pitcher suggests some business approaches which could increase deal certainty.

A recent report has highlighted the challenges around divestment activity for the energy and natural resources sector. From a shrinking pool of buyers and ever-changing regulation, to issues with senior management and employee transfer, the research, called Streamlining for Success from law firm Eversheds, reveals the growing difficulty of divestments, with larger deals taking up to two years to complete.

Divestments have often been seen as the “always the bridesmaid, never the bride” end of dealmaking. Everyone in a business wants to be involved in the adrenaline rush of completing a merger or acquisition, where there is a clear sense of the company being on an upward trajectory of growth, but a divestment is different. It is about dividing assets and, as breaking up is never easy, there is often plenty of clearing up to do.

At a time when there is a greater focus on divestment activity Streamlining for Success, which was published this spring, examined the views of over 150 senior lawyers and executives across 34 countries. It found that nearly half (46 per cent) of respondents in the energy and natural resources sector said their M&A strategy was solely focussed on divestments – the highest of all sectors surveyed and much higher than the 26 per cent average.

Divestments and Deal Certainty

Collectively the respondents to the Eversheds Streamlining for Success study have worked on more than 2,400 M&A deals across 60 jurisdictions during the past five years. Nearly two fifths of these were divestments. Drawing on this vast experience, the study concludes with six key points to increasing deal value and certainty:

•         Adopt a clear and cooperative approach to communicating with the buyer

•         Keep in regular contact with local management at the target company to maintain morale

•         Have clear separation plans, which you share with the buyer

•         Keep a close eye on conflicts of interest

•         Build flexibility into legal contracts

•         Plan for delays 

Also, energy and natural resources was the only industry group surveyed where the average number of divestments was greater than the average number of acquisitions made in the past five years. This can perhaps be linked to the rising backlash against vertically integrated energy companies, with competition issues sitting high on the regulatory agenda, forcing businesses to think strategically about offloading non-essential or not profitable parts of their portfolio.

The study reveals the most problematic area of a divestment for the sector was finding the right buyer, and with established players in the energy and natural resources sector all looking to sell non-core assets, respondents noted that they were encountering more and more bidders from private equity and investment funds. Respondents noted they were having to familiarise themselves with how various types of investment fund operate in order to answer potential questions from regulators.

Similarly, sellers are now encountering strategic buyers from regions with which they have little or no previous experience. In some cases this has led to culture clashes and protracted negotiations. Even when dealing with buyers who broadly share the same assumptions, geographical remoteness frequently leads to delays or complications.

Consistent with other industries, businesses in the energy and natural resources sector sometimes also encounter issues with local management and have sometimes struggled to reconcile the interests of outgoing teams with those of the parent company.

Employee transfer was, more broadly, an important consideration. Employee demands for fixed contracts covering the next few years often make for an inflexible and unattractive asset. When this is added to union expectations that only established buyers should be allowed to take over the business in certain jurisdictions, sellers are finding it very difficult to do business.

Another widespread problem for larger companies looking to sell business units formed as spin-offs in the past was tax. In situations where the book value is much lower than the sale price, extra work is created for legal teams to satisfy tax and regulatory authorities.

Smaller energy concerns faced difficulties carving out businesses and making them saleable, with companies operating in retail energy markets encountering separation issues (including IT) more often than those in the merchant space. Understanding how to correctly allocate costs and earnings was something these energy suppliers found particularly difficult.

Despite recent CMA findings that vertical integration does not actually impede competition, 2015-2017 is likely to see more separations, as C-suite executives look for better returns on capital ratios.

To do this well, deal teams must have the opportunity to prepare their businesses for the challenges they face on complicated divestments. This requires a much closer working relationship between the lawyers negotiating deal terms and regulatory clearances, and the operations team executing the commercial transaction and separation plans – a point that came through very clearly from the businesses involved in the study. Energy and natural resources companies need to look closely at their current processes around managing divestments to ensure they maximise the benefit of such deals, rather than tying themselves up in separation knots further down the line which could have been avoided at an earlier stage.