Divestments and working capital

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Divestments and working capital management

Are you leaving money on the table?

Big numbers

  • Cash release opportunities can exceed 10% or even 15% of revenues in non-core businesses.
  • The leading 2,000 US and European companies have US$1.3t of cash unnecessarily tied up.*
    • Nearly 7% of combined revenues
    • For every US$1b in revenues, the opportunity for working capital improvement averages US$70m

Find out why companies should extract working capital before an asset sale.

The paradox of inaction

Despite the benefits, most sellers do not improve performance ahead of a sale. Only 35% of executives seek to extract working capital prior to divestment.*

Paradoxically, while this was the least frequent way for companies to add value to their business pre-sale, it was the most frequently identified action that companies did not take that would have added value.

*Source: 2015 EY Global Corporate Divestment Study

Which of the following pre-sale value-creation initiatives did you undertake?

Chart 01

Which step did you not do but now feel you would have benefited from the most?

Chart 02
Why you shouldn’t wait

Management is often insufficiently aware of or insufficiently interested in the scale of the opportunity to be motivated to act or they may delay action because of competing deal priorities and perceived implementation difficulties.

However, these excuses rarely prevail under even modest scrutiny.

Perceived challengeReality
Working capital optimizations provide a benefit only over the long term.Though certain benefits from structural working capital optimization changes take time to realize, opportunities for quick wins abound. Even if realized within 12 months of a sale, a well-developed story line can lend support in negotiating a lower working capital peg, which would otherwise be challenged during diligence.
Increased payment terms can be a barrier to negotiating better pricing for procured goods.By rationalizing and consolidating suppliers, the increased volume and spend with fewer suppliers enable better negotiating leverage – for both cash and cost. Also, a rationalized supplier base, especially with private equity buyers, eases the NewCo separation effort and set-up.
Inventory reductions target lower production requirements and, accordingly, lower overhead absorption rates.The quickest win in inventory is rebalancing the mix, typically by finessing the underlying logic for stocking and replenishment decisions to better align with demand. A better mix can support larger sales and production volumes with a lower inventory balance and, at the same time, improve margins by reducing overtime, order expediting and obsolescence write-offs.
Post-sale, there is little or no value to RemainCo of any optimization performed for NewCo.

Deal fatigue might prevent the seller from leveraging separation work efforts after a time-consuming and expensive divestment – the organization seeks to transition to newer strategic and operational opportunities.

However, during the sale process, the seller should identify and rationalize contracts and suppliers for the divested entity. This momentum provides a natural opportunity for RemainCo to capitalize on work efforts already conducted for separation purposes, in addition to initializing other working capital transformation efforts.

Timing is everything
  • For a typical cash release initiative, >50% of the identified opportunities may be realized within the first 12 months, with benefits starting to flow within the first 3 to 4 months from the start.
  • Companies should act within 18 to 24 months of an asset being contemplated for sale for the seller to retain the full value of those improvements.
  • The research presented in EY’s Working Capital Management Report 2014 found the opportunity fairly evenly split between the primary working capital drivers:
    • Accounts receivables (35%)
    • Inventory (30%)
    • Accounts payable (35%)
  • Given the speed at which cash flow improvements can be driven from payables and receivables in particulars sellers should be optimistic about chances of extracting value at a sufficiently compelling return prior to a transaction.
Where to start

Success requires planning, ideally as a routine of the portfolio review process. Companies that do this well start early and follow a sequence of activities, including:

  • Benchmarking key working capital ratios against peers and across business units to select candidates for improvement and further analysis
  • Conducting granular analysis to narrowly define the opportunity and required actions
  • Focusing on actions that will drive improvements in the near term
  • Establishing clears goals and operational metrics to track progress
  • Aligning management incentives to those goals
  • Developing a compelling story line for all potential improvements, whether delivered or not
How EY can help

EY’s dedicated divestment and working capital transformation professionals can help clients improve portfolio management, divestment strategy and deal execution.

Specifically related to working capital in the context of a divestment, we can assist with:

  • Establishing working capital requirements at NewCo
  • Valuing post-spin working capital improvements
  • Developing sell-side narrative for working capital peg and future improvement opportunities
  • Identifying and executing working capital improvement opportunities pre- and post-sale
  • Designing working capital improvement services in TSAs

Companies that plan for working capital release ahead of a divestment significantly improve the total economic return from the deal.

*Source: All tied up: Working capital management 2014