Private Equity Carve-Outs Ride Post-COVID Wave

Germaine Gurr and Arlene Arin Hahn are partners at White & Case LLP. This post is based on a White & Case memorandum by Ms. Gurr, Ms. Hahn, Darragh Byrne, Ferdinand Mason and Tzi-Yang Seow.

Last spring, Dell spun off its cloud computing business, VMWare, in a deal valued at nearly US$63 billion, with the equity from the deal funneled to existing shareholders including Dell itself and the PE firm Silver Lake Partners, Dell’s strategic financial partner since 2013.

The unconventional Dell deal serves as a bellwether for surging PE carve-out activity, and for increasingly out-of-the-box dealmaking.

Corporate divestitures to PE have boomed over the past 12 months. Following the market pause in Q2 2020, such deals spiked to highs not seen for at least four years.

H2 2020 witnessed US$254 billion in private equity carve-outs, according to data from Dealogic. The momentum carried over into 2021: In H1, US$281.1 billion in such deals was recorded, a 197% year-on-year increase. The numbers reveal a rise in deals at the top end of the market, as volume of 436 deals in H1 2021 was only a 12% rise on H1 2020—and a drop on the 520 transactions struck in the second half of 2020.

The Dell VMWare deal—though unusual in many ways—exemplified the strength of the US market for PE carve-outs. US-based deals were responsible for US$133.5 billion of deal value, nearly half of the global total.

Fit for repurpose

The pandemic forced many companies to issue debt in 2020 to raise cash to see them through the worst. Now many are reassessing their core business models and competencies and putting non-performing or strategically tangential assets on the block to raise funds and pay down those lockdown liabilities.

That suits a cash-heavy PE marketplace just fine. According to Preqin, the industry raised US$459 billion in the first half of 2021, a 51% increase on the same period last year and the highest figure in at least the past five years. The total sum of dry powder is now estimated to be in the region of US$1.9 trillion.

Much of that money will go toward straightforward leveraged buyouts of private companies and sponsor-to-sponsor deals, as well as take-privates. But carve-outs may be comparatively attractive from a valuation perspective.

Research by EY shows that PE sponsors are able to buy corporate-owned assets cheaply, for superior returns. In a sample of 12 carve-outs, PE funds were able to deliver internal rates of return (IRRs) of 34% on average—a significant improvement over the average PE IRR of 14.1%.

Energy and utilities spark

The technology sector dominates in the PE carve-out space, with 84 transactions in the computers & electronics sector in H1 bringing in US$84.3 billion. This was the largest value of any sector, and represents more than a sevenfold increase on the US$11.8 billion in deal value recorded in H1 2020.

But energy and utilities carve-outs also are hot. Notable deals include an EIG Energy Partners-led consortium buying a 49% stake in Saudi Aramco’s oil pipelines business for US$12.4 billion. The deal involved a so-called “lease and lease-back arrangement” that sees EIG and its co-investors own nearly half the rights to 25 years’ worth of tariff payments for oil transported through Saudi Aramco’s stabilized crude oil pipeline network.

In another infrastructure deal, valued at US$11.7 billion, Meridiam, Global Infrastructure Partners and Caisse des Dépôts et Consignations carved out the unwanted assets left over from the mega merger between French waste water management giants Veolia and Suez.

These two deals helped boost total value for the oil & gas and energy & utility sectors, respectively. The oil & gas sector saw value nearly double from US$11.1 billion in H1 2020 to US$21.8 billion in the equivalent period this year, while volume ticked up from 10 to 16 deals. Energy & utilities saw deal value rise by 260% year on year to US$29.5 billion, while volume rose by 3% to 39 transactions.

From spinoff to SPAC

In some recent cases, carve-outs to PE are merely a first step toward a public listing via SPAC.

In 2020, fuel cell manufacturer Horizon Fuel Cell Technologies spun off Hyzon Motors, a manufacturer of hydrogen fuel cell commercial vehicles, with seed money from TotalEnergies Carbon Neutrality Ventures and others. In July 2021, Hyzon went public through a US$2.7 billion SPAC business combination with Decarbonization Plus Acquisition Corp. The merger and listing set up Horizon to begin production of heavy-duty trucks and coach buses.

And in February, Ardagh Group spun off its metal packaging business through a merger with a listed SPAC backed by billionaire Alec Gores, in a deal that values the new company at US$8.5 billion.

Separation anxiety

Assets are in ample supply, and carve-outs make bigger profits. That makes plenty of justification for pursuing transactions that have a reputation for being difficult to pull off.

Extricating a business from its parent can make for a thorny transaction. The balance sheet has to be divided up, and there is often overlap with business being retained by the vendor. Typically, operations are enmeshed, both sides sharing sales teams, IT infrastructure, logistics, HR and other back-office functions. These deals can also be disruptive, potentially destabilizing customer and supplier activities.

Due diligence—legal, financial and commercial—is thus especially important for carve-outs. PE funds have to know exactly what it is they are acquiring—and what they’re not. It also helps to gain a true picture of the cost synergies that will be lost as part of extracting the business as a standalone entity. That will naturally influence price negotiations.

But with so much capital at private equity’s disposal, and so much pressure on companies to hone their strategies and raise cash, the opportunity more than outweighs the challenge.

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