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Global Corporate Divestment Study

a 2016 | ey.com/divest Global Corporate Divestment Study Learning from private equity: experts at extracting hidden value

Our perspective Roughly half of the companies surveyed for our Global Corporate Divestment Study are considering a divestment in the next two years. Yet many of these companies will struggle to generate maximum value from their divestments. This is all the more reason to share leading practices now — particularly those of organizations that excel in finding value. Private equity (PE) firms are skilled value-finders. They are serial buyers and sellers, expert at locating hidden upside in companies. They often exit at a multiple that is many times the original purchase price. As key board members, they have an innate understanding of their portfolio Paul Hammes companies’ inherent value and whether to continue to invest or if it is EY Global Divestiture time to divest. Advisory Services While corporations have a different core mission from PE firms, they can Leader learn lessons from PE on how to maximize shareholder value. Corporates face particular challenges in maximizing value from divestments: some companies may be too opportunistic, reacting to an interested buyer rather than thinking strategically about who might be the best acquirer. Many are reluctant to invest management time in an asset they plan to sell, or they may be unwilling to allocate scarce capital to such businesses. Yet by failing to properly prepare assets for sale, companies only make them less appealing to the next owner. This year’s Global Corporate Divestment Study focuses on the critical lessons corporations can learn from PE to increase divestment success. Our findings are based on interviews with 900 global corporate C-suite executives and 100 private equity executives, as well as external data from nearly a decade’s worth of divestments. For the M&A markets, 2015 was the biggest year on record — and divestments were a significant part of that story. The divestment of non-core or underperforming businesses is now widely seen as a key way for companies to fund the next phase of growth. So what comes next? As we look ahead to 2016, an M&A slowdown appears unlikely. Global economic and policy conditions mean that companies are likely to continue with aggressive moves to protect revenue and market share while boosting margins and profitability. While acquisitions are companies’ most likely response, strategic Steve Krouskos divestments should also be a top priority. EY Global Deputy Moreover, many potential buyers are sitting on large war chests of cash Vice Chair, to fund bold acquisitions. Nonfinancial corporates in the S&P Global Transaction Advisory BMI currently hold more than US$5.4t in cash and equivalents on top Services of US$1.2t of dry powder from private equity funds. In short, now is an especially good time to evaluate businesses for potential sale or spin-off.

Key findings Lessons learned Why divest Don’t wait for a buyer — make a move before you’re forced to act Page 7 Use divestment proceeds for an acquisition Page 8 Prove divestment value 70% 84% to your investors of companies are using believe their divestment created long- Page 8 divestments to fund growth term value in the remaining business Less need for speed: big change over last year Portfolio review Page 9 Frequency: make reviews a habit, not an event Page 11 Data: good decisions don’t come from bad information Page 12 56% 49% Analytics: critical for performance measurement of companies’ portfolio review say access to meaningful data Page 12 processes have resulted in is the biggest portfolio review Communication: poor unsuccessful divestments challenge information-sharing hinders divestment success Execution Page 15 It’s still your business: don’t ignore it until it’s off your books Page 17 Operational separation: vital to value creation, but often neglected 75% 33% Page 18 more companies generate a sale more companies generate a sale Communicate synergies: price above expectations when they price above expectations with an take back the buyer’s upside focus on creating value pre-sale operational separation plan Page 19 Keep a buyer in it to win it: management quality and commitment 49% of companies are planning Page 20 Provide the right details: to divest within the next two years keep buyer’s needs in mind Page 20 3

Are companies achieving their divestment goals? Considering that all of our study respondents already made a major divestment in the past three years, it is remarkable that nearly half expect to divest again in the next two years. This is an indication of how deeply embedded divestments have become in corporate strategy. Moreover, 60% expect the number of strategic sellers to increase in the next year alone. Yet despite the anticipated growth in divestment activity, many companies continue to take a tactical approach to their transactions: 52% say their last divestment was opportunistic, and the greatest portion (46%) say their next asset sale, if any, will likely be opportunistic as well. This is a major shift from previous editions of the Global Corporate Divestment Study that saw companies making divestments more strategically — proactively selling assets, often strong ones, that were no longer core to their business. When do you expect to initiate your next divestment? What do you expect to happen to the number of willing strategic sellers over the next 12 months? 49% of executives expect to divest in the next two years 28% We are not Within the next 37% actively planning 12 months 60% a divestment 46% but are open to Within the opportunities 17% next 2 years 5% 4% 3% We do not expect to make any divestments in the Within the next 6 months foreseeable future Increase Stay the same Decrease 4

Achieving divestment goals A successful divestment meets three criteria: • Has a positive impact on the valuation multiple of the remaining company • Generates a sale price above expectations • Closes ahead of timing expectations Only 19% of sellers in our survey meet all three key success criteria. What sets these high performers apart? They take the time to prepare well in advance of a divestment, they understand the potential buyer pool and the buyers’ needs, and they communicate the value of the transaction to internal and external stakeholders. What triggered your most recent major divestment? Why the private equity perspective Opportunistic (including unsolicited approach by a buyer) on exits is important 31% 52% Our survey is based on interviews with both corporate and Unit’s weak competitive position in the market PE executives. The corporate responses we received suggest 18% there is much companies can learn from expert buyers and 36% sellers — private equity firms — regardless of whether they Not part of the core business consider PE a likely buyer of their business. 15% 28% Over the past three years, PE firms have exited companies High future cash investment requirements at nearly 1.5 times the rate at which they’ve acquired them; 13% in fact, the 20 largest PE firms have each sold an average of 31% eight companies per year. Moreover, they are very good at Negative impact on risk/reward balance of portfolio what they do: 12% • Over a 10-year period, US PE firms outperformed public 43% 1 markets by 62%. Concerns related to shareholder activism • Only 1% of PE firms that responded to our study say their 11% last exit did not meet timing expectations. 19% Swapping assets This section focuses exclusively on the overall divestment 0% rationale and performance of our roughly 900 corporate 3% respondents. And the next two chapters focus specifically on what portfolio-review and divestment-execution lessons Most important factor Consideration (all that apply) companies can learn from PE in order to improve overall transaction success. Even as corporates are taking a more opportunistic approach Corporations have clearly bought into the idea of selling, to divestment in this more-active M&A market, the vast yet their results to date have been mixed. Given the high majority are satisfied that making the divestment in the first expectations corporates have for their divestment activity place was the right move. Among companies that completed a over the next couple of years, we strongly recommend that divestment, 84% said they believe it created long-term value in future corporate sellers look to the PE buy- and sell-side the remaining business. But there is room for improvement — perspectives to improve their divestment processes. our survey also reveals that these divestments may not have met the full range of success criteria (see box above), indicating there is still value to be captured. 1 ® Private Equity Growth Capital Council Performance Update Report, March 2015. Cambridge Associates U.S. Private Equity Index (excluding venture capital) ® versus S&P 500 Index (including dividends). 5

Achieving divestment goals In depth Market data shows positive effect of corporate divestments Nearly a decade of deal-market data tells us a great deal about divesting — both its potential and its limitations. 2 Based on market data from nearly 800 deals globally since 2006, we have found that strong companies use strategic divestments to improve earnings and increase shareholder value at a greater pace than the market. Moreover, larger divestments seem to have a greater positive impact on the remaining company post-sale. However, for underperforming companies, while divestments often improve their value relative to the market, a divestment on its own does not tend to fix systemic weaknesses, especially in companies that are not performing in line with peers. The market likes a big deal Recent deal trends — the effect Investors tend to reward companies for transformational of divesting 10% of a company divestments. For strong companies — those that outperform We have also seen a number of trends recently among more their respective index — generally, the more transformational sizable deals — companies that divested at least 10% of their the divestment, the greater their stock price outperforms total enterprise value within the last five years.3 the index in the year following the sale (comparing post- close performance versus the year before). For example, Stock price performance since 2006, companies that divested 5% of their business Strong companies tend to outperform the public index at outperformed by 91 basis points more in the year post- an even greater rate once they divest. These companies divestment. However, companies that divested 20% of their outperformed the public index by 612 basis points more business increased their outperformance by 1,104 basis than they did in the one-year period pre-sale. Similarly, points during the same time period. while a divestment is not a quick fix, even underperforming These figures may even understate the case. In the above companies were able to get 235 basis points closer to their measurement, the one-year performance period pre-sale benchmark’s growth rate. includes a period of roughly three to six months between when a company announces a deal and when it closes. During Effect on EBITDA multiple this period, the company’s stock price will already begin to Strong companies are able to unlock shareholder value reflect the market’s perception of the potential transaction, with their divestments. The median growth rate of their and some of the increased value may already be recognized EBITDA multiple one year after their divestment was pre-close. This fact only enhances the potential effect of 24.3%, compared to 6.1% for underperformers. In sum, divestment: it implies that outperformance versus the while there is a large dispersion between outperformers benchmark could be even greater than what is reflected in and underperformers, on average, companies generally the post-close performance. experience a positive effect on their EBITDA multiple post- sale. This is the effect of increased investor confidence in Difference in median outperformance one year post-sale the remaining company that stems from an increased focus versus one year pre-sale (2006–15) on the core business and improved growth prospects. Stock price versus MSCI World Index price Effect on revenue growth 1,200 For strong-performing companies, divesting generally has — 1,000 perhaps ironically — a positive effect on revenue growth. The s median revenue growth for outperforming companies the t n year after their divestment was 4.5% (versus -0.9% the year i 800 o before the sale); for underperformers, the increase the first p s i s 600 year after sale was 0.8% (versus -1.8% the year before). This Ba revenue growth is likely the result of companies shedding 400 slower-growth or underperforming businesses and using 200 divestment proceeds more aggressively to grow their core business or pursue new markets. 0 5% divested 10% divested 20% divested 2 S&P Capital IQ and EY analysis. Divestments completed between 1 December 2006 and 1 December 2015, comprising at least 5% of parent company total enterprise value, where parent company revenue was greater than US$250 million; sample size of 788. 3 Sample of 241 companies that divested between 1 December 2010 and 1 December 2015. 6

Achieving divestment goals What can corporates do to improve divestment performance? Don’t wait for a buyer — make a move before you’re forced to act The increased popularity of opportunistic divestments is Percentage of high-performing deals for each likely the result of the more active M&A marketplace, filled strategic trigger (measured by impact on valuation with a myriad of eager and proactive buyers, as well as the multiple of remaining business post-sale) opportunity this deal market provides companies to raise fast cash. However, our research shows that opportunistic Concerns related to shareholder activism divestments are among the least likely to positively affect 51% the remaining company’s valuation multiple post-sale. High future cash investment requirements Among respondents who achieved a high-performing deal, 46% those triggered by opportunism make up one of the smallest Not part of the core business proportions, whereas those triggered by shareholder 41% activism concerns or future cash requirements include much larger percentages of the high performers (51% and Unit’s weak competitive position in the market 46%, respectively). 38% Opportunistic (including unsolicited approach by a buyer) 31% Negative impact on risk/reward balance of portfolio 30% There are numerous potential reasons for such varying success between divestments driven by shareholder activist concerns and opportunistic divestments: Trigger Activism-fueled divestments Opportunistic divestments Management focus Confronted with a real or perceived activist An opportunistic divestment may mean an external threat, a company may need to sharpen focus on party is paying more attention to a business than its core strategy, review its portfolio and create the actual owner. The owner is likely to undervalue shareholder value. its own business and/or not take the time to prepare a proper value story for the buyer. Investor perception Investors are likely to react positively if they hear Opportunistic divestments can be confusing to that an activist shareholder — one with a reputation investors — its not a strong story when a company for creating value — has an eye on a company. that had previously considered a business to be Activists often coalesce a strong message about core suddenly sells because it was approached what needs to get done in a company, and the by a potential buyer who found more value in the market responds to the perception of future company’s business than the company itself was value creation. able to identify. Companies are much more likely to improve the value of a business over the long term if their divestment decisions are consistent with their announced strategy. In other words, they should think like an activist before there is any concern about being forced into action. 7

Achieving divestment goals Use divestment proceeds for an acquisition A key to divesting successfully is not only to plan for the sale, but also to consider how to use the proceeds. Seventy percent of our respondents used the funds from their previous divestment to grow their core business, through investing in new products/ markets/geographies or acquiring a complementary business. On the whole, compared with last year, companies are more focused on investing in organic growth and less on using divestment funds for an acquisition or pursuing new markets. For example, compared with last year, 35% fewer companies are planning to make an acquisition with divestment proceeds (11% versus 17%). Those who did use their previous divestment to fund an acquisition were 62% more likely to have experienced a higher-than-expected valuation multiple on the remaining business post- sale than a company that used the funds to pay down debt (47% versus 29%). What did you do with the funds raised Percentage of high-performing deals for each use of from your last major divestment? divestment funds (measured by impact on valuation multiple of remaining business post-sale) 2016 results: Made an acquisition 70% divested 47% Pay down debt to fund growth Returned funds to shareholders 13% 42% 39% Invest in core Invested in new products/markets/geographies Return funds to 12% business 40% shareholders 17% 14% 34% 2015 results Invested in core business 17% 36% 23% Paid down debt 11% 29% Make an acquisition 20% Invest in new products/ markets/geographies Prove divestment value to your investors In order to have a positive effect on valuation multiple, How would you assess the valuation multiple of your it’s not enough to achieve a good sale price and close the remaining business after your last divestment? deal on schedule. Sellers must communicate the deal’s alignment with future strategic direction — why they are divesting, how they define their core business and how they will use divestment proceeds. In our survey, just over one-third of companies succeed in this regard: 38% said their most recent divestment exceeded expectations in terms of its effect on the valuation multiple of the 38% remaining business. More than half (55%) said their 55% Exceeded expectations divestments were in line with expectations. Met expectations Did not meet expectations 7% 8

Achieving divestment goals Less need for speed: big change over last year Two-thirds of companies now place greater emphasis on value rather than speed. This is another significant shift from last year’s divestment study, which found a 50/50 split between speed and value. This change reflects the focus on overall shareholder value. And sellers know that strong availability of capital means greater competition for good assets and potentially higher bid prices. Perhaps unsurprisingly, companies that prioritized value were more successful at all three divestment success criteria: price, speed and valuation multiple post-sale. The likely reason for this much stronger performance is that companies prioritizing value are often well-prepared for the separation process and buyer communications. However, those that prioritize speed often take shortcuts with buyer information and operational separation planning, which ends up lengthening the process and eroding value. What was your main priority in your last divestment? Percentage of high-performing deals by priority during last divestment (speed versus value) Price 42% 28% 33% Value Impact on valuation multiple Speed 41% 32% 67% Timing 36% 24% Value Speed Consider all potential buyers Only 11% of executives surveyed sold to private equity buyers in their most recent major divestment. One key reason is that sellers think strategic buyers will pay a higher multiple. But that isn’t necessarily the case. Private equity buyers are often more creative in their evaluation of potential acquisitions. Corporate buyers, by contrast, are often unwilling to pay for synergies. Market data shows that strategic and financial buyers pay similar multiples for businesses, and there is no clear pattern of one buyer type consistently paying more than another. Median implied EV/EBITDA multiples paid for global transactions 12x 10x 8x Financial buyer 6x Strategic buyer 4x Exceeded expectations Met expectations 2x Did not meet expectations 0x 2011 2012 2013 2014 2015 Source: S&P Capital IQ, EY analysis, 1 January 2011 to 1 December 2015. Includes all transactions globally (4,341) where the buyer took a majority stake in the business and the target businesses had positive EBITDA multiples. 9

Portfolio review: think frequent and flexible Most companies believe they run effective portfolio reviews, but they are often slow to pivot as market conditions change. The value of non-core businesses under a corporate umbrella can erode when there is no divestment imperative. In extreme cases, inaction can leave companies vulnerable to shareholder activism or hostile bids. In our survey, 56% of corporate respondents say shortcomings What do you consider to be the main challenges in the portfolio review process resulted in failure to achieve associated with portfolio reviews? (Select top three.) intended divestment targets. There are many challenges — not least getting access to accurate, comprehensive data, and Access to accurate, comprehensive data communication shortcomings between the board or strategy 49% team and the M&A team. And nearly half of companies (44%) Better communication between board/strategy team and M&A team say one of their most significant challenges is making the 44% portfolio review a strategic imperative. Dedicating specialized resources to the process PE owners, on the other hand, tend to place their investee 44% businesses under constant review, such that they can use their Making the portfolio review process a truly strategic imperative influence to change strategic direction quickly. PE firms also 44% use aggressive industry benchmarks and advanced analytics to Consistently applying more sophisticated analytics tools to the process assess capital performance. This means they are acutely aware 42% of when and how to grow, fix or exit a business, and they Overcoming emotional attachments to assets/conflicts of interest largely avoid crisis management and fire sales. 21% Lack of leadership support 53% 18% say they have held on to assets too long when they should have divested them 10

Portfolio review Lessons learned from private equity Frequency: make reviews a habit, not an event Private equity firms make portfolio reviews an ongoing How frequently do you assess your portfolio to activity, more so than their corporate peers. For example, determine business units/brands to grow or divest? more than one-quarter of PE firms carry out portfolio reviews As necessary/opportunistically quarterly, compared with just 7% of corporates; in all, nearly 33% half of PE firms conduct reviews at least twice a year as a 12% matter of course. Quarterly This PE approach should serve as a model for all enterprises, 26% particularly as the digital revolution, big data and activist 7% investors are impacting everyone’s business model and forcing Twice a year companies to review performance more often. Specifically, we 22% believe corporates should carry out three key types of reviews: 30% • In-depth portfolio review. These reviews should be Annually conducted once or twice a year. 19% 50% • Quarterly performance review. Every quarter, public Every two years companies should understand in detail performance against 1% plan, macro market dynamics and competitor actions, and accordingly, whether any changes are required to their Private equity Corporate capital allocation and structure. • Use analytics for real-time insight. Companies should use internal and external analytics to stay closer to their businesses and ideally have real-time access to meaningful Percentage of high-performing deals by frequency of granular performance data in order to make faster and portfolio review (measured by impact on valuation multiple) more precise decisions. Our survey shows a clear link between frequent portfolio Quarterly reviews and divestment success. Among the respondents 48% who experienced high-performing deals, 48% carried out As necessary/opportunistically reviews quarterly and 37% annually — a 30% difference in 38% likelihood of success. Twice a year There are other implications of infrequent portfolio reviews. 37% Shareholder activists tend to get involved when the market Annually perceives that a company does not appreciate the inherent 37% value in its portfolio of businesses and is slow to act. This is Every two years becoming a widespread problem: 78% of executives expect 29% the same or an increased number of unsolicited or hostile bids within the next year. Shareholder activism in the US • The number of activist campaigns increased by 17% between 2010 and 2014 — and 2015 is set to outpace 2014 (annualized 644 campaigns in 2015 versus 518 in 2014). • Divestments are the second most frequent change activists are pushing, behind governance — which can also result in a divestment. • Technology, consumer products and retail, and life sciences have been the most targeted sectors over the last five years (455, 322 and 265, respectively). Source: Shark Repellent and EY data analysis. 11

Portfolio review Data: good decisions don’t come from bad information Nearly half of corporate executives say access to accurate, comprehensive data is a significant portfolio review challenge. Data causes divestment dilemmas Businesses are often burdened with unclear cost allocations, • 81% say poor-quality data makes it difficult to use onerous intracompany pricing policies and lack of dedicated analytics effectively. balance sheet responsibility. This makes a business’s • 46% of PE buyers say availability of sufficient granular contribution to the portfolio, as well as potential stand-alone data is the most important factor in staying in an performance, difficult to determine. acquisition process (e.g., gross margin, cost of sales, Below are suggestions to help better understand portfolio working capital). performance and create a better value story for a buyer. • Conversely, 44% of PE buyers say lack of confidence in information is the most significant factor that causes a • Produce more granular data. PE firms empower their PE firm to reduce its offer price or walk away from a deal. information systems to provide a deeper dive into business unit financials. The costs of this effort are not inconsequential but should be recouped through • Stress-test the data. Empower a portfolio management incremental shareholder value over the long term team comprising people from different functional areas to • Set benchmarks like an outsider. Align the key make sure the data is accurate and supportable performance indicators used for portfolio reviews with • Understand business complexity. Consider the extent to those that are typically looked at by external investors which each business unit is integrated with the remaining company (e.g., overlap in customers, vendors, facilities, shared services) Analytics: critical for performance measurement The use of analytics isn’t just about tools. It’s about taking advantage of a proliferation of data that is now accessible both to a company and its outside influencers. The last thing companies want is for a third party (e.g., a shareholder activist, a potential buyer) to uncover something about the company that its leadership didn’t know because they hadn’t fully considered all potential sources of available data. Companies need to make sure their analytics provide answers to critical questions like these: • What are the true drivers of historical and forecast performance (financial and nonfinancial)? • What are probable future outcomes for the portfolio under various assumptions, and how could this affect a deal as well as the remaining organization? 42% • What strategic options offer the most value- creation potential? of executives say they need to apply • What are the risk and return characteristics of each more sophisticated analytical tools to business in the portfolio, and what is the overall effect of their relationships and interdependencies? their process 12

Portfolio review Priority analytics capabilities are not areas of strength Sixty-two percent of PE executives say that they find predictive modeling most important to assess business performance, compared with 56% of corporates. PE firms are also slightly more likely to use commercial analysis and to model multiple scenarios. While corporates are placing increasing importance on analytics, few believe they have advanced analytics capabilities. Which analytics do you find most important How effective are your analytics capabilities? to assess business unit performance? Predictive modeling (e.g., price elasticity, workforce Predictive modeling (e.g., price elasticity, workforce analytics, sensitivity to market changes) analytics, sensitivity to market changes) 62% 8% 60% 32% 56% Commercial analysis (customer segmentation, Commercial analysis (customer segmentation, market share, size and growth) market share, size and growth) 51% 7% 55% 38% 50% Model multiple scenarios Model multiple scenarios 42% 8% 68% 24% 39% Model tax footprint and tax rate Model tax footprint and tax rate 38% 11% 54% 35% 43% Social media analysis (customer perception) Social media analysis (customer perception) 7% 65% 24% 11% 13% Private equity Corporate Not effective Somewhat effective Very effective Companies that do rate their abilities as very effective are more likely to carry out divestments that exceed expectations, likely because robust forecasts support the equity story, and therefore the diligence process. Increase in likelihood of strong sale price and timing performance if analytic capability is rated as very effective The potential buyer of a manufacturing company asked for 20 years of insurance claims data. The buyer wanted the Model tax footprint and tax rate data to use as a basis to predict future costs. The seller 23% had the data but had never analyzed it before, so they 27% hadn’t considered how it would affect the bidder’s view of Social media analysis the business. 19% 5% Model multiple scenarios 18% 0% Predictive modeling 16% 30% Commercial analysis 11% 26% Price Timing 13

Portfolio review Companies plan to invest in the Which analytics capabilities do you expect to highest-impact analytics invest in within the next two years? To their credit, many companies recognize this structural Commercial analysis weakness and are planning to address it. Successful 63% companies are increasingly seeing the benefits of 51% using predictive analytics to provide early visibility to Model tax footprint and tax rate the expected performance of each business, as well as 52% greater insight into the expected value of a sale, including 47% associated synergies. A greater percentage of PE firms Predictive modeling expect to ramp up their commercial analysis capabilities 51% (63%) than their corporate counterparts. These capabilities 70% could help companies better understand their competitive Model multiple scenarios positioning and customer trends to better inform valuation 48% and transaction decisions. Predictive analytics, commercial 45% analysis and scenario modeling can also help executives Social media analysis (customer perception) identify what attributes of a deal might attract a broader 11% group of owners willing to pay more for an asset, and when 19% and why they would be willing to pay more. Private equity Corporate Social media is being overlooked Every day, more than 500 million opinions, comments and suggestions are posted on Twitter, with countless more appearing on reviews, blogs and other online forums. These real-time, unfiltered opinions contain a treasure trove of intelligence that can help companies track market trends and extract insight for portfolio reviews. For example, social media analysis helps executives understand sentiment changes about a division, product or service and benchmark them against various business units, specific competitors or entire industries. In addition to traditional metrics, these findings can serve as indicators of future business prospects. Social media analytics can even help companies understand investor opinions if the company becomes an activist shareholder target. Many companies are already leveraging social media analytics for product development. Ideally, these analyses should expand beyond individual business units and into wholesale portfolio reviews, which will help companies compare potential growth across business units and help inform decisions on whether to invest in a business or sell it. Critical analytics capabilities that can provide objective and actionable insights Capability Benefit Commercial analysis Customer segmentation and churn Helps inform the enterprise on customer base, how to influence buying patterns and related impact on forecast Stakeholder sentiment Supports the value story and ongoing revenue and EBITDA Predictive modeling Cost analytics Drives value creation road map relative to buyer synergies; allows for benchmarking on a pro forma combined basis Price elasticity Reveals potential implications of future price changes Workforce analytics Identifies productivity drivers and go-forward impact on EBITDA/value creation Working capital analytics Optimizes working capital; assists in setting closing working capital peg/value creation Tax analytics Details tax cost both pre- and post-close Scenario modeling Tests the impact of various drivers on deal value 14

PPoorrttffooliolio rreevviieeww In depth Communication: poor information-sharing hinders divestment success Improving communication between the Managing internal conflicts of interest board/strategy team and M&A team One in five companies (21%) says that overcoming emotional Forty-four percent of executives say they need better attachments to assets or other conflicts of interest is a communication between the board or strategy team and significant portfolio review challenge. Here, we outline some the M&A team. Here are some leading practices to improve key ways to overcome it. the dialogue: During the portfolio review process: • Establish portfolio review protocols so that it is clear • Define objective evaluation criteria which businesses are on a watch list • Develop appropriate models, timelines and milestones • Discuss portfolio review findings regularly in board meetings relative to pending transactions to allow time for to support objective decision-making value enhancement • Involve the business stakeholders in the process so that • Develop related stakeholder communications, including they understand performance expectations, and the review communiqués directed to equity analysts feels less like an event — or a threat • Align internal functional work streams and Once the decision has been made to divest: service providers • Listen to employee concerns early and explain the vision for the separated business Appoint a project leader to manage • Involve business stakeholders in discussions with external the portfolio review process advisors so they understand potential opportunities, both Forty-four percent of corporate executives say dedicating for the parent company and for the target specialized resources to the process is a significant portfolio • Incentivize key executives to effectuate a successful review challenge, and nearly one in five companies (18%) transaction (e.g., retention payments, stock options, say they lack leadership support. A key way to resolve these performance bonuses) issues is to enlist a project leader who is sufficiently senior and experienced in the organization to have the C-suite’s ear. This person is empowered to secure the smartest functional leads — colleagues who aren’t always readily available — and to make them accountable. No external advisor can do that. A company publicly announced the timing of a spin-off without alignment among the deal team. During the separation, the company discovered several regulatory hurdles in numerous countries that delayed the transaction by six months. The stock lost more than 20% of its value post- announcement and did not recoup its losses until after separation. 15

Deal execution: fail to prepare, prepare to fail With boards under constant scrutiny to build shareholder value, sellers of corporate assets need to answer three critical questions: What drives the business’s purchase and valuation decisions? How can the seller develop a value story tailored to individual bidders in order to maximize value? What impact will the divestment have on the remaining business? Sellers who can answer these questions make an asset easy to buy and create competitive tension. The value story should clearly articulate the future value of the separated business, which often deviates from the current operating model under the current corporate umbrella. And yet, just over one-third (36%) of companies have developed consistent execution procedures across their divestments. Corporates continue to point to deal execution as a divestment area ripe for improvement. 16

Divestment execution Lessons learned from private equity It’s still your business: don’t ignore it until it’s off your books Only 41% say they are very good at continuing to create This short-sightedness is challenging to deal execution results. value in businesses they intend to sell, an area where Our research shows that those who continue to create value PE excels. Corporate and PE executives agree that most in a business targeted for divestment are 75% more likely to companies sacrifice value due to pressure to allocate receive a higher-than-expected price and 59% more likely time and resources to their core businesses (42% and to experience a higher-than-expected valuation multiple 47%, respectively). post-sale. Sellers must therefore continually evaluate the potential returns from continuing to optimize the business’s attractiveness to buyers. In your last major divestment, how would you rate What do you see as the main causes of the effectiveness of each of the following steps? value erosion in corporate divestments? Focus on management team quality Lack of focus on non-core business/competing priorities 8% 38% 54% 47% 42% Identification and mitigation of stranded costs Confidentiality concerns meant disposal had to be executed quickly 7% 43% 50% 41% 35% Conducting commercial diligence Lack of fully developed diligence materials 9% 45% 46% 36% 31% Consideration of exit alternatives Board decision already made/announced fixed end date 6% 48% 46% 27% 26% Creating value even though intend to sell Business was not presented stand-alone 11% 48% 41% 26% 33% Seller was not able to implement crucial restructuring Not effective Somewhat effective Very effective 22% 33% Private equity Corporate 17

Divestment execution Operational separation: vital to value creation, often neglected One of the most effective ways to create value pre-sale is to Which value creation initiatives did you present a compelling vision to a potential buyer of how the undertake before your last divestment? business will be operationally separated and how it would fit into the buyer’s organization. This initiative comes up most Enhancing revenue frequently when corporates are asked about the step they 40% did not undertake on their most recent divestment, but wish 71% they had. Operational improvements to reduce costs/improve margin 24% Sellers should be able to ensure that: 60% • Stand-alone financials can withstand diligence Optimizing legal structure • Assets, liabilities and operations within the perimeter of 15% 70% the deal have been vetted Operationally separating the business partially or fully • Separation activities, particularly long lead-time items, 11% have already commenced. Sellers are often reluctant 61% to implement these measures until a buyer has been Optimizing tax structure identified and appropriate personnel are cleared because 6% they can generate significant work and cost. But waiting 54% for buyer agreement can cause delays and increase Extracting working capital transaction execution risk. Ideally, a seller will begin 4% separation as part of its preparation process — developing 37% a clear view of what is included in the deal and preparing a detailed separation road map. This plan details timelines, costs and transition arrangements, which enhances buyer Most important for enhancing value Undertook (all that apply) confidence and adds certainty to negotiations. Which step did you not do but now feel you Increase in likelihood of high performance on each would have benefited from the most? metric if value creation initiative is carried out Operationally separating the business partially or fully Enhancing revenue (e.g., product improvement or distribution expansion) 25% 43% Extracting working capital 57% 21% Operational improvements to reduce costs/improve margin 36% Operational improvements to reduce costs/improve margin 13% 18% Operationally separating the business partially or fully Optimizing tax structure 33% 17% 49% Enhancing revenue Optimizing tax structure 10% 15% 35% Optimizing legal structure Optimizing legal structure 9% 6% 46% Extracting working capital 2% 8% Price Timing 18

Divestment execution Communicate synergies: take back the buyer’s upside Most PE firms (58%) said synergies were the source of their Which of the following buyer communication greatest upside. This suggests that corporate sellers should initiatives did you undertake? be much more rigorous in how they identify, communicate and value potential synergies for each potential buyer. Presented the synergy opportunity for each likely buyer It may also suggest that PE is good at building scale through 34% acquiring platform companies and subsequently bolting on 76% acquisitions. In essence, they are finding synergies and are Developed value creation road map (initiatives thereby able to create an efficient cost base and a more that potential buyers could implement) efficient organization overall. 31% 70% Similarly, presenting each likely bidder with its own tailored Prepared audited financial statements for the divested business synergy opportunity was found to have a significant impact 19% on overall success. 64% Provided an estimate of one-time separation costs 6% for PE buyers Where did you find the most 47% upside in your most recent corporate acquisition? Created stand-alone operating model(s) reflecting the buyer pool 6% Synergies 44% 58% Prepared vendor due diligence reports Expand top line/buy and build 4% 19% 35% Working capital Most important for enhancing value Undertook (all that apply) 13% Reducing overhead 6% Increase in likelihood of high performance on each Offshoring metric if buyer communication initiative is carried out 2% Prepared audited financial statements for the divested business Renegotiating supplier contracts 53% 1% 40% Plant rationalizations/closings Developed value creation road map (initiatives 1% that potential buyers could implement) 39% 22% Presented the synergy opportunity for each likely buyer 36% 17% A potential buyer was very focused on Created stand-alone operating model(s) reflecting the buyer pool understanding stand-alone costs. The seller 12% refocused the conversation on market, 41% functional and country overlap. Leadership Prepared vendor due diligence reports convened staff across functions to crunch 10% numbers and determine the value the buyer 25% could extract relative to synergies. The seller Provided an estimate of one-time separation costs 9% ultimately identified US$32 million in synergies, 45% representing US$208 million in value based on the sale’s 6.5x multiple. Price Timing 19

Divestment execution Keep a buyer in it to win it: management quality and commitment PE firms say management quality and commitment are What do you think are the two most important types the factors they prioritize most when deciding to stay in an of information a PE buyer requires to stay in an auction process. If a PE firm does not have confidence in auction or purchase process for corporate assets? who will run the business and deliver on plan, they will seek out their own team. Management quality/commitment 57% Corporates, like PE, should give sufficient focus to the 45% management factor while also keeping in mind that, at Availability of sufficient granular data some point in the sales process, management loyalty will 46% shift from the current owner to the potential new owner. 48% Therefore, sellers should establish rules and incentives to Recent value creation initiatives (e.g., new product introductions) keep demarcation lines clear until a sale is concluded. 45% 43% PE firms seeking add-on acquisitions and strategic buyers might use the existing business’s management or choose Convincing equity story which management team they prefer. Regardless of a 28% buyer’s intentions regarding current management, a 33% business with a strong management team is much more Well thought-through stand-alone case/costs likely to be run well and use strong data for both its 22% decision-making and the sale process. 31% Private equity Corporate Provide the right details: keep buyer’s needs in mind PE buyers, in particular, have an eye for detail. But sellers On a recent complex carve-out transaction, a seller should be able to provide the following to any smart buyer: • Explanations of margin development and cost pass-through, circulated 20 targeted-buyer presentations, but the including detailed value creation bridges and a clear view to information did not explain clearly what was actually the forecast included in the deal. • Clarification if the business will be stand-alone , and The result: more than 70% of the potential buyers sufficient details regarding stand-alone consequences declined, and the remaining six dropped out early in • Links between performance of the business and the the diligence process. One potential buyer said, “Far markets in which it operates too much time would be required of us to purchase • Future plans and opportunities for the business, including this business.” additional upside potential that is not reflected in the current-state business 20

Divestment execution Most important financial factors for buyers More than half of PE respondents (56%) say growth potential • Sellers must provide credible information to buyers. is the financial factor they most prioritize, followed by Nearly two-thirds of corporate executives say they prepare potential EBITDA multiple and internal rate of return (IRR). It audited financials — and yet, lack of faith in information is the is therefore incumbent upon sellers to employ data analytics leading cause of PE buyers discounting a deal. Any potential (e.g., social media, predictive analytics) as well as traditional buyer needs to understand the deal-basis financials (e.g., commercial diligence to help buyers understand the growth how the company is being run, how it has performed, what potential. As for EBITDA, value creation bridges are critical to cash flow looks like on a pro forma basis) helping buyers identify efforts that can be undertaken to drive value post-close (and therefore the EBITDA multiple they are willing to pay). for PE buyers What are the two most important What makes a buyer walk away from a deal financial factors your company requires to stay in an auction or purchase process for corporate assets? Companies should understand how to create a compelling story for experienced buyers. Particularly among PE buyers, Growth potential there is often a stark difference between what sellers think 56% causes a reduction in offer price or a bidder dropout and what Potential EBITDA multiple PE firms say actually drives them away. 41% Corporates think that lack of confidence in the management IRR team and level of capital investment required are the most 38% likely factors. For PE respondents, the management team Stability of earnings is indeed important, but so too are inconsistent or declining 27% financial performance and commercial factors. Capital investment required We draw two major conclusions from these responses: 12% • Corporate executives may need to focus on different Return on assets employed priorities. Early in the process, PE wants strong 12% management in place. But while this will make them Revenue size interested in the asset, PE buyers also want confidence in 9% the financials. This means sellers must gather sufficiently One-time costs granular data to support the equity story 3% What factors do you think are most likely to make a PE buyer reduce its offer price or drop out of the bidding process? 44% 39% 33% 34% 33% 32% 36% 24% 27% 24% 23% 20% 17% 13% Lack of confidence Inconsistent or Commercial factors Lack of faith in Auction process Level of capital No clear plan in information declining financial (i.e., customer management team too competitive investment required of separation/ performance stability/growth (information complexity factors) is limited) Private equity Corporate 21

Conclusion Looking forward: since you’re likely to divest Nearly half of companies plan to divest in the next two years, and another 46% are open to the possibility. For example, life sciences companies often divest to fund new opportunities, financial services companies continue to react to regulatory changes, consumer products companies are better at predicting or reacting to customer preferences, and technology companies are keeping pace with fast innovation and activist shareholders. Unless you’re part of the 5% that does not plan to divest remaining business over the long term. Private equity firms over the next two years, now might be the ideal time to start have proven to be successful buyers and sellers. They are not considering if you have the right infrastructure and teams in the end-all, but they transact more often than corporates and place to decide what, when and how to divest. their 10-year performance is impressive. Evidence from this study clearly shows that companies that With limited resources and time, companies should re-examine divest strategically — including preparing assets for sale and which practices are shown here to have the greatest correlation carefully considering how to use sale proceeds — are much with success, and which aspects of the value story are most more likely to execute divestments that positively affect their important to discerning buyers. Conclusion Related thought leadership About this study In light of rapid technological advances, regulatory changes, increased shareholder scrutiny and customer purchasing power and demand shifts, strategic portfolio reviews are the most important tool to optimize capital allocation. Decisions regarding which assets to invest in or sell off will drive a company’s competitive advantage and long-term growth. Frequent and effective reviews help companies avoid some symptoms of portfolio inertia that negatively impact The EY Global Corporate Divestment Study focuses on the critical lessons Sector-specific Global Corporate business performance: corporations can learn from private equity relating to portfolio review and Lack of alignment between capital allocation and the strategic value of portfolio components Divestment Study reports • divestment strategy and execution. The results of the 2016 study are based Neglecting market trends, resulting in investment gaps and missed opportunities ey.com/divest • on more than 900 interviews with corporate executives and 100 private Reactive postures that result in lower-quality investment options and wasted effort in evaluating • equity executives surveyed between September and November 2015 by FT • Consumer products • Life sciences non-strategic options Remark, the research and publishing arm of the Financial Times Group. • Financial services • Technology An effective portfolio review agenda is based on an up-to-date de nition of the core business — that is, a clear model of where the company should be focusing its capital to reach current and future market needs. The review itself should then • Executives are from companies across the Americas, Asia-Pacific, Europe, the Middle East, India and Africa. analyze whether each business unit  ts within that core strategy. Performing this assessment regularly — ideally, every six months — should reveal divestment candidates as those business units that are under-performing or non-core to strategic goals, as well as those that may have greater value for another • CEOs, CFOs or other C-level executives make up 82% of executives surveyed. owner or as a separate entity. But portfolio review results are only effective if companies dedicate resources to implement suggested changes and divest units that are a poor strategic  t. Companies are realizing that divestments are a growth tool, similar to acquisitions. Those that adopt leading practices are • Executives stated they have knowledge of or direct hands-on experience Roadmap to completing divestments that achieve higher sale prices and are rewarded by investors through stronger valuation with their company’s portfolio review process and have been involved in Divestments and multiples on the remaining business. These high performers, just 12% of executives, are in a better position to adjust to carve-out sale changes within their sector and in the economy as a whole. working capital at least one major divestment in the last three years. success management • While nine industry sectors are represented, the study primarily focuses ey.com/carveouts ey.com/transactions on consumer products, financial services, life sciences and technology. • One-third of corporate executives represent companies with annual Respondent demographic revenues of US$1b–US$5b, and 27% represent companies with revenues that exceed US$5b. 80% of executives are CEOs, CFOs or other C-level executives. • Tax strategies to increase divestment Executives are from companies across the Americas, Asia-Paci c and Europe, the Middle East, India speed and value • • Private equity executives represent firms that have US$1b or more in Tax strategies to assets under management; 40% exceed US$5b. and Africa. More than eight industry sectors are represented. Tax-free spin-off increase divestment • • This year’s study also incorporates external data from select divestments More than half of the executives represent companies with annual revenues that exceed US$1b. speed and value • roadmap (US) that were closed between December 2006 and December 2015. Executives stated they have knowledge of or direct hands-on experience of their company’s portfolio review ey.com/transactions • ey.com/spinoffs process and divestment activity. Produced in association with Remark Research from the Financial Times Group 22 32

How EY can help EY’s dedicated, multifunctional divestment professionals can help clients improve portfolio Contacts management, divestment strategy and execution. Pip McCrostie First, we help each client understand the performance of its EY Global Vice Chair Transaction Advisory Services business relative to peers and the rest of the portfolio, including [email protected] assessing the quality of information and developing more reliable +44 20 7980 0500 data for the evaluation process. We then help clients decide where capital can be released from underperforming or non-core Steve Krouskos activities and reallocated toward higher-growth areas. EY Global Deputy Vice Chair Transaction Advisory Services We then work with clients to prepare them for a divestment [email protected] and become an informed negotiator. Our work with corporate +44 20 7980 0346 and private equity clients includes a variety of divestments, Paul Hammes including sales of the entire company, carve-outs, spin-offs EY Global Divestiture and joint ventures. Advisory Services Leader For carve-outs in particular, we advise on which businesses are [email protected] worth investing in and which may be worth more to another +1 312 879 3741 owner. Our sector-focused teams can also help clients understand Rich Mills the effect a divestment could have on the remaining company’s EY Americas Divestiture Advisory growth, brand and stakeholders. Furthermore, we can help Services Leader maximize transaction value by guiding you through preparation [email protected] and execution and removing any potential bumps in the road before +1 404 817 4397 buyers get involved. For example, we can create a compelling value Martin Hurst story by analyzing the growth opportunity, assessing underlying EY Europe, Middle East, India and Africa trends, and identifying hidden value in earnings, corporate Divestiture Advisory Services Leader allocations, real estate, working capital, human resources, IT, [email protected] operations and tax. +49 6196 996 27365 Finally, we assist with negotiations, Day One readiness and helping Stephen Lomas your company manage its remaining cost structure and focus on EY Asia-Pacific Divestiture future growth. Advisory Services Leader [email protected] +61 3 9288 8441 Peter Wesp Japan Divestiture Advisory Services Leader [email protected] +81 3 458 26400 23

EY | Assurance | Tax | Transactions | Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. About EY’s Transaction Advisory Services How you manage your capital agenda today will define your competitive position tomorrow. We work with clients to create social and economic value by helping them make better, more informed decisions about strategically managing capital and transactions in fast-changing markets. Whether you’re preserving, optimizing, raising or investing capital, EY’s Transaction Advisory Services combine a unique set of skills, insight and experience to deliver focused advice. We help you drive competitive advantage and increased returns through improved decisions across all aspects of your capital agenda. ©2016 EYGM Limited. All Rights Reserved. 1509-1644612 EYG no. DE0666 ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. The views of third parties set out in this publication are not necessarily the views of the global EY organization or its member firms. Moreover, they should be seen in the context of the time they were made. ey.com