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Captives unbound: carve out and captive opportunities

31 March 2009 

The latest of BLP’s outsourcing events focused on carve-out and captive opportunities. The economic environment was undoubtedly having a profound effect, said EquaTerra’s Europe and Asia Pacific Managing Director, Phil Morris, as he offered a sell side perspective. ‘The times speak to a need to do something different with anything that’s not fundamental to the way organisations operate in the marketplace,’ he said. ‘Most of what people have to sell are shared services – but will anyone be interested?’ In fact, the market was ‘fantastically interested’ in anything that represented market share and growth in difficult times, he stressed.

Companies were changing strategy, he said. ‘Running an offshore captive was never an easy thing and has now got harder.’ Economic conditions meant that people were ‘turning off budgets all over the place,’ as they focussed on protecting the welfare of their businesses at home.

However he urged delegates to beware of short-term strategies. ‘Changing tack to do something short-term, with a view to taking it back when the situation improves, is a recipe for disaster,’ he said. ‘The carve-outs, acquisitions and outsources that actually work are the ones that go in one direction – they gain a life of their own.’ These allowed the creation of wealth, he said, while the deals in which the original parent became resentful were the ones that failed. ‘Make everyone remember why you did it and what it gave you – context is integral to long-term success.’

With complex, multi-faceted deals in far-flung locations it was essential that due diligence be absolutely accurate, he stressed, and there also was no substitute for specialised legal advice and accountants that knew the full tax implications of transactions.

While there was no excuse for not doing thorough due diligence on both buy and sell sides, this did not ‘get you the whole way’, BLP Partner and Head of Corporate, John Bennett, told delegates. ‘Relying on due diligence doesn’t do much in legal terms unless you back it up with warranties and indemnities. On the sell side, it’s also essential to look at what services you’re willing to hand over to your service provider.’ On the buy side, meanwhile, it was important to consider what sort of commitments would be forthcoming from the seller, he said.

It was vital to maintain a focus on core business, he pointed out, as managing a captive could be a huge distraction, not least through staff and management turnover. ‘Transferring fixed costs to variable costs is important, as is eliminating risks such as inflation, exchange rates and tax.’ 

Risks from the sell side were loss of control, data protection, confidentiality and competition concerns, and ongoing obligations to avoid undue operational risks. There were also reputational risks and the covenant strength of the buyer to consider, he said, while on the buy side, quality of earnings and anticipating change were key. ‘We’re going through a period of enormous change and seeing things that no one would have anticipated,’ he said. In this climate it was essential to make sure risks were mitigated and minimised.

In terms of deal structure, sale and purchase agreements and master services agreements were inextricably linked, he said. There were also practicalities from a tax point of view, such as de-grouping charges, separation issues – whether the captive truly operated on a stand-alone basis – and employee questions. ‘It’s important to ensure as a buyer that you don’t inherit liabilities you’re not expecting,’ he said – one real fear was defined benefit pension schemes, where the financial risks could be significant. ‘Future proofing is the most difficult area,’ he said. ‘Can changes be anticipated in this day and age? No – therefore it’s a question of where the risks fall.’

Looking at the situation from the buy side, Warburg Pincus International Principal Guy Sochovsky said that, for private equity, the basics were about using growth as an opportunity to transform book value into equity value. ‘We’re about generating returns on capital and taking balanced risks,’ he said – the fundamentals were an operating baseline that was leveragable and a management team with a strong go-to-market plan.

Private equity had the capacity to act as a catalyst for change, he told delegates, as well as to attract and incentivise management talent. It was also fundamentally neutral. ‘These are difficult deals to execute,’ he said. ‘There are a lot of stakeholders – the board, the counter party, employees. It takes a lot of time, energy and passion.’

Nonetheless there were a range of opportunities, he stressed, not least in the UK and Europe, including shared services in the public sector and the opportunities offered by bank restructuring and reconfiguration. ‘There are a lot of assets that sit in the banking universe,’ he said. Private equity could also offer integrated customer relationship management, as ‘high end customers want high end service’.

In many ways, the nomenclature of the sector was no longer relevant, Phil Morris told the seminar, with ‘buy’ and ‘sell’ now effectively arbitrary terms – and this, said Guy Sochovsky, was what made the situation fundamentally attractive.



 



 

 

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