Compelling and auditable carve-out financial statements

04/07/23

Unlocking greater value from divestitures (part 2)

The preparation of both deal-basis financial information and audited carve-out financial statements is usually critical to support the asking price for a divestment candidate and comply with potential regulatory requirements. In this article, Patrick Theune, Matt Reindl, and Steve Zikeli, Capital Markets and Accounting Advisory Services specialists at PwC, outline some frequent challenges in preparing carve-out financial statements and the best ways to address them.

Value creation of divestitures

Divesting companies that are no longer strategic fits can create significant value for companies and their shareholders. PwC’s Divestiture Study, a comprehensive study of 2,500+ senior leaders related to corporate divestitures, shows that over the past ten years, the average company that made a divestiture saw an increase in its market-adjusted stock price around the date of announcement. The top 25 per cent received a ten per cent boost. When tracking the companies that had a positive return at announcement, over the next twelve months, their stock price outpaced industry peers.

Support the value potential

Audited carved-out financial statements can boost confidence in the performance and potential of the carved-out entity by describing the financial position of the specific activities being sold and their historical costs. They can increase the number of interested buyers and ensure more competition in bidding. This preserves value and gives (potential) buyers confidence in the historically reported performance of the assets coming to market.

Pay attention to regulatory requirements

A divestiture may also require the preparation of financial statements. This depends on the structure of the transaction, the parties involved, related capital raising activities and/or the jurisdiction of the buyer. The completion of a transaction or the related deal financing may be contingent on providing carve-out financial statements, especially in cases where the buyer is based in the United States.

There are also scenarios where European Union-based deals require special purpose financial statements. For example, spin-offs, or when the buyer is issuing high-yield bonds. A thorough understanding of the relevant regulatory requirements will be crucial and will help avoid surprises down the road that can derail the deal process.

As an example, when the carve-out financial statements are to be included in an SEC filing, applicable SEC rules will determine the form of the filing, the annual and interim financial statements required, the age of the financial statements, and whether the financial statements need to be audited. This can be the case if the carve-out entity is registering for an initial public offering using form S-1/F-1.

Additionally, if the carve-out entity is purchased by an SEC registrant (or Foreign Private Issuer with US reporting obligations) and it meets certain significance thresholds set by the SEC, the acquirer may be required to include the carve-out financial statements within their form 8-K/6-K, pursuant to Regulation S-X Rule 3-05. Involving the right capital markets and accounting expertise early in the process will provide a thorough understanding of the regulatory landscape that potential buyers will need to navigate. Anticipating these buy-side requirements can accelerate the deal process and reduce the risk of delays and value leakage.

Prepare carve-out financial statements

While selling a specific part of a company may seem clear in theory, organizations and their operations are generally highly intertwined. The preparation of carve-out financial statements can involve multiple business units and legal entities across the globe, and will likely include operations or products that will remain with the business once the divestiture is completed. This process results in the creation of an ‘entity’ for financial statement purposes that may not have previously existed from a management perspective, e.g. the ‘entity’ does not align to the company’s legal organization chart.

It is unlikely to have clean, discrete financial information that is immediately ready to be used in the carve-out financial statements. Rather, management often needs to retrieve data - including subledger or transaction details - from various ERP and financial systems and aggregate the data. This is often a difficult and time-consuming exercise where the expertise of accounting advisors can be highly advantageous.

Below, we outline some of the frequent challenges we see in preparing carve-out financial statements and the best ways to address them.

Challenge	Best Practice
There are often differences between deal-basis financial information and IFRS-compliance financial statements.	Prepare a single source of truth with regards to accounting data, and create a clear bridge between the two reports that contemplates differences in the deal perimeter.
Determining which account balances and entities should be included in the carve-out financial statements can be highly judgemental .	Engage the assistance of seasoned professionals and keep a thorough documentation of management’s approach and the judgements involved.
Aggregating data sources and preparing carve-out financial statements of a division for the first time can be very time-consuming. Delays can be a deal breaker or result in a price hike if financing costs must increase.	Understand the requirements for carve-out financial statements upfront. Allow sufficient time. Engage professional advisers to compile the financial statements and manage the project across various divestiture workstreams.
There is a lack of authoritative IFRS guidance for carve-out financial statements, and there are multiple technical accounting complexities that must be dealt with.	Maintain robust documentation as to the accounting conclusions reached. Ensure these conclusions agree to the accounting adjustments needed to the baseline financial information for the carve-out entity. Get buy-in from the auditors along the way. Having experienced accounting advisors can help to execute the deal with speed and confidence.

Importance of speed to execution

Divestitures are complex undertakings, and deal speed is important at every step of a divestiture process. Shortening the period of time from the decision to divest to closing the deal has been shown to increase the likelihood of a positive total shareholder return. For instance, according to PwC’s Divestiture Study, when the time between announcement and close was less than twelve months, the median seller had greater excess returns compared to its industry peers — and even greater returns when close was less than six months. When the time was more than twelve months, the median seller underperformed industry peers.

Therefore, anticipating the financing needs, including financial reporting requirements, of your buyer pool is critical. Companies can begin preparing the needed carve-out financial statements, including audits, and prevent bottlenecks that will cause delays in the overall divestiture process.

Planning and executing a successful divestiture is far more challenging than most companies expect, and there is a high risk of value leakage. PwC can bring key insights to help you make confident decisions to unlock value. Our deals advisors use a tech-enabled framework to provide solutions to carve-out financial reporting, sell-side financial due diligence, tax structuring, operational / IT separation, and human capital strategies.