How carving out businesses boosts share prices

The idea that the whole is greater than the sum of its parts does not always hold true for companies. ‘Mini-conglomerates’ with jumbled portfolios tend to trade at a discount. 

With finite time to assess opportunities, investors often lean towards clear-cut investment cases.

In a tough environment for attracting shareholders, a growing number of listed companies are recognising the benefits of a simpler, more focused business structure and turning to carve-outs, where a parent company sells a division to a trade or private equity buyer.

Earlier this week, engineering consultancy Ricardo (RCDO) announced it had sold its defence division for £67.5mn as part of a five-year strategic shift, launched in May 2022, to reposition the business towards environmental and energy transition consulting. 

The proceeds would be used to buy an 85 per cent stake in Australian infrastructure advisor E3 Advisory, which the company said would partly offset the “near term” hit to earnings from the sale of the defence unit. Last month, Irish conglomerate DCC (DCC) said it would put its healthcare division up for sale and consider options for its technology unit, as it looks to refocus on its energy business. 

Selling off disparate segments, especially for companies with multiple units that investors or management see as underestimated by the market, can simplify the business narrative, and provide cash that can be reinvested in higher-returning divisions, to pay down debt or returned to shareholders. 

Carve-outs can also shine a light on the undervaluation of the remaining business. This is evident in recent transactions by Capita (CPI) and GlobalData (DATA), which both sold their subsidiaries at valuations close to the entire market cap of the group. 

Two case studies

A combination of the above could drive a re-rating of the remaining business, at least in theory. The good news is there have been some recent examples to back this up in the real world. 

The most obvious is Ascential (ASCL), whose £1.2bn takeover by rival Informa was completed in October at a punchy 50 per cent premium. A series of events over an 18-month period led to this outcome, starting with management’s decision to break up the business in January 2023.

Ten months later in October 2023, the company sold its trend forecasting business WGSN and digital commerce division for a combined enterprise value of £1.4bn, leaving just the core events business behind and rewarding shareholders with an £850mn payout through dividends and buybacks. 

Business safety and regulatory compliance specialist Marlowe (MRL), whose aggressive acquisition spree in recent years had left shareholders frustrated over its ever-increasing debt pile, is also a good example of value being created through carve-outs. 

In February, the company sold its governance, risk and compliance (GRC) assets to UK private equity firm Inflexion for £430mn. This was more than Marlowe’s market cap the day before the announcement, despite the division only accounting for 40 per cent of group Ebitda. 

The sale allowed the company to pay off debt and return £225mn to shareholders through a special dividend and share buyback programme. The shares have produced a total return of almost 90 per cent year to date. 

Another move that helped drive this return was the spin-off of its occupational health division Optima Health (OPT) onto Aim in late September. That resulted in a much simpler investment case for the remaining company, now refocused on its testing, inspection and certification (TIC) business. 

Cassie Herlihy, associate director at Gresham House, told Investors’ Chronicle cases such as Ascential and Marlowe can act as a blueprint of how carve-outs can work, giving boards and management teams the confidence to pursue a similar strategy. 

“Hopefully there'll be more, because I do think it's a positive for equity markets,” she said. “We've had so many good companies leaving the market, and this is a way for businesses to stay and be more valuable over time. With carve-outs, you're getting some jam today, but more jam tomorrow.”

Potential carve-out candidates

Ricardo may have more work to do on this front. Its legacy performance products unit, which manufactures engine and transmission parts for high-performance vehicles, does not fit with its new strategy and could be sold alongside the defence arm, according to Herlihy.

The disposal would enable the company to reinvest the cash into its higher-margin, less capital-intensive environmental consulting business. It would also streamline the group’s investment case, which she said would allow for a rating “more closely aligned to other environmental consultancy firms”.

With 19 business units, Next 15 (NFG) could also do with some slimming down. The data-driven growth consultancy has shed half of its market value this year after it warned subsidiary Mach49 had lost its largest customer in September. 

While some of the group’s divisions are going backwards, others are thriving. One example is retail marketing agency SMG, which has more than doubled in revenue and profitability in the last three years according to a spokesperson. Next 15 has an acquisitive strategy, but its overly complex business structure means its overall valuation is lower than a sum-of-the-parts tally. 

Management appears to have caught on to this. After posting flat revenues and a double-digit drop in profits in its interim results, chief executive Tim Dyson said the headline figures masked “some strong performances” by a number of its brands. 

Following a review, the board said it had determined there was a need to make Next 15 “simpler in structure”. This could entail consolidating business units, but may also involve divesting some older legacy subsidiaries. 

Another potential carve-out candidate is International Workplace Group (IWG). In March 2023, Sky News reported IWG had put Worka, an app that helps IWG clients compare and book places to work globally, up for sale.

The broadcaster said the aim was to sell a 50 per cent stake for £800mn. This would make the subsidiary worth £1.6bn, approximately the same as the market capitalisation of IWG as a whole at the time. Nearly two years later, this has not yet materialised. However, Investec analyst Michael Donnelly said IWG was still weighing up strategies to revive its share price, which is down about 40 per cent in the past three years. Actions could include selling all or part of Worka, or listing the division in New York to capitalise on the higher tech valuations in the US market. 

“The US is a very business friendly environment,” he said. “The opposite is true of the UK, so a spin-off or a carve-out in that environment would seem to make a lot of commercial sense. It's difficult to see how it wouldn't be an imminent and obvious catalyst.”

IWG's medium-term debt target is to achieve a net debt-to-Ebitda ratio of 1x. A cash inflow from a divestment of this scale would undoubtedly make a big dent in the company’s debt figure. This, in turn, would open the door to returning some cash to shareholders. 

Even with strategic reviews and divestment programmes in place, re-ratings are unlikely to happen before a business is actually sold. 

However, investors may find buying opportunities ahead of carve-outs taking place within companies where both the market and management can see an easy option to reshape the business for the better.