When I spoke this week to John Potter, who leads the U.S. deals business at PwC, he was feeling a little harried. I could understand why. It had been a busy day—the latest busy day in a very, very busy year for anyone who works in the business of buying and selling companies.
“I mean, I try to avoid the hyperbolic statements of extremes,” Potter told me. “But from an M&A cycle perspective, there’s no doubt that we are in a different time than we’ve ever been in before.”
Deal volumes are surging. Deal values are skyrocketing. Stock prices continue to climb. And shareholders everywhere are itching for juiced-up returns.
For many large corporations, there’s a clear side effect: These days, there might be more pressure on conglomerates than ever before to divest non-core divisions. In an environment where easy capital seems to be everywhere and activist investors loom on every horizon, many companies are deciding that the best way to maximize value in a business unit is to sell it to somebody else.
“The public markets have continued to go up,” says Keith Campbell, who leads the carveout team at the consulting firm West Monroe. “So there’s constant pressure to outperform.”
Globally, we’ve had nearly $1.36 trillion worth of corporate divestitures so far in 2021, according to Refinitv, the highest total of the past decade and a 35% increase over last year. The spate of splits made major headlines last month, when General Electric, Johnson & Johnson and Toshiba all announced plans to break themselves up into several smaller companies.
In some ways, it’s all a symptom of innovation and competition. In today’s crowded landscape, it’s more difficult than ever to dominate a market. And with so many shareholders clawing for every last dollar in potential profits, nothing less than domination will do.
Which means GE, J&J and Toshiba likely won’t be the last sprawling entities to decide that bigger isn’t necessarily better.
“With all the new players being created in so many different markets, and the Amazons out there, you have to really continue to change and reinvent yourself,” Campbell says. “And you can only do that is so many core operating business. Which is kind of why we think the conglomerates, the cross-vertical conglomerates, are a little bit of a thing of the past.”
PwC’s Potter laid out some of the logic driving this trend. When a company has a handful of different divisions under one corporate umbrella, it’s an inescapable fact that some will be prioritized over others. GE, J&J and Toshiba now seem to be acknowledging the longstanding argument from activist shareholders that, for the divisions on the bottom of those totem poles, the best path forward might be to branch out on their own.
In a drearier market, the safety of the J&J bosom might have more appeal. But the past 18 months or so have been an optimal environment for public companies. And the investors in those companies are expecting optimal performance.
“A lot of times, folks will look at five businesses within one company and say, these five things on their own are worth more than this company as a whole,” Potter said. “And how do you unlock that value that’s being suppressed when we put the five things together? I think that’s where a lot of the activity that we see today is really focusing.”
All three of GE, J&J and Toshiba plan to break up into a series of standalone private companies, which makes sense given their enormity. For corporations looking to spin out smaller units, a sale to private equity is another option. Some firms, like One Rock Capital Partners, specialize in these sorts of transactions—which carry some inherent complications.
“In general, carveouts are more risky [for private equity] than a traditional new platform investment,” Campbell said. “Because you have to go through the transition, and you’re installing new management, you’re putting in new processes, new systems, and there’s just a lot of change going on.”
With that additional risk, though, can also come additional reward.
“If you’re comfortable with the sweat equity that you put in on that, and the investment that’s required, and you can underwrite the one-time investment, and you can find an incoming CEO or management team that can run the business, the returns are excellent,” he said.
In the end, it all comes down to the returns. Every company needs some financial input to create financial output. The carveouts, spinouts and other deals will keep coming as long as private equity firms and other strategic buyers believe they have the ability to tilt that equation in their favor.
“People think of divestitures as, oh, you’re selling non-core assets, you’re selling underperforming businesses,” Potter said. “Why would you buy something that’s underperforming? No, you’re buying something because you believe in its performance, and you’re going to invest in it, give it the investment and attention it needs to thrive.”