As central banks continue their campaign to cool inflation, interest rates remain at elevated levels not seen in well over a decade. For companies, this makes funding growth initiatives and refinancing existing debt much more expensive.
At the same time, shareholders are increasingly demanding that companies double down on their core competencies and shed non-core assets. The “conglomerate discount,” wherein the market undervalues diversified companies relative to the combined value of individual parts of the business, is one of the main drivers behind these calls.
This combination—of onerous financing and investor emphasis on pure-play businesses—is causing companies to explore carve-outs and, relatedly, spin-offs. Separating different divisions into distinct entities unlocks value by allowing each to pursue a focused strategy tailored to its markets, competitive dynamics and capital needs.
Capital efficiency
There is little definitive data on the relative capital efficiency of European companies, but with the EU’s emphasis on sustainability, high levels of regulation and strict labor laws, efficiency is likely lower than in the US, for example. Many European markets are also relatively mature economies in which established companies often face slower growth rates and may struggle to deploy capital as efficiently as those in emerging, high-growth markets.
In theory, these conditions should push European companies to pursue carve-outs and spin-offs, yet these types of deals have not yet caught on this year.
In Q1 2024, 731 corporate divestitures were announced in Europe, the lowest figure in the last four years, according to Mergermarket. This represents a year-on-year decline of 17 percent and a quarter-on-quarter drop of 22 percent. Collectively, these transactions were worth US$94.7 billion, twice the figure recorded in Q1 2023, but down 42 percent on Q4 2023 and behind the four-year quarterly average of US$112.4 billion.
Spin-offs vs. carve-outs
Before examining some of the more notable corporate divestments announced recently, it is important to draw distinctions between these deal types.
In a spin-off, an independent company is created through the distribution of new shares of an existing business or division to the parent company’s shareholders. The new company becomes a separate entity with its own management team, board of directors and publicly traded stock. Shareholders receive a pro-rata distribution of its shares, while still retaining their ownership in the parent company.
By contrast, a carve-out involves the divestment of a subsidiary or division of a parent company to another company or a private equity firm. Both instances involve disentangling balance sheets and assets, but the key difference is that carve-outs actually raise cash for the parent.
Notable divestments
The biggest divestment in Q1 was more of an arm’s length internal reorganization than an outright sale. Danish anti-obesity drug champion Novo Nordisk agreed to acquire three fill-finish manufacturing sites in Italy, Belgium and the US from Novo Holdings, its largest shareholder, for US$11 billion.
The acquisition is part of a broader transaction where Novo Holdings is acquiring Catalent, a contract development and manufacturing organization. The deal is expected to significantly expand Novo Nordisk’s manufacturing capacity from 2026, enhancing its ability to serve more patients with diabetes and obesity.
A more traditional carve-out example is the divestment by Vodafone Group of its Italian subsidiary, Vodafone Italia, to Swisscom for US$8.7 billion. Swisscom plans to merge the business with its existing subsidiary Fastweb, combining their respective mobile and wireline networks.
PE-backed deals
Given today’s tighter refinancing environment, forecasters have anticipated that PE-backed European carve-outs will gather momentum, unlocking cash to de-lever balance sheets. So far, this has yet to materialize. Companies appear reluctant to transact amid concerns that their assets could be undervalued by sponsors, who are factoring in the higher cost of capital.
Many businesses are instead biding their time and, if necessary, lowering their overheads. For example, Nokia in Finland is planning to cut up to 14,000 jobs, and Deutsche Bank in Germany is set to reduce its workforce by 3,500 in back-office roles. In the UK, Rolls-Royce is laying off 2,500 employees.
On the other side of the negotiating table, PE firms facing higher financing costs appear to be shying away from carve-outs, which are inherently complex processes that can take over a year to execute. In these conditions, where elevated interest rates inhibit appetite for intricate transactions, sell-side companies and buy-side sponsors are being equally judicious about what deals to pursue.
Equity markets
In the case of spin-offs, there has been no sustained uptick in Europe yet this year. Why might this be? As a proxy for risk appetite, a slower IPO market can inhibit the valuation and after-market performance of a spun-off entity, undermining shareholder value. Last year, there were just 107 IPOs across Europe raising €10.2 billion, a far cry from the 422 worth €75 billion in 2021. The market has yet to recover, with 26 IPOs announced in Europe in Q1, down marginally year on year from 28 in Q1 2023.
The quieter IPO market may be one reason why companies are delaying their plans. However, the after-market performance of newly listed companies in Europe has been improving. EY data shows that the average return on the 26 newly floated companies in Q1 was 88 percent, 25 percentage points higher year on year, indicating growing confidence among both issuers and investors. Stock markets have had a strong start to the year as investors anticipate looser monetary conditions, potentially paving the way for more IPO activity and improving spin-off prospects.
The benefits of carve-outs, spin-offs and other divestments in terms of capital efficiency, business focus, value creation and raising cash are as compelling as ever, especially with continuing high interest rates. However, the practical realities of market uncertainty, valuation gaps and execution challenges have so far seen companies and private equity firms adopt a wait-and-see approach.
As the IPO market continues to recover and interest rate expectations stabilize, the conditions for a rebound in activity are likely to emerge. In the meantime, companies will need to weigh the strategic imperatives of optimizing their business portfolios and the urgency with which they need to address their leverage ratios.
