Are companies willing to divest after the pandemic?

In 2019, companies in the Asia Pacific sought to sharpen their focus on capital allocation, which include, among others, carving out non-core businesses or underperforming assets. In fact, the 2019 EY Global Corporate Divestment Study reported that 82% of executives in these companies planned to divest within the next two years. However, in light of the COVID-19 crisis — with governments implementing border closures and lockdowns that have triggered business shocks and disruption — will the appetite for divestment remain high among Asia Pacific companies as they look beyond the crisis?

Before the crisis, EY surveyed Asia Pacific companies in early 2020 then conducted a resurvey in April 2020. The results affirmed that many companies still had a high intent to divest. Of these companies, 75% said that they planned to initiate their next divestment in the next two years — marginally up from 74% pre-crisis — with 59% saying that they aim to divest in the next 12 months.

HOW WILL THE CRISIS INFLUENCE ASIA-PACIFIC DIVESTMENT ACTIVITY?
There are four key factors that will, individually and collectively, likely drive and influence regional corporate divestment activity in the next six to 12 months.

Factor 1: Balance sheet strength

Some companies have turned to the capital markets to build up weakened balance sheets, which reduces the need to divest to raise liquidity at this volatile time. For example, several well-known Philippine companies are raising up to P30 billion this year via bond issues, with tenors ranging from two to 30 years. These will be used to fund new and existing projects, working capital, refinance costly existing debts, and general corporate purposes. Additionally, a bank plans to issue the Philippines’ first bonds aimed at raising fresh funds in response to the pandemic, specifically for eligible micro, small and medium enterprises.

However, companies that have difficulty in accessing capital markets may need to think more proactively around capital recycling through a divestment strategy.

These strategic capital decisions were teased out in the April 2020 survey where 54% of Asia Pacific companies said they are contemplating raising capital in response to the pandemic. Moreover, 64% said they would seek to reduce debt through divestments.

Factor 2: Digital transformation

If digital transformation was not a strategic priority pre-crisis, it is and should be now. A number of companies were forced to rely almost entirely on their existing digital infrastructure to function and communicate.

The survey revealed that 56% of Asia Pacific companies will likely divest for this purpose, a significant increase from 31% of respondents pre-crisis. Remarkably, 67% of executives from Greater China said they would divest to fund technology investments — up from 42%. It seems that divestments have become an even more attractive option to fund needed technology investments.

Factor 3: Supply chain diversification

Globally, 36% of companies (27% pre-crisis) were planning to focus more on their supply chains prior to divesting. US-China trade tensions had already brought this issue into focus. The crisis has now led them to reevaluate and reengineer their supply chains to increase control and minimize the risk of future disruption. This will likely lead to increased investment and divestment activity. Consider how Japan recently set aside $2.2 billion of its economic stimulus package to aid its manufacturers shift production out of China as the crisis disrupted supply chains. Additionally, according to the most recent EY Global Capital Confidence Barometer, 67% of Asia Pacific companies (73% of Greater China respondents) said that they had already taken steps to restructure their supply chains.

Factor 4: Portfolio optimization

According to 54% of Asia Pacific companies surveyed, asset portfolios will need to be re-shaped for a post-crisis world. Another 68% of the companies surveyed stated that they had held on to assets for too long, triggering portfolio optimization moves, which they expect to accelerate due to the crisis. Moreover, 58% of the companies expect to see an increase in distressed divestments over the next 12 months.

While it’s difficult to anticipate what the future holds, companies should start making adjustments based on macroeconomic scenarios that are likely to emerge.

HOW SHOULD SELLERS PREPARE?
Companies should actively refocus their attention on preparing assets for sale as part of pursuing their medium-term divestment strategies, most of which were developed pre-crisis and remain in-play. In some cases, the pandemic may have caused an acceleration in divestment plans.

However, these strategic capital decisions need to be reassessed due to the crisis. For instance, about 53% of Asia Pacific companies surveyed said that the economic impact of COVID-19 will likely increase the price gap between what sellers expect and buyers are offering. In addition, 52% said there will be less certainty regarding which assets to divest — a sharp increase from 28% pre-crisis.

Some 46% stated that their level of divestment preparation would also have to be revamped as how companies prepare their assets is crucial for a successful sale. The standard approach for sellers is to ensure that the business is as attractive as possible by aligning management incentives with a good sale outcome and ensuring that corporate overhead allocations are thought through.

However, this approach will now need to be fortified by other key considerations.

As a result of the impact on financials in the first two quarters, sellers should craft a credible story based on reasonable assumptions that would explain to prospective buyers how their companies will look and perform in a post-crisis world. This could be an opportunity as COVID-19 resulted in rethinking the way many organizations run their businesses and the close scrutiny of cost models.

Sellers should also present a story depicting at least the next 12 to 18 months. The more clarity and certainty they can provide prospective buyers over a longer period of time, the higher the likelihood of receiving higher bids for their assets. They must evaluate the vulnerability of supply chains to post-crisis-type risks. Prospective buyers will likely focus on this, so sellers should have a robust action plan to mitigate this risk. As companies rethink sourcing, there will be inevitable consequences for lead times, cost efficiency and, hence, working capital.

COVID-19 has been the ultimate test of demand elasticity, for which the aftermath analysis will provide very interesting insights.

PORTFOLIO MANAGEMENT WILL NEED A STRATEGY RETHINK
While some large companies across the Asia Pacific had increasingly sophisticated approaches to divestment and active portfolio management, a buy-and-hold strategy still remains all too common among many companies in the region. However, the impact of COVID-19 could help accelerate this shift towards a more sophisticated, focused and intensive portfolio management approach in the region.

Coming out of this crisis, EY teams expect to see far more sophisticated ways of thinking and strategies around topics like balance sheet strength, capital allocation, and supply chain vulnerabilities among others, ultimately provoking a strategic rethink around portfolio management and driving both investment and divestment activities.

EMERGING WITH AGILITY AND RESILIENCE
Now is a crucial time for Asia Pacific companies to be decisive as they position themselves to emerge from the crisis with greater operational agility and resilience. Essential to that will be a divestment strategy shaped by various key factors and the need for portfolio optimization in preparation for a post-crisis world. These include rebalancing portfolios and preserving value — with 71% of Asia Pacific sellers reporting that they would only accept a 10% or less reduction in sales price in the next six to 12 months.

The Asia Pacific region has a history of coming out stronger after major crises. The decisiveness shown by governments to deal with COVID-19 gives confidence and hope that the region will potentially lead a resurgence in global economic activity.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views reflected in this article are the views of the author and do not necessarily reflect the views of SGV, the global EY organization or its member firms.

Miguel Carlo S. Rancap is a Senior Manager from the Strategy and Transactions Service line of SGV & Co.