Realizing the Potential of Divestiture & Restructuring Activity: A Real Estate & Facilities Perspective

As recently reported by Deloitte, divestitures continue to be a significant driver of total merger & acquisition (M&A) activity, representing 31 percent of overall M&A volume and 39 percent of overall M&A transaction value in 2009. Strategic buyers (i.e. — organizations that acquire a target to strategically enhance or expand operations) are aggressively participating in divestitures to take advantage of historically low valuations and fine tune their existing business portfolios. Financial buyer participation has been somewhat curtailed but will necessarily expand as private equity groups continue to raise capital and will need to place funds.

Regardless of the industry, perspective or the size of the deal under consideration, every organization is looking to maximize the value of its respective business portfolio. Enlightened buyers will engage in rigorous pre-deal evaluation efforts, spanning all aspects of the business and each of the key enabling functions. Pre-deal evaluation efforts are conducted to determine if the projected post-deal operating cost structures will allow the organization to achieve the desired financial performance metrics after the carve-out.

While the traditional enabling functions (such as finance, tax, human resources, information technology, etc.) are considered standard components of any pre-deal analysis, some buyers do not consider the post-transaction implications of an organization’s real estate and facilities management function. As one of the largest operating expenses of most organizations, the total cost of ownership associated with real estate and facilities can substantively impact the long-term cost of running the newly separated entity. In some cases, because of significant one-time separation costs and inefficiently managed operations, real estate and facilities can also impact the valuation associated with the target. By working closely with the target to identify opportunities to optimize the real estate and faciltiies management function, buyers can further efforts to realize the full potential associated with a carve-out.

While numerous articles have been published about the real estate and facilities integration planning considerations of a merger or acquisition, less content exists relative to planning for the real estate and faciltiies aspects of divestitures. While this article is not meant to be a “how-to guide” for real estate divestiture planning, it does provide a primer about the key challenges that are encountered as part of any divestiture or carve-out.

Key Divestiture Challenges and Potential Solutions

Divestitures present a unique set of challenges and opportunities, whether you are the seller, a strategic buyer or a financial buyer. These challenges make divestitures much more complex than typical merger integrations. Based on our experience, we have identified five key challenges and potential strategies you may consider during your next transaction.

Challenge #1: Misalignment of Priorities

Divestiture transactions involve a variety of different stakeholders, the priorities of which are often not aligned. The list of stakeholders will include the seller, the buyer, leadership of the to-be carved-out organization and potentially regulators (depending on the nature of the business). Within both the seller and buyer organizations, various enabling function representatives, including real estate and facilities management, will also have a part in the discussion. To effectively align the various and often diverging agendas of these stakeholders, the divestiture management team needs to clearly define and communicate the end-state goal and strategy. The strategy should be supported by a separation roadmap that each stakeholder associated with the divestiture process can align to and track.

The real estate and facilities management function will be responsible for a number of different activities as a part of carve-out efforts, including but not limited to:

1. Compilation of comprehensive portfolio and financial data for the to-be, stand-alone business
2. Coordination of property transfers, leasehold assignments, sub-lease agreements and asset dispositions
3. Physical separation projects, including efforts to demise premises
4. Relocation of staff, personal property and other equipment
5. Coordination of signage fabrication and installation, as required
6. Coordination of facility access ID badge production for employees of the to-be, stand-alone business

Each of these real estate- and facilities-related activities carries numerous dependencies and contributes to the critical path of other separation efforts. As such, it is of critical importance for the real estate and facilities management function to tightly integrate with the overall separation roadmap.

Strategy: Establish clear principles and management accountability to guide decision making relative to real estate and facilities separation matters

A critical component of the divestiture planning process involves securing and demonstrating board-level support. Executive leadership should contribute to the development of and endorse the separation strategy and establish a governance model/structure to address the day-to-day issues that will arise as part of the transaction negotiations.

As the transaction proceeds, the seller is focused on closing the transaction and proceeding with optimization of the retained business. Concurrently, the buyer continues to learn more about the to-be acquired business and is likely to proceed with additional negotiation and restructuring of the deal. With respect to real estate and facilities, the seller may not always provide the level of insight and information requested by the buyer, which makes a full understanding of one-time physical separation and post-transaction recurring costs challenging.

These real estate and facilities separation issues and concerns need to be addressed in a timely manner. Guiding principles should be established and enforced through the governance process. The guiding principles are typically designed to address disagreements around responsibility for various one-time physical separation costs. Physical separation costs can be significant, depending on the level of entanglement between the organizations, so neither the seller nor the to-be divested entity should leave these matters to chance.

When a seller and buyer are negotiating the details of a divestiture transaction, real estate and facilities are often omitted from the list of key integration or separation planning concerns. While real estate and facilities are typically one of the largest operating expenses of most organizations, these costs are sometimes percieved as “just another factor of production” or a SG&A cost that is primarily fixed. Contrary to popular belief, Deloitte’s experience has shown that real estate and facilities can have a significant impact on valuation and the complexity of the proposed carve-out effort.

If real estate and facilities considerations are treated as an afterthought, the opportunities to maximize value through the divestiture process are put at risk. This challenge applies to both the seller and the buyer.

Strategy: Real estate and facilities management executives need to be proactive about conveying the value add associated with advanced planning

From the seller’s perspective, positioning of the ongoing operations for success post-transaction is paramount. In the real estate and facilities arena, this involves negotiating for the planned retention of facilities that are currently shared with the to-be divested business unit, assuming these shared facilities are strategic to the seller’s operation. In addition, the seller is incentivized to maintain control of facilities that contribute to strong employee satisfaction scores at an appropriate cost. Employee satisfaction may be impacted by a popular or convenient commuting location, strong building/neighborhood amenities or other factors.

For the buyer, each facility that it assumes responsibility for as part of the divestiture carries a certain level of exposure. On one level, each additional facility increases the buyer’s recurring cost profile post-transaction. On another level, one-time separation costs must by projected for every facility in the portfolio. At certain locations, separation costs may simply consist of signage replacement, while at other locations the one-time separation costs may include staff relocations and physical demising of an existing facility or the complete build-out of a new facility.

As a stand-alone operation, the recently carved-out business unit may lose economy of scale benefits. In many organizations, facilities management and physical security contracts are centrally procured and managed to increase sourcing leverage. As such, the new, smaller, stand-alone organization may experience increased operating costs. One-time separation costs also need to be minimized, as these capital costs can be significant and complicate negotiations.

Given the potential implications relative to both recurring and one-time costs, the benefits of addressing real estate and facilities considerations as part of separation planning and the deal negotiation process should be clear.

While most business executives are accustomed to dealing with markets that have a high degree of liquidity, real estate and facility assets typically exist in a thinner market with potentially large ranges in valuation. Real estate and facilities management professionals understand that property valuation is as much art as it is science, a nuance that is often lost on other stakeholders. In addition, real estate and faciltiies data is often not well maintained, resulting in data gaps, data integrity and quality concerns. This operating context drives the need for particularly rigorous due diligence and analysis relative to real estate and facilities portfolio exposure.

From the buyer’s perspective, the more real estate and facilities data that can be made available pre-deal, the better. Unfortunately, all of the data requested by the buyer is typically not available. In some cases, the information is not readily available because the real estate and facilities assets were not actively managed by the seller. In other cases, stakeholders within the seller’s organization are not in a position to fully cooperate with the buyer. These challenges are often par for the course and result in the need for the development of educated assumptions and cost projections on the buyer’s part.

The real estate and facilities management function can add value in this challenging situation by understanding and regularly monitoring:

1. the operating and capital project costs associated with the types of facilities occupied by the company
2. the dynamics of the sub-markets hosting the properties under discussion
3. the business requirements and strategic plans associated with each key division

The key lesson learned relative to being prepared for a potential divestiture is that you cannot wait until the deal is announced to begin your data collection and planning. In these situations, procrastination may result in the inability to effectively negotiate the optimal scenario for your side of the transaction (seller or buyer) and drive disproportionate cost structures post-transaction. Put simply, the seller may end up with a large pool of stranded assets. Conversely, the buyer may take on unwanted, excess facility capacity. Each of these scenarios carrries a cost penalty that will need to be addressed.

Real estate and facilities management practitioners need to be well informed about the exposure and valuation associated with properties and leases that may be involved in a future transaction. For leases, the critical elements include remaining term, the size of each leasehold and the cost of occupancy within the context of the broader market. Accounting impacts associated with mark-to-market rules and the ramifications of potential sale-leaseback activty can result in ugly surprises for key stakeholders. Also, be sure to understand the tax implications of property sales post-transaction.

Strategy: Actively drive rigorous financial due diligence around real estate and facilities costs; understand and socialize the desired end state to enable effective separation planning and optimize the portfolio

Before a deal is struck, the buyer’s focus will be on effectively capturing the to-be, stand-alone business, minimizing disruption to the carved-out operations and assuming control of only those assets and infrastructure that are absolutely required to operate the business. For the seller, the focus is primarily on minimizing disruption to the retained business, as well as minimizing the exposure assciated with stranded assets that may result from the divestiture. The due diligence and planning work conducted by the real estate and facilities management function is critical to driving successful outcomes from both the seller and buyer perspectives.

To optimize the outcome, the seller’s real estate and facilities management function should endeavor to understand the relative value of property liabilities, depending on whether the assets are retained by the seller or transferred to the buyer. Depending on the seller’s go-forward business plans and market conditions, opportunities may exist to reposition and better leverage assets across the retained business. This may include opportunities to dispose of selected assets and generate revenue for the company. Alternatively, if the seller’s future state operating model will not require selected property because of full or majority occupancy by the to-be divested business unit, the assets may be negotiated into the transaction to reduce the seller’s ongoing cost structure.

To be best informed, the seller’s real estate and facilities management function should selectively leverage external service providers for valuation, brokerage and advisory support to guide the company through the asset optimization process. Ideally, the seller will consider the key negotiating levers, including solid information on the market, property valuations, lease rates and optimal lease timeframes. For the buyer, the challenge is to catch up to the seller’s level of understanding, retain independent valuations and build these into the negotiations strategy.

Collocated operations can be a costly matter to address. Previous to the decision to divest of a specific business unit or division, the collocation of operations drove cost optimization and, in some cases, business synergies. With the pending carve-out, collocation forces discussions about the transfer of property with sale, lease assignments, sub-leases, the demising of premesis and other separation-related matters. To make effective decisions about these matters, the real estate and facilities function needs to understand the end-state blueprint for the carved-out entity.

Disentanglement decisions regarding some locations will be relatively simple. At other locations, the stay vs. go vs. collocate decisions will be highly visible and, potentially, expensive. During these discussions, analytical rigor and a deep understanding of real estate sub-markets is critical. This presents a great opportunity for the real estate and facilities function to demonstrate value add.

Strategy: To effectively negotiate real estate and facility asset retention and/or transfer, conduct a comprehensive review of operations and actively manage business requirements

Divestitures can happen relatively quickly, so real estate and facilities management groups that maintain a passive approach to space and data management place themselves in a challenged situation when presented with a potential carve-out scenario. If you do not have a structure and process in place to actively manage business requirements and translate the operational needs of your business unit clients into workplace demand, a planned divestiture may cause the real estate and facilities management group to scramble for the data required to enable effective decision making. In some cases, buyers have been known to interpret the lack of data as evidence of a poorly managed function with potentially hidden liabilities.

Despite the advances in real estate data management and related information technology, many corporations still lack the systems to manage critical data elements. For example:

1. Which legal entity owns each property?
2. Which legal entity holds the lease to each of your locations?
3. How does the ownership and/or leasehold structure map to physical occupancy?
4. Is a given location strategic to one or more of the business unit occupants?
5. Are options in place to downsize leasehold space?
6. What is the potential impact of unamortized leasehold improvements?

While frought with challenges, divestitures can provide opportunities for realignment of the real estate and facilities portfolio. To leverage these opportunities, the real estate and facilities management group needs to understand the growth and contraction plans for each business. In addition, divestiture activity can provide an opportunity to reallocate vacant space to better support the needs to expanding operations, while constricting the footprint of stable or stagnant business units.

The real estate and facilities function should also focus significant attention on the language and details associated with license agreements, as many space-related matters will likely be addressed through this type of contractual arragement. Another matter to keep at the forefront during the separation negotiations process is the level of contribution from both the seller and the buyer, relative to demising, relocation and stranded asset carry costs.

Challenge #5: Need for transitional services and agreements

In recent years, many large organizations have shifted toward centralized or shared services operating models for the planning and delivery of support and infrastructure services. The centrally managed or shared services often include activities from a wide array of enabling functions, including finance, human resources, information technology, legal, real estate and facilities. In the process of shifting from business unit or division-focused service delivery to a shared services model, organizations were able to increase efficiencies and better leverage economies of scale. Implementing a shared services approach often required the transfer of staff, skills and expertise that originally resided within business units or divisions to the newly formed shared services group. By leveraging staff across multiple business units or divisions, individual employee utilization increased, and the total number of staff required to deliver a given service decreased.

While overall operating costs for the enterprise typically decreased in the shift to shared services, the dependency of business units on the corporate shared services entity increased. As with most enabling functions, a greater degree of entanglement with “corporate” relative to real estate and facilities management service delivery results in physical and operational separation challenges when a company decides to divest itself of a specific business unit or division.

Given the relative speed with which many divestiture transactions occur, the buyer often needs to purchase transitional services from the seller to minimize business disruption during separation efforts. With regard to real estate and facilities management, transitional services may include real estate transaction management, move/add/change and facilities work order management support, property management, project management and other facility/site services. If you are dealing with a strategic buyer, the infrastructure may already be in place to provide the required real estate and facilities management services, thereby mitigating the need for complex and potentially costly transitional services. When a financial buyer is in the mix, transition service agreements (TSAs) are more likely to be required because many private equity firms often manage their portfolio companies as stand-alone entities poised for an IPO or eventual sale to a strategic or other financial buyer.

From the buyer’s perspective, the timeframe associated with TSAs should be minimized to encourage timely separation from the seller and drive increased cost effectiveness. As the seller is not likely to be in the business of providing services to external entities, there is typically limited incentive to provide high-quality services. TSAs can be an expensive option for the buyer, and costs often increase significantly should the buyer require services beyond the originally negotiated TSA timeframe. Collectively, these factors drive the need for the carved-out entity to stand up as an independent business as quickly as possible.

Strategy: Only negotiate for and commit to transitional services that are absolutely required; plan to exit TSAs and license agreements as quickly as possible, without jeopardizing business continuity and operations

Regardless of the transaction structure, some level of TSAs will likely be required to maintain business continuity. Organizations should work to replace services provided by the seller as quickly as possible. If new, separate contracts need to be established for real estate and facilities services to support the new stand-alone entity, accelerate negotiations and formulate your TSA exit plans in advance. It will be important to understand how each real estate and facility management service will be exited, replaced and cancelled.

In most carve-out situations, only a portion of the real estate and facilities management resources transfer to the stand-alone entity from the seller, so depending on the buyer’s structure, there may be an opportunity to restructure your approach to real estate and facilities management service delivery. Do you build the required capabilities internally? Do you buy the required expertise from one or more real estate service providers? Do you establish a hybrid model to more effectively maintain service levels, while providing optimal flexibility? These options should be carefully considered given the direct short- and long-term budget impacts.

Lastly, the real estate and facilities function should be mindful of the fact that establishing TSAs and license agreements enters the organization into a business relationship that must be actively managed over time. There is a clear benefit to selecting your TSA and license agreement managers well in advance, so that they can drive the negotiations process up front. By building effective working relationships between the former parent and newly carved-out entity, day-to-day efforts and the inevitable service-related disagreements are less likely to become controversial and/or litigious.

In Summary

By actively managing the presented challenges, both sellers and buyers can better optimize value of the retained and divested real estate and facility portfolios, respectively. With the increased number of anticipated divestiture transactions, an opportunity exists to establish a critical review of real estate and facilities management costs as a core component of pre-deal evaluation efforts.

To prepare for the potential divestiture, real estate and facilities management professionals should:

1. Maintain a comprehensive and detailed database of owned properties and expense/income leases
2. Understand the total cost of ownership/operations associated with the portfolio
3. Understand the strategic business plan for each division within the company/organization
4. Understand the key real estate and facility dependencies between the “corporate” entity and each division, including matters related to space, services, outsourcing contracts, IT infrastructure, etc.

By continuing to demonstrate value add, the real estate and faciltiies management lead can earn a “seat at the table” and properly position the function for future success.

Editor’s Note:
At press time, George G. Bouri had accepted the position of Senior Vice
President, Global Real Estate & Facilities Services, for Time Warner.

About the Authors

George G. Bouri, SLCR, MCR, is a Principal in Deloitte Consulting’s Strategy & Operations Group and the Leader of the Capital Assets and Real Estate Transformation Practice.

Francisco J. Acoba, SLCR, MCR, is a Senior Manager in Deloitte Consulting’s Strategy & Operations group and is part of the Capital and Real Estate Transformation Practice.

Sean Goldstein is a Manager in Deloitte Consulting’s Strategy & Operations Group and is part of the Capital and Real Estate Transformation Practice.