How asset light approaches can help companies drive higher returns

The EY 2020 Global Corporate Divestment Study reveals ways companies are streamlining operations and strengthening the valuation of the remaining organization.

As companies enter the recovery stage from COVID-19, their portfolio optimization efforts will include a review of capital allocation across the enterprise. Companies may re-evaluate ownership of non-core assets and operations, and potentially migrate to an ecosystem of strategic partners. These partners, typically “better owners or managers” of such assets, can help transition fixed costs to a variable cost structure, enhance company agility, shift resources to focus on core or critical capabilities and enhance valuation.

The asset light approach, while not necessarily new or novel, is poised to become more prevalent now with a renewed focus on supply chain resiliency. This approach has been driven by several factors over the last few years — the onset of digitization, economic downturn, shareholder activism and unprecedented levels of cash within private equity (US$1.5t). Research has consistently shown that asset light companies in any sector achieve a greater total shareholder return (TSR) than their asset-intensive peers in the same sector.

Cultivating partnerships for a more agile operating model

As they look to the future, companies can begin the journey by analyzing their products, markets and operations to determine the type of partnerships that could be appropriate.

As an illustration, after reviewing transaction options to transition production to a third party, one multinational launched a sell-side auction process of a small portfolio of factories while procuring a long-term supply agreement to buy back product. Another multinational, a consumer goods company, transitioned its entire sales and distribution operations for a non-core region to a distributor-based customer interaction model. Such actions are evidenced across sectors in the EY study, with about a third of consumer (30%) and a quarter of advanced manufacturing (27%), automotive (24%) and technology hardware (26%) companies reporting that they have transitioned their manufacturing operations before putting the business up for sale.

Lessons learned

Companies that embark on this journey with strategic partners should prepare to adopt workarounds to manage barriers. Select lessons learned include the following:

Scoping and evaluation:

• Evaluate all products, businesses and geographies — no sacred cows
• Make the joint business case robust enough to withstand multiple years
  
• Properly weigh benefits (e.g., cash release, return on assets improvement and reduced complexity) with operational challenges and risks (e.g., quality, disconnect with customer and brand image)
  

Deal structuring and enablement:

• Prepare required opinions, memoranda, operating manuals, documentation and legal agreements to effectuate the new intercompany operating model
• Consider go-forward transition service agreements, take or pay arrangements and intangible asset valuations as part of divestitures
  

Tax and accounting:

• Consider operating model impact in asset-light environments from a tax (direct and indirect) perspective, including value-added tax, payroll registration, income tax and customs
• Evaluate accounting impacts with respect to treatment of the deal to avoid surprises with respect to go-forward reporting (i.e., unexpected balance sheet retention)
  
• Manage global tax considerations related to asset sales
  
• Structure asset sales in a tax-efficient manner — consider the degree to which the continued dependencies in the operating model (e.g., outsourced manufacturing) create “control” from a tax perspective with the associated requirements of arm’s-length transfer pricing
  
• Check potential effects on tax attributes and their future availability (e.g., tax losses or net operating losses)
  
• Preserve and extend tax rates and income expectations previously obtained via rulings, advanced pricing agreements (APAs) or statutes that may have been predicated on a different operating model (e.g., ownership of manufacturing assets)
  

Collaboration and governance model:

• Collaborate early with your asset light partner on the future-state operating model and governance structure
• Clearly define the partner pricing mechanism and method for tracking value levers - both quantitative and qualitative
  
• Avoid unnecessary or redundant oversight, controls and incremental costs
  

Lastly, it is important to note that the strategic, financial and operational objectives for sellers and buyers may differ in a transaction. One party may be focused on improving return on invested capital and releasing capital for redeployment, whereas the other may be focused on improving overall operational efficiency and utilization of assets. Knowing what each partner’s value drivers are before an arrangement not only speeds the process but helps both parties to achieve their often unique and potentially divergent desired outcomes.