With listed UK equities trading at a significant discount relative to historical averages, as well as to global and private market peers, the recent surge in merger and acquisition (M&A) activity over the past 18 months is both understandable and warranted.
One notable trend within this landscape is the rise in carve-outs – where a parent company divests a subsidiary or business unit – which has gained momentum among listed firms.
Carve-outs frequently offer an excellent opportunity to unlock value without necessitating the sale of the entire business. They can also lead to a re-rating of an undervalued company, with the cash proceeds reinvested for growth, used to reduce debt, or returned to shareholders.
So far in 2024, there have been more than 20 significant carve-outs from UK-listed companies, with divestments accounting for over 50% of the parent group’s market cap. Most of these have been sold at valuation multiples higher than the overall group’s valuation multiple, with some even exceeding the entire market cap of the parent company – shining a light on the undervaluation of the remaining business.
We saw this with UK business-critical services company Marlowe selling its governance, risk and compliance assets to private equity firm Inflexion for £430m. This was more than the market cap of Marlowe on the day before the announcement, despite these assets only accounting for about 40% of group EBITDA (earnings before interest, taxes, depreciation and amortisation).
Similarly, Capita sold its standalone, non-core software business to MRI Software in a deal valuing the subsidiary at about £200m. Capita’s market cap was £264m the day before the announcement, despite the subsidiary accounting for just 14% of group EBITDA.
A case study in value realisation
A good example of how carve-outs can unlock significant value can be seen with Ascential. At the beginning of 2023, the company announced a strategic review with the intention of splitting the business through a series of interdependent transactions.
Ascential consisted of three distinct high-quality business units – digital commerce, product design (WSGN) and a market-leading events business. There was limited crossover between each segment and a lack of a cohesive group strategy, which meant the market failed to value the business properly on the sum of its parts.
Fast forward 18 months and all three business units have been successfully sold, amounting to a total value of approximately £1.9bn, versus a market capitalisation of £915m prior to the review announcement.
After the sales of the digital commerce and WSGN business units at attractive valuations at the end of 2023, we initially thought we might have missed out on the upside. However, the remaining events business still traded at a significantly discounted valuation. After further research and discussions with industry experts, we built conviction in the quality of the business and looked to capitalise on the attractive entry point. In July this year, the business received a takeover offer from Informa at 16.6x forward earnings – a premium versus prior transaction multiples of 13-14x EBITDA.
Opportunities in eliminating complexity
Ascential's success story is not unique and similar opportunities for value creation exist in companies like Ricardo, a global strategic, environmental and engineering consultancy. Ricardo has been executing a clearly defined strategy to reposition the business by focusing on higher margin, higher growth and lower capital-intensive parts of its business.
Despite clear repositioning progress and significant growth within its energy and environmental division, the business continues to trade at a stark discount to transaction multiples for similar entities.
Part of the reason for the discounted valuation is the fact the business is inherently complex and operates across several geographies. It also has five business units, two of which do not align with the re-defined strategy.
From our perspective, carving out the non-core defence and performance product units can unlock value that could be reinvested to drive growth in its core elements. Simplifying the story will also enable it to command a valuation more closely aligned with other environmental consultancy firms.
Another prime candidate is Restore, which provides document management, secure recycling and relocation services across five distinct business units. In our view, its records management division alone is worth more than the company’s current market value, offering option value on the other units. This division boasts long-term loyal customers and delivers stable and strong recurring revenues – contributing about 46% of total group revenue and 80% of profit.
These factors make it an appealing acquisition target, particularly for private equity buyers. A catalyst for this could be the sale or closure of some of the smaller non-core components of the group.
Cassie Herlihy is an associate director at Gresham House. The views expressed above should not be taken as investment advice.