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By Richard L. Kaye

Acquisitions, whether at the hand of a corporation looking to expand or a private equity sponsor looking to build the portfolio, almost always involve expendable assets that the buyer regards as surplus, duplicative, underperforming, or not synergistic with the strategic platform of the combined business. These transactions can challenge even the most astute negotiators. Many a deal has fallen through simply because buyer and seller can’t to come to terms on how to handle the unwanted assets.

Now, however, a relatively new concept called “Asset Disaggregation” is being employed to systematically remove troublesome assets that otherwise might be a major obstacle to getting deals done.

Briefly, the asset disaggregation strategy involves a structured sale of undesired assets to a third party, typically at the time the transaction closes or immediately thereafter. The third party then takes control of the assets and monetizes them through various means, including a resale. The spread between what the third party paid for the assets and what they are able to recover, net of expenses, represents the intermediary’s return on investment.

The third party assumes a relatively high level of risk in an asset disaggregation deal. But this is the reason that both buyers and sellers find the format attractive. They have come to understand the inherent hard and soft costs associated with the asset disposition process and recognize the benefits of conveying the work and risk to others.

This article explains in general terms how the asset disaggregation strategy can be applied in an acquisition and how a properly structured transaction can benefit all parties. This strategy, moreover, can be applied in a merger where duplicative assets are identified. Divestiture can be especially problematic when the U.S. Justice Department or the FTC in their role as antitrust regulators demand that operations be divested as a condition for clearing a deal.

The term Asset Disaggregation was coined several years ago by The Hilco Organization, a longtime practitioner in valuation, acquisition, disposition, and financing of business assets. Within the context of a corporate merger or acquisition, the term denotes the pulling apart or separation of a compendium of business assets into two major categories: “what’s wanted” and “what’s not wanted.” The nature of the transaction usually drives the disaggregation process.

When the buyer intends to maintain a continuing business through acquisition, albeit with certain strategic or operational changes, unwanted assets typically are characterized as underperforming or non-synergistic with the intended business platform. Take a multi-line industrial products manufacturer being acquired by a private equity sponsor. The buyer sees an opportunity to make strategic changes by eliminating several product lines. Asset disaggregation can be employed to sell off these products and their associated assets.

If the deal is a merger involving two firms that want to integrate after they have been direct competitors or operated within the same supply chain, unwanted assets typically are characterized as duplicative or surplus. An obvious example is the merger of two companies that manufacture the same consumer product. Duplicative assets could include manufacturing facilities or selected machinery and equipment, distribution centers, real estate, and intellectual property such as trade names. Surplus assets might include raw materials, work-in-process or finished goods inventory, leased or owned office space, or rolling stock such as trucks and rail cars.

In a merger of retailers, redundant or overlapping store locations and associated leasehold obligations, as well as in-store inventory, are constant issues that need to be addressed.

Undesired assets can hinder an acquisition or merger in two ways. For openers, there are the problems in valuing the assets and subsequently building that value into a deal’s financial structure. Second, even if acceptable values can be established and a transaction can be completed, considerable time and expense can be incurred after closing to dispose of the assets, and perhaps divert the management from the core goal of making the combination work.

In an acquisition, the buyer would be inclined to significantly discount, if not place a zero or even negative value, on non-synergistic assets. As a result, the buyer would drive down the bid price to a point where it might not be an acceptable offer to the seller, which seeks full value for all assets. In yet another scenario, the buyer might insist it doesn’t want to purchase expendable assets, leaving the seller with the unpalatable choice of walking from the deal or accepting a partial sale it and being left to shed relatively worthless bits and pieces.

If the buyer absorbs another company via merger, target shareholders could experience significant dilution if duplicative assets are valued on the basis of their worth to the seller instead of as dispensable assets in the combined business.

In both scenarios, the burden falls on senior executives and support staff—all of whom should be focused on managing the business going forward—to dispose of the unwanted assets, or at least manage a complex process that could involve multiple outside advisers. This time and effort could be better spent on building the combined venture.

Asset Disaggregation strategy is designed to short-cut the disposition process, take the problem off management’s hands, and realize acceptable values for assets and operations that may still have considerable use for other businesses

As a fictitious example of how the process works, assume XYZ Industries LLC is acquiring ABC Manufacturing Co., Inc. in a cross-border deal uniting two consumer electronics manufacturers that market their products through proprietary retail chains in North America and Europe. XYZ Industries is headquartered in the U.S. and ABC Manufacturing in Germany.

ABC has certain product lines and several hundred retail stores that would substantially enhance XYZ’s market strength on both sides of the Atlantic. However, ABC also has four manufacturing facilities in Europe and two in North America that are deemed non-strategic because they overlap with similar operations that XYZ owns and has decided to retain. ABC also has more than 400 duplicative retail stores in both regions.

ABC executives are amenable to being acquired. But XYZ executives know that the success of the acquisition depends on paying ABC reasonable value for millions of Euros in assets that have little or no value to the business plan of the combined firm. XYZ elects to adopt an Asset Disaggregation strategy. After meeting with the third party asset disaggregator to formulate a game plan, they approach ABC executives with a plan involving the disaggregation process.

The third-party disaggregator firm will appraise the portfolio of assets that XYZ does not require as part of future business plan. This valuation, covering all excess production facilities and contents as well as the leaseholds and inventory in 400 retail stores, will enable the disaggregator to structure a financial package and recovery strategy. The plan also will deal with local and national laws in Germany regulating costs and benefits for plant shutdowns, employee terminations, and store closings.

In this case, the disaggregator proposes to put up its own capital along with XYZ and purchase the portfolio of unwanted assets at a price that satisfies executives and shareholders at ABC, while significantly reducing XYZ’s capital outlay and bank leverage requirements. The reduction is critical because of the difficulty and high cost to finance assets that lenders know will not fit the future business plan.

Furthermore, the disaggregator offers XYZ an arrangement to share in recovery proceeds beyond an agreed threshold. Initial proceeds from the orderly liquidation process reimburse the disaggregator; additional proceeds are shared with XYZ on the basis of an agreed formula. This enhancement mitigates the possibility of a windfall that solely benefits the disaggregator. Yet, it enables the disaggregator to optimize earnings for taking the risk and generating value beyond expectation.

An example of how asset disaggregation helped make a deal happen involves the purchase by music retailer Trans World Entertainment Corp. of rival merchant Wherehouse Entertainment Inc. Trans World Entertainment ultimately acquired 111 Warehouse Entertainment stores for $40.6 million. However there were underperforming stores and overlapping locations that made the initial deal structure difficult for Trans World Entertainment to manage.

The entirety of Wherehouse Entertainment was for sale. That meant Trans World executives could determine the specific store locations they wanted and which they didn’t. Armed with this information, they teamed with an asset disaggregator who, at closing, purchased 34 unwanted stores and later disposed of the inventory and reduced the leasehold obligations.

From the Wherehouse Entertainment perspective, the whole company was sold instead of just those locations desired by the buyer. Trans World Entertainment purchased only what they wanted for a price that could be justified and added positive value from the assets it didn’t want.

Whether you are a financial or strategic buyer, or your target is a competitor or an upstream or downstream member of your supply chain, the key to successful asset disaggregation is early involvement with a qualified disaggregation partner.

The best partner offers these characteristics:

• internal asset valuation capabilities across the entire spectrum of business assets, including enterprise valuation;

• proven asset disposition capabilities across all asset categories— but particularly physical assets such as machinery and equipment, inventory, and real estate—along with know-how in winding down operations;

• willingness and ability to finance acquisitions with internal risk capital, and

• demonstrable deal structuring experience.

The effective use of asset disaggregation can facilitate the successful completion of a difficult merger or acquisition, both on the domestic front and in cross-border deals.

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About the Author: Richard L. Kaye is an Executive Vice President of The Hilco Organization, Northbrook, Ill, an advisor and facilitator on business asset appraisals, asset disposition and principal acquisition, and specialized financing.