Can someone explain to me how it is helpful to sell a subsidiary in order to pay down debt? Wouldn't our net debt not change at all, and therefore equity value would not rise? It seems the only way to increase equity value is by paying down with FCF. But I may be thinking of this completely backwards, any help would be really appreciated!
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It is dependent on what valuation/multiple you sell the subsidiary at and what the valuation of the remaining business is.
E.g. - you buy company ABC for EV of $1,000M and has EBITDA of $100M (EV/EBITDA 10x). You fund this with 6x debt ($600M) and remaining with equity ($400M). Lets say that the $100M EBITDA is comprised of: $75M of 'Core ABC' and $25M of 'Subsidiary ABC'
Lets now say you sell the Subsidiary for 14x EBITDA, so an EV of $350M and use the proceeds to repay debt
The post sale Core ABC structure looks like this: Debt of $250M ($600M less $350M from sale) on EBITDA of $75M, so net leverage of 3.33x. If the Core ABC business is valued at 10x EBITDA, then you have an EV of $750M, implying an equity value of $500M ($750M less $250M of debt). The equity value has now increased by $100M
The key inputs and variables here are: 1) the multiple you sell the subsidiary at and; 2) the multiple you value the post-sale business.
If - you sold the subsidiary for 9x EBITDA, you sell for EV of $225M and reduce debt to $375M. Net debt and NLR has been reduced but your equity value has been diluted because your EV is $750M (10 x $75M) but equity value is now $375M ($750M less $375M), which is less than the $400M at entry. Of course, if you value the post-sale business at 12x for example, you have an EV of $900M and subtracting net debt of $375M implies equity value of $525M
So again all depends on 1) what you can sell the subsidiary at and; 2) what you value the post-sale company at
Good answer. This covers the primary value drivers.
Would also add ignoring CoC implications, often a sale of a subsidiary will coincide with a dividend, or dividend recap. Credit agreements will dictate leverage levels in which asset / stock sales are permitted, so the sale triggers debt paydown to that level, then a dividend on the residual. Helpful for IRR.
Thanks guys! Really helpful
Great answers
If the Core company is valued at 10x and the subsidiary is valued at 14x, how is the combined company only valued at 10x?
Because someone may value the sub higher if separate bc of a host of possible reasons that wouldn’t be the case on a combined basis (some orphan division that’s non core but valued by its competitor)? It’s not uncommon....
Nicholas broke down the cash flow / accretion-dilution method very precisely, and often times these types of divestitures are contemplated in asset-based or RE contexts as well. If the assets are tied to some LTV ratio (like a mortgage) or if it's an ABL revolver tied to inventory/AR, the debt-paydown part of the equation will be driven by those ratios/advance rates. You can compare the cash flow those assets generate to the debt paydown / asset coverage they provide.
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