Equity carve-outs can be attractive for groups in order to raise valuation potential and to reduce the so-called conglomerate discount. For this purpose, a holding company separates its subsidiary or division and floats its shares on the stock exchange. This can also be an attractive alternative to a sale to strategic investors or to private equity funds. Professor Dr. Michael Schlitt (Partner at Hogan Lovells Frankfurt and Head of Capital Markets Germany/Corporate Capital Markets & Securities Europe) explains the latest developments regarding equity carve-outs.
Professor Schlitt, what is the typical rationale behind equity carve-outs and what should executives be aware of when considering an IPO of a division?
Schlitt: There are multiple and complex motives for an equity carve-out. Moreover, the spin-off of a part of a company into an independent listed company has to be the right choice from the perspective both of the group as well as for the division itself. For the group as a whole, the carve-out offers the opportunity to bring about a strategic reorientation. It can also have a positive impact on the group’s valuation, which is sometimes better when parts of the group are separated from the group. In the case of diversified industrials, i.e. companies that are characterized by a multitude of largely independently operating corporate divisions, an appropriate distribution of financial resources and management resources can sometimes be difficult. The concentration of an important division of the group in a separate listed company can help to promote the independent further development of such division. Furthermore, investors will generally appreciate the increased transparency brought about by a spin-off (e.g. with regard to the profitability of the individual company component) and the reduced degree of complexity in the group structure. For the division that is to be listed on the stock exchange, the IPO can also be advantageous for various reasons. Thus, a “prestigious” component of the company can be positioned independently on the capital market.
Which legal aspects play the most important role when it comes to a carve-out? Are there any specific legal hurdles or challenges talking about a carve-out?
Schlitt: When a subsidiary goes public by way of a carve-out, various implications under company law must be taken into account. On the one hand, the shareholders of the group will be interested in ensuring that the shares of the new entity to be listed are not sold “below market value”. Against this background, the question arises as to whether shareholders should be involved in the decision to go public by requiring the Annual General Meeting to vote. Both the court rulings and the prevailing opinion in the literature deny this on the grounds that the IPO of a subsidiary is generally not a structural change requiring the approval of the Annual General Meeting. The value of the shareholding is not reduced as the parent company receives a corresponding consideration and the Management Board is obliged to achieve an appropriate issue price anyhow.
Does the question of whether the shareholders of the parent company should be granted a “pre-emptive right” to the shares of the subsidiary also play a role in this regard?
Schlitt: Yes, indeed. This question is also answered correctly in the negative by the prevailing view. The reason for this is that the statutory subscription right of the shareholders is only intended to protect them against dilution of participation and voting rights associated with capital measures, but does not grant them a right to the preservation of individual, particularly valuable, assets of the company.
Which legal aspects are currently of special relevance regarding the IPO of a carved out division?
Schlitt: In the marketing of a carve-out IPO, questions of market abuse and insider law, which have been fundamentally revised by the Market Abuse Regulation, are currently being raised. Normally, questions of market abuse only become virulent to a limited extent in IPOs, as insider law comes into play not earlier than with the submission of the application for admission. The situation is different when the parent company is already listed on the stock exchange. Insider law will then apply from the very beginning. Depending on the ratios within the group, the IPO of a subsidiary by way of equity carve-out may constitute insider information at the level of the parent company. As a result, when marketing the offering to investors, information on the subsidiary’s IPO may only be passed on within a narrow legal framework. The Market Abuse Regulation establishes detailed procedural requirements for such market soundings, which must be observed in particular by the underwriters.
In terms of carve-outs, dual track strategies often come into play — which aspects are important from a legal perspective in this regard?
Schlitt: Dual-track strategies aim at increasing transaction security and maximizing the sales proceeds by combining an IPO and an M&A sale process. The parallel preparation of an M&A process and an IPO increases the time and expenses. Such a combination, however, can lead to considerable synergy effects, for example with regard to due diligence. Also synergies can be achieved when creating the documentation, for example by using the management presentation of the M&A process in many parts as a roadshow presentation for IPO marketing. In addition, information memoranda are usually prepared for the purpose of marketing the transaction and transmitted to potential investors. There is an overlap with the prospectus to be prepared for the listing of the new entity. When transmitting information to investors, the requirement of consistency with the contents of a prospectus to be published at a later date must be observed: in general, investors must not receive any information that exceeds the information level of the prospectus.
Many thanks, Professor Schlitt.
Professor Dr. Michael Schlitt is a Partner at Hogan Lovells in Frankfurt and Head of Capital Markets Germany/Corporate Capital Markets & Securities Europe. He advises investment banks and international groups on capital markets and corporate finance matters. Widely recognized as one of the outstanding capital markets lawyers in Germany, Michael has significant experience in international capital markets transactions, particularly IPOs, right issues, block trades/accelerated book builds, convertible, exchangeable hybrid, high yield and corporate bond transactions as well as public takeover and finance transactions.