Nilly Essaides, Director & Practice Lead, Financial Planning & Analysis, AFP
So far this year, the market absorbed nearly $26 billion of new spinoffs, according to a May 31, 2016 article in the WSJ. That tops the previous high in 2007 and more than doubles last year’s total.Investors, frustrated by years of zero returns, are trying to squeeze every possible return out of their stockholdings. That’s particularly true for activist investors who are putting extra pressure on management to boost performance by monetizing every valuable asset.
The challenge: Identifying the right assumptions
Spinoffs don’t happen by magic or overnight. When a company decides to let loose a previously wholly owned unit, there’s a lot of disentanglement to do, in every area – operations, HR, and yes, finance. Sometimes the process of cutting the old unit completely off can take months, as the parent continues to provide support services to help its offspring figure out what it needs to develop independently, outsource or may not need at all.
One of the key groups that needs to learn how to work independently is FP&A: It’s the core planning and analytics engine of the new enterprise and is charged with helping it chart its forward course.
In nearly all cases (but for very large spinoffs), FP&A either didn’t exist or relied heavily on help from HQ to for its budget and forecasting assumptions. When the strings are cut, FP&A faces a multitude of questions separated into two main parts:
What costs were allocated to the unit before? And what was the revenue picture historically based on the previous business model? And
How will cost and revenue flows change on a go-forward basis depending on what the business model is going to look like post-separation?
“Because we were a 2015 carve-out from a larger corporate parent, one of our largest challenges is that we don’t have meaningful historical financial data to provide a baseline for comparing actual results or building our next budget,” said the FP&A executive at a company now owned by a private equity firm.
At least to get things going, “we put together historic, carved-out financial statements and had those audited but they included a lot of corporate allocations and other costs that were based on how the company was operated historically, which isn’t in line with how we will operate the company in the future since the company wasn’t managed as an independent business,” he said.
“The challenge for FP&A has been to create an independent budget based on our new operating model, without a lot of relevant historical data to ensure accuracy and completeness as we have no reference point."
“As we went into the 2016 operating plan, we had to put together a plan from the bottom up, and really piece it together without the benefit of a baseline.” The same thing goes for the pro-forma financials for the businesses. Compounding that, immediately after the spinoff and acquisition, the company went through a new ERP implementation along with building up a lot of the company’s G&A infrastructure including accounting, HR, IT, and legal since those were all shared services provided by our parent company. However, “now we can move forward with a new system and a new set of numbers.” To further complicate the picture, our company has completed two add-on acquisitions in our first six months that has added additional layers of complexity to its business.
There are often more challenges than just figuring out what assumptions to use:
Small spinoffs may not have FP&A talent in house or may get assigned one FTE from the parent and must build the department from scratch, acquire or develop talent, while building budgets and forecasts for senior management, investors and regulators.
Spinoffs may have been used to working with the parent’s financial system and may or may not be large enough to justify continued use of the same system/ERP module. That may mean downgrading to excel or conducting a search for a new platform as the company is getting its training wheels.
Finally, FP&A is also often working with a fresh management team that is not used to running an independent operation. That’s a culture shock (even if a liberating one) for some executives. It may trigger some leaders to demand more information, more frequently as they have a harder time making decisions or demand new forms of analysis to help get comfortable with their new job. It’s FP&A’s role to support both management and the business during that transition.