UNLOCKING VALUE IN OPERATIONAL ASSETS Can asset monetization benefit your company? By Bill Miller and Rich Wightman, ISG Directors www.isg-one.com
INTRODUCTION Asset monetization is a business transaction that converts an asset from one that does not directly generate income or other financial value into one that does generate income or other financial value. While nearly any asset can be monetized, the types of assets discussed here are operational those that a company owns or otherwise controls to support internal operations and/or the delivery of services to internal customers. These assets can be tangible or intangible and can include data centers, business processing facilities, real estate and improvements, information technology hardware and licensed software, intellectual property (unique processes, internally developed software, etc.) and an experienced workforce. Asset monetization is just one of many strategies companies use to drive better financial performance through revenue growth and better cost management by unlocking some or all the economic value embedded in various operational assets. This unlocked value might be in the form of cash, longer-term changes to lower or introduce variability to the cost structure, or other conversions of non-income generating assets to current or future bottom-line value. Whether to monetize an asset or not (and if so, how) is a strategic question with long-term implications on financials, operations, organization, and risk management. This ISG white paper describes different types of asset monetization strategies and outlines an objective, fact-based approach to assessing requirements and determining whether asset monetization is a viable option. UNLOCKING VALUE IN OPERATIONAL ASSETS BILL MILLER and RICH WIGHTMAN 1
TYPES OF MONETIZATION STRATEGIES An asset can be monetized in a wide variety of ways, depending on a company s objectives and the nature of the asset. While the variety of combinations and permutations of these approaches is extensive, the diagram below illustrates the most common approaches to monetization. Categories of Asset Monetization Strategies The first major delineation is whether the company retains ownership of the asset. This is a fundamental difference and defines the monetization strategies that can be pursued. MONETIZATION WITHOUT OWNERSHIP CHANGE Monetization strategies that retain asset ownership tend to be of two broad types, as described below. Improved Asset Utilization This approach generates income from underutilized assets to help offset costs of those assets; e.g., real estate, facilities, or equipment assets that are underutilized. For example: Leasing unused space in a facility Leasing unused hardware or bandwidth More complex strategies can involve a sequence of several actions, such as consolidating operations to free up and lease available space. These strategies tend to be more opportunistic and tactical and employ traditional asset valuation techniques, using standard market, cost and income approaches to valuation. Benefits include cost reductions as well as incremental revenue to offset existing costs, as opposed to a transformational change in operations and/or costs structure. Asset Commercialization This approach is more complex than simply making better use of underutilized assets, and tends to be more strategic by converting an asset that has only internal use into a marketable asset that delivers a product or service that can be sold to other companies. For example: Licensing a software application developed for the company to other companies Converting an internal process into an outsourced service for third parties These strategies often require an investment in the asset to make it marketable and applicable to a broad customer base, with a serious management commitment to develop the infrastructure necessary for sales, implementation, customer support, invoicing, collection, etc. In other words, the company essentially takes on the characteristics of an outsourcing service provider or a vendor. ISG has found that these transformations are extremely difficult to implement and manage, as they involve forecasts of future sales and profits from marketing the services to other companies. The financial and organizational commitment is significant to move from an internal services operation to a sales and external customer-oriented provider. Few companies can do this without substantial investments in new people with different skills and a vendor-oriented infrastructure. While the transformation can be done, we have found the joint venture strategy (discussed later) is often more successful. UNLOCKING VALUE IN OPERATIONAL ASSETS BILL MILLER and RICH WIGHTMAN 2
MONETIZATION WITH OWNERSHIP CHANGE Monetization strategies that involve ownership change (in whole or in part) are usually driven by a company s strategic objectives. Specifically, monetization is ancillary to some other desired change. These strategies tend to fall into three categories: Asset Sale The most obvious monetization technique is the sale of an asset and is common within many corporations. If the assets are tangible (e.g., buildings, land, etc.) the valuation is straightforward. Valuation of intangible assets or going concern valuations (e.g., patents, carve outs, business units, etc.) can be more complex. For operational assets, the two most basic variation of an outright sale are: Sale without future use: This is a standard divesture of an asset where the seller has no interest in having future use of, or access to the asset. Sale with future use: This technique involves the seller contracting with the buyer at the time of sale for contractual rights for access to, or use of the asset. The sale/leaseback of a building is probably the most common use of this technique. Another, more complex, example is the sale to a third party service provider of a data center or business processing shared services unit, with a simultaneous agreement to buy back services from the provider. This example is very similar to an outsourcing transaction where operational assets are transferred as part of the deal (as discussed below). The difference is the sale with future use technique is generally for a single client for a specific asset. The outsourcing technique is used when the service provider wants to use the asset for additional clients. Joint Venture with Third Party This technique usually entails creation of a Special Purpose Entity (SPE) owned by the company and a third party. These are often generically referred to as joint ventures. The SPE acquires the assets in question with the expressed purpose of providing services back to the company, and marketing the services to other companies. Operationally, this looks very much like the commercialization strategy mentioned earlier, but with co-ownership by the company and another party (or parties). An emerging joint venture trend is industry utilities where multiple companies contribute similar operational assets to reduce costs and take advantage of the greater efficiencies a utility offers. Companies have banded together for years to create purchasing co-ops and consortiums, but more formal SPEs are being created to manage the operations and sell the utility s services to other companies. Each contributing company gets an ownership stake in the SPE for future value and revenue possibilities. Outsourcing to a Third Party Transfer of asset ownership incorporated with an outsourcing transaction is the third type of approach to monetization with ownership change. In this case, the new owner (the service provider) uses the asset to serve clients in addition to the selling company. Valuing an asset as part of an outsourcing transaction can be complicated given the difficulty of assessing value prior to engaging with service providers in a detailed way. For example, a company may have a business processes shared service facility that has additional capacity in floor space, staff, and/or equipment. The company can outsource the processing to a third party that takes over the shared service center and provides services to the company, with the intent to sell services to other companies. This approach has similarities with the sale of an asset with future use approach, except the new owner explicitly plans to use the center to support new clients. In these instances, value is determined partially by various traditional approaches, as well as how the asset complements the service provider s business objectives. (See Special Case of Monetization with Outsourcing below.) ASSET VALUATION UNDER DIFFERENT STRATEGIES For any monetization approach, what are the assets worth? is a central question. Since virtually all monetization strategies have a financial objective, valuation is often the factor that determines if the strategy is a go or no go. UNLOCKING VALUE IN OPERATIONAL ASSETS BILL MILLER and RICH WIGHTMAN 3
FIVE STEPS TO ASSESSING MONETIZATION OPTIONS ISG has a framework to support clients in their assessment of asset monetization options. Through a logical and sequential process of answering five critical questions, companies can reach a go/no go decision about monetization. If the decision is a go, the process can help define a strategy that best suits specific business requirements. Five Questions 1. What are we trying to achieve? The management team must be aligned on why an asset monetization is even being considered. Without concurrence on why, you will never get to what or how. Asset management strategy objectives are not always internally aligned. Is it a cash infusion? Ongoing lower operating costs? Improving the balance sheet and capital structure? Maybe elements of all these? Other motivations? Clarity of objectives is especially important because asset monetization is not a discrete strategy, but complementary or integral to another. Therefore, objectives may be much broader than just the monetization component. 2. What assets do we want to monetize? This (seemingly obvious) question must be considered ensure management is in agreement about the assets to be monetized. At this point, the level of specificity does not have to be an audited inventory but the company needs to decide, what s in and what s out. The types of assets can be: Tangible assets such as data centers, business processing shared services centers, call centers, physical plant and equipment, IT hardware and infrastructure, etc. Intangible assets such as developed software, unique business processes, intellectual property, royalty agreements, patents, etc. Assembled workforce is not always recognized as an asset, but it has value in certain types of monetization strategies. For example, monetization as part of an outsourcing transaction can drive value from the assembled workforce if that workforce can be used to expand the customer base for the service provider. 3. How might a monetization approach or solution be structured to support our defined objectives? The deal structure possibilities are almost endless, but as discussed previously, they tend to fall into two major groups depending on whether ownership of the asset is transferred. From the list of potential monetization structures, the one or two workable ways should be shortlisted for deeper value and business impact analysis. 4. What are the assets worth? The value of the asset is driven partially by the strategy to be pursued; hence, the valuation will be driven by the one or two workable strategies defined in question #3. The greatest variability in value tends to occur when the asset is to be transferred to a service provider as part of an outsourcing transaction. The reason is that value estimates vary depending on how the asset is presented to the service provider community, and the level of service provider interest. Often, ad hoc discussions with service providers help assess how the asset will be viewed and valued. This valuation scenario is discussed more fully later in this white paper. 5. What is the business case? A quantitative and qualitative analysis addresses how the shortlisted monetization strategies and deal structures impact the company s financial, operational, organizational and risk profile. Asset monetization deals can be complex and the financial assessment can be equally so. The best results come from a collaboration of specialists in operations, finance, accounting, tax and legal. Monetization strategy risks vary widely depending on the nature of the strategy. For example, simply leasing unused space in a company-owned facility has a small risk footprint. Conversely, commercializing an asset or in a conjunction with an outsourcing transaction carries a more substantial risk. UNLOCKING VALUE IN OPERATIONAL ASSETS BILL MILLER and RICH WIGHTMAN 4
SPECIAL CASE OF MONETIZATION WITH OUTSOURCING Monetization as part of an outsourcing transaction presents an additional set of unique considerations for a go/no go decision. In ISG s experience, these unique considerations fall into five areas: Making the decision Valuing the assets Going to market Structuring the deal Avoiding the pitfalls Making the Decision The decision to outsource a function needs to be evaluated and assessed on its own merit. The management team needs to look at the costs, risks, and benefits separate from monetization. The outsourcing decision has to be made ahead of the monetization decision in priority and importance. In other words, the monetization tail should not wag the outsourcing dog. Once the decision to outsource has been made, the opportunity to monetize assets as part of that transaction can be evaluated. If the decision is made to forgo asset monetization, outsourcing can still be a viable strategy. Valuing the Assets Value in connection with an outsourcing transaction is driven by the service provider s view of the company s assets; i.e., value is the buyer s concept, not the seller s. From the service provider s perspective, value is determined by the broader business objectives, the costs structure they acquire, their investment appetite, and whether the asset fills a business void. This last factor is especially important. Service providers are particularly interested in acquiring assets when they can be opened up to the market. For example, the level of interest increases materially if the seller s assets provide more capacity the service provider wants and can use for new clients, or if the assets give the service provider new capabilities and offerings they can sell to new clients. In order to gauge potential value, understanding the service providers and their strategic direction is therefore imperative. Because value to a service provider is dependent on their business structure and strategies, not all service providers will view the value of the specific asset the same way. The bottom line is that the marketplace of service providers not your value assessment drives the deal. More specifically, the factors driving valuation in an outsourcing transaction include: Who is viewing it: The value of your operational assets is not the same to all service providers. One service provider may have a similar facility supporting other clients nearby and find little or no value. Conversely, another service provider may see a new line of business or new market providing value beyond the scope of your deal. Ability to open up the asset: One of the keys to perceived value by a service provider is the ability to use your company s asset beyond the obligation to provide services back to the company. The more capability to leverage the asset across more clients, the more valuable the service provider will view the asset. Obligations to use the asset: While your company is transferring ownership of the asset, a coterminous transaction obligates the service provider to continue delivering services with the acquired assets. In other words, the service provider is bound to the asset for a specified period. The size and duration of that obligation can have a material impact on how the service provider views the asset s value. Encumbrance of the asset: Depending on the agreement, you may restrict the service provider from utilizing assets for purposes other than your operations, thus diminishing value to the service provider. In general, when restrictions increase, value decreases. A service provider is highly unlikely to overvalue an asset "just to get the deal. As a result, don t overestimate your leverage in an asset valuation. While service providers are eager for business, they are profit-making enterprises, and as such invest capital only where there is an opportunity for an adequate return. Going to Market If the decision is made to outsource, and if management determines that asset monetization should be part of the deal (or at least be a consideration), the go-to-market strategy needs to be crafted carefully. The company needs to recognize that it is both buying and selling, this changes the way the market is engaged. UNLOCKING VALUE IN OPERATIONAL ASSETS BILL MILLER and RICH WIGHTMAN 5
The company is buying in the traditional sense that it is soliciting service providers to take over certain operations of the company. This process normally involves a Request for Proposal, provider evaluations, due diligence, and the other typical steps in selection of an outsourcing partner. But the company is also selling the assets to be monetized. The opportunity to sell any product or service is improved when it is positioned and presented well to the right target market. The company cannot assume that just because it sees an attractive and valuable asset that the market will. As discussed in the preceding section, service providers will view the asset value in the context of their business strategy and unique situation. Consequently, the assets to be monetized need to be packaged and presented to highlight the attractiveness and speak to potential buyers (i.e., service providers). As with any sale, the information about what is being sold needs to be more than a litany of facts and data in a spec sheet. It needs to be packaged and presented so that the buyer will know how it can add value to their business. The right packaging and presentation of an asset monetization opportunity requires a good knowledge of the service providers being considered, and an understanding of their business objectives. This will optimize the way the asset is presented and valued by the service providers. The bottom line: the client company must know how their asset will be viewed (and valued) by potential service providers, and position the assets to spotlight how the assets can help a service provider s business. Structuring the Deal If asset monetization will be part of an outsourcing transaction, the last consideration is how the deal will be structured for the company to receive the value. Typically, a company can realize the value in three primary ways: Cash Payment(s): The most straightforward way for a company to receive value in return for the asset is for the service provider to pay cash up front, either in a lump sum or through a series of payments over a contractually defined timeframe. Shared Value: This approach can be more complex as the payments are determined by an agreement to jointly share in future value based on some triggers or milestones. These arrangements are usually associated with transactions where the service provider is expanding the use of the asset to other clients and will share the revenue or profit with the selling company. Such transactions can be more complex and often involve greater value risk to the company, but usually have greater upside value potential. Lower Fees: Rather than cash up front, or the risk of shared value, many companies want to lower their cost structure over time. In these situations, the value may be received as a lower fee structure from the service provider than would be offered absent asset monetization. To take a simplistic example, if the cost per unit (of whatever is being outsourced) is $10.00 without monetization, it might be $9.50 with the asset. Avoiding the Pitfalls Depending on how the deal is structured and value received; some potential pitfalls should be avoided as part of the outsourcing/monetization transaction. Cash Infusions Treated as Loans or Off-Balance Sheet Financing: If the contract is written to include any upfront cash payments, these might be treated as loans on the balance sheet. Termination Charges: Outsourcing transactions typically include charges associated with certain events that trigger an early termination of the contract. Service providers may want to structure termination fees to ensure they recover their initial investment. These charges are commonly considered as liabilities and need to be assigned an appropriate risk factor. Tax Treatment of Asset Sale: Avoid surprises at how the IRS treats gain or loss of assets sold in a monetization, and subsequent tax and impact on financial statements. Additionally, if multi-national aspects are associated with the transaction, country and local tax laws need to be fully assessed for their impact on the economics of the deal. Future Use of Assets: Unless specifically written in the contract, your company has no claim on, or rights to, use of or limiting the use of the asset, so be careful how the contract is written. Use of SPEs: Under Sarbanes-Oxley, SPEs have to be structured carefully to provide visibility of the company s true financial position. UNLOCKING VALUE IN OPERATIONAL ASSETS BILL MILLER and RICH WIGHTMAN 6
Monetization During a Restructuring Some asset monetizations are individual transactions, but more and more frequently, monetization is part of a company s larger restructuring initiative. A specific asset is just one part of a larger strategy and transformation. Usually, these types of restructurings involve outsourcing some functions, selling assets, and realigning staff. In these scenarios, monetization considerations become more complex. This is particularly true for assets with a book value close to the original purchase price/cost, but a market value below book value. By using restructuring reserves correctly, the write-off amount between book value and the sales value can be addressed to minimize or eliminate the impact on current OpEx. The strategies and tactics can be quite complex for using restructuring reserves in conjunction with asset monetization. Issues surrounding accounting treatments, valuations, and contractual language require specialist advisors supporting an overall strategy. UNLOCKING VALUE IN OPERATIONAL ASSETS BILL MILLER and RICH WIGHTMAN 7
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