Five Accelerators for Oil and Gas Carve-Outs and Divestitures

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Acquisitions and divestitures have been part of the norm in the oil and gas industry for decades. But while the acquisition side of corporate reshaping is well studied and there is a lot of industry knowledge about how to acquire businesses and integrate them1, effective divestiture practices are not nearly as well known or widely used.

The reasons behind divestitures are clear: They are typically pursued to generate cash so that companies can invest in more promising parts of the hydrocarbon value chain, reduce their exposure to a particular part of the value chain, or exit areas of activity where they no longer have a competitive advantage. As a result, several peripheral industries—such as independent refiners, petrochemicals producers, pipeline operators, and oil field services companies—have grown into major industries in their own right.

Margins across the value chain have been a key driver of this development. The very real threat of oil costing $10 a barrel in the late 1990s was a key driver of the supermajors’ strategy to drive down cost by exiting non-core activities in exploration and production, which preceded the snowballing growth of the oil field services industry. Similarly, since the end of the Golden Age of Refining in 2007, the oil majors have accelerated divestments in refining.

Where oil majors have been big sellers of assets that no longer fit their strategies, a wide range of buyers have apparently found those assets to be an excellent fit with their own strategies. Not surprisingly, Asian national oil companies have been amassing upstream assets to secure access to resources; but they have acquired downstream assets as well. For example, PetroChina has been pursuing deals in areas as diverse as Scotland and Latin America. Even airlines have entered the game, as seen with Delta’s 2012 acquisition of the Trainer refinery located outside Philadelphia.

Regardless of a company’s reasons for selling its assets—and the buyer’s reasons for acquiring them—there are five leading practices this paper describes that can lead to faster, smoother carve-outs and transitions and let the seller ask for (and get) premium prices.

1 “The Evolving Role of the Integration Manager,” Accenture, 2012.

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Putting yourself in the buyer’s shoes

Not surprisingly, the high degree of integration often makes acquiring or divesting any piece of the puzzle highly complicated. Before a buyer is able to bid with confidence, it can be important to understand if the assets for sale make up an attractive business in their own right, what the dependencies are on the seller, and what risks come with separating the business. For the seller to be able to successfully carve out and sell the business, it must understand the full scope of what is being sold as well the financial and operational impact of the separating business on the retained business (the “parent company”).

Once the strategic decision to divest the business has been made, the seller can benefit from conducting an extensive due diligence effort, or “baselining,” of the separating business before initiating the transaction process. This includes assessing the status of assets, processes and employees of the separating business, the time to profitability on a standalone basis, and the linkages to the parent company and third parties. At this time, the seller can also benefit from understanding any Health Safety Security Environment (HSSE) or compliance issues that might deter potential buyers.

Gathering this information early on and with the perspective of someone who would buy the business allows the seller to enter the negotiation process much better prepared: helping to understand exactly what to carve out and providing the opportunity to design an operating model for the separating business that will be attractive to potential buyers. This process can also help uncover any “bad news,” such as compliance issues, before they become an obstacle to negotiations with potential buyers.

In addition, the results of this baselining exercise can help the seller better understand the impact of the separation and prioritize work streams on areas that have to be examined further.

There are five key aspects to cover in this due diligence (see Table A).

In addition to helping the seller construct a deal that will be more attractive to prospective buyers, this due diligence exercise can help the seller set more realistic expectations for the time and effort needed to close the deal successfully. Typically, the more the answers resemble the characteristics in the Simpler column of Table A, the less-

complex the deal and the more likely it is the divestiture could be completed in six to 12 months; and the more the answers resemble the More Complex column, the more complex the deal and the more time needed (12 to 24 months).

One major oil and gas company reviewed these key issues for the parts of its petrochemicals portfolio that it wanted to divest and discovered that the physical integration with some of the company’s refining assets complicated the carve-out. As a result of the analysis, it restructured the asset package to include refining as well as the petrochemicals assets originally considered. Not only did the restructuring reduce the effort needed to accomplish the separation and cut the time to the sale by several months, but the inclusion of the refining assets made the package more attractive to buyers, resulting in a price far above initial expectations.

1Oil and gas companies are highly integrated across a number of dimensions, such as:

• Critical third party relationships with oil field service companies for exploration

• Production joint ventures with competitors

• Complex hydrocarbon flows between plants on refining and petrochemicals sites

• Product marketing arrangements

• Terminal storage, pipeline transportation, ocean-going transportation/transport vessels

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Category Simpler More Complex

Scale of Assets Small Examples: storage terminal, propane or LPG retail, regional aviation fuel business

LargeExamples: complex refinery, multijurisdictional pipeline network, multiple geographically dispersed upstream assets

Scope of Assets Limited to well defined portion of the hydrocarbon value chainExample: distribution pipeline

Multiple areas of the hydrocarbon value chain Examples: regional integrated business comprising gathering assets, pipeline, terminals, refinery, road transportation, wholesale facilities, retail facilities

Technology Decentralized landscape Highly centralized, integrated, ERP centric landscape

Geography Localized/Regionalized Example: terminals in a single country or state

Distributed/Distant Examples: retail stations in multiple countries or states; international assets far removed from parent company and subsidiaries

Geopolitical First-world economies with transparent policies and stable structures

Unstable or dynamic regions with histories of political instability and corruption

Table A

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Managing the critical paths

One strategy to reduce this complexity is to divide the planning along functional lines (refinery operations vs. finance vs. HR, etc.). This approach can help in making sure that nothing falls through the cracks. However, in our experience, the seller can improve the odds of surfacing the key separation challenges and the areas of work that require the greatest attention and support by, instead, structuring the planning and execution around the four aspects of separation that need to occur:

1. Operational separationActivities related to the separation of the operational relationships that might exist between the separating business and the parent company (e.g., feedstock streams, site infrastructure and services).

2. Organizational separationDefining the set of employees who are to remain within the separating business and the organization structure that are to be in place post-separation.

3. Support function separationSplitting the support functions that are common between the separating business and the parent company (e.g., ERP and non-ERP IT applications; legal, finance, performance measurement and review process; technical and engineering support services).

4. Legal separationAll physical assets, IP, contracts, people, and liabilities are transferred (“ring-fenced”) into legal entities that are completely separate from those of the parent company (e.g., additive supply agreement, jet fuel offtake agreement).

Organizing a carve-out into these four themes can make it easier to identify and proactively manage the critical path within each area and help to make sure there are adequate resources provided to drive accountability. Ultimately, this will help ensure that the carve-out and transaction timelines are met.

2Even in the simplest divestitures, a lot of details have to be taken care of. Keeping a good overall picture of what will be involved can make it easier to be proactive in coordinating all the activities that must occur. Still, there can be a temptation to kick off projects or work streams as each issue arises. As a result, the seller can rapidly end up with an unwieldy program (25 to 45 separate work streams is not unusual). That complexity of activities can be nearly impossible to manage, particularly over the typical 12 to 18 month timeline of an oil and gas separation program.

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Right-sizing the support functions

However, the activities that oil and gas companies are divesting often have very different characteristics than the core activities for which the parent company support environment was created. It goes without saying that fuel retail, specialty chemicals production, power generation, distribution and transportation, refining, and exploration and production are all very different from each other in many respects. These activities vary in terms of scope, capital requirements, the time horizon of critical management decisions and the profit margins generated.

Therefore, a more effective approach is to design a work environment from a clean sheet based on what is best suited to the size and function of the separating business, focusing on what it needs and can afford. For example, trying to apply the corporate standards of a major oil company (in areas such as HR processes, legal support and ERP systems) to a much smaller entity may risk saddling the new entity with an overhead structure that not only is unaffordable, but also out of line with what the future owner of the separated business wants.

As an example, following its $9 billion acquisition of BP’s olefins and derivatives business, focused petrochemicals company INEOS immediately restructured the support functions to fit its lean, asset-centric management model. The reason was simple: INEOS believed that its own fit-for-purpose management approach would result in more efficient decision making as well as lower cost.

3It can be tempting for the teams working on the carve-out to try to recreate the support environment of the parent company in the separating entity. This is not particularly surprising: The oil and gas industry represents cross-industry best practice in areas such as HSSE and large-scale capital expenditure management.

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Being proactive about IT separation

But, it may also have made carving out an asset or business unit significantly more challenging. Couple this with a diversity of buyers from small private equity firms with no IT assets to IOCs with advanced IT applications and infrastructure of their own and it becomes even more challenging to determine a direction to take.

An IT carve-out can be controlled and managed similarly to a standard large IT project. However, there are major differences that can influence the speed, quality, and effort required to carve out and transition the IT such as:

Aiming for a solution on Day 1Work closely with the separating business to define a good IT solution for its need. This does not necessarily mean the systems need all the functionality and refinements of the parent company as described under point 3 above. Nor does it mean putting in place the solution for the coming 10 years. Indeed the solution should be fit for the purposes of Day 1 operations only. System requirements and design can be a source of tension between the retained and separated business that need to be actively and closely managed by the senior leaders within the business.

InnovatingExploring the use of new technologies then can expedite the carve-out and reduce the overall cost. For example, use of cloud technology or technologies that can copy ERP systems (e.g., SAP SLO) as an interim solution for the separating business.

Employing rigorous project managementPlanning and building the new system or IT solution should be done with the same rigor and controls that you would use to build your own to avoid costly mistakes later. Identify acceptance criteria with the buyer as soon as the buyer is identified, so that the criteria can be managed during the IT transition.

Clearly identifying any need for third-party supportEngaging existing system integrators and support providers early, setting realistic expectations as to their role in the transition. These vendors may have intimate knowledge and access to the systems, which could be invaluable in executing the transition. Equal regard should be paid to software licenses and support contracts that will need to either transition to the buyer or be

replaced, as identified in the due diligence phase. Such licenses and contracts can be at risk of becoming “showstoppers” at the completion date if agreement isn’t reached between the buyer and IT provider.

Minimizing transition services agreements (TSAs) for ITThough TSAs are essential in many areas for a smooth transition (see next section), minimizing the IT services provided through TSAs can be beneficial. Setting up such services can add complexity to the deal and add time to the negotiations and transition. Also, TSAs for IT can result in significant restrictions on the parent company’s IT environment post-close as it may restrict the upgrade or decommissioning of retained systems and can be difficult to exit.

4Since the early 1990s, integrated oil and gas companies have made significant investments in creating integrated IT landscapes, often incorporating as much as possible the complete hydrocarbon value chain from upstream production to downstream refining and retail. This integration has often supported better decision making and operational efficiencies and created technological economies of scale.

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Tackling TSAs head on

While ultimately the buyer’s needs often determine the scope of the TSAs, the seller can benefit from having a firm idea prior to negotiations on what services it is willing to provide. After potential transition services are identified the buyer then has an opportunity to decide whether it can and wants to provide them post-close—and, if so, for how long and at what cost. Unless there are significant stranded costs that need to be managed, the seller’s objective should be to transfer all services to the buyer quickly—that is, the seller may not want to be mired in complex and/or long-lasting TSAs after the sale is complete. A seller is often better off focusing attention post-close on restructuring the remaining core business.

Many sellers view TSAs as a hassle that do nothing to increase the value of the deal, and therefore leave them to the period between signing and close when they know who the buyer is. But if a seller starts developing TSAs that late in the process, it may not have a clear answer to what TSAs it can provide—and at what cost—at the earlier stages of the deal process. This can significantly reduce the

pool of bidders because it will only be companies that can provide the services themselves—typically, competitors in the same geographic markets as the separating business—that will be willing to take the risk of acquiring the separated business. Further, a robust approach to TSAs can lead to a smoother transition, reduced transition costs, and a faster close.

To foster an environment in which this process can be seamless, we advise that sellers dedicate a work stream designed to document key existing service level agreements and develop the TSAs: Often service-level agreements have not been formalized in a company. Documenting service level agreements can help a seller identify which subset will eventually become transition services to the buyer, which services need to be managed internally, and which ones to outsource. For example, when one global oil company completed its due diligence for the divestiture of its refining assets, it quickly realized that there were a number of services being provided by the parent company that were not captured as costs on the separating business’

books (including retail franchise contract administration and legal costs). The seller then set about establishing and documenting agreements for all these services. Potential buyers were able to better understand exactly what they were getting and not getting in the deal—and also decide early on what services they would need on Day 1—which increased confidence behind the bids.

5Since there is rarely enough time before the closing of the transaction to make the separating business fully independent of the parent company, in many cases the parent company needs to provide services to the separating business for a period after the closing. Hence, the need for transition services agreements. Areas often covered by TSAs range from supplying steam on a refining site to providing shared reception or payroll services.

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Conclusion

Putting yourself in the buyer’s shoesPerforming a due diligence exercise to understand how a buyer would view the separating business can help the seller shape a more attractive package. This can also guide the separation activities.

Managing the critical pathsCarving out a portion of the business requires four types of separation: operational, organizational, support function, and legal. Structuring the planning and execution around these areas can help ensure the critical path is visible and gets sufficient attention.

Right-sizing the support functionsTrying to duplicate the full administrative environment of the parent company in the separating business can be problematic. Doing so may burden the separating business with costs and complexity it is unable to bear and that will be unattractive to potential buyers. Instead, consider designing an organizational support system that is suited to the separating business.

Being proactive about IT separationIT is woven through the fabric of most organizations and often needs to be unwound with the same care and diligence as when it was originally stitched together. Start early in thinking about how to create a fully functional IT system that will support the separating business only as long as necessary. Avoid creating a legacy system that potential buyers may not want or will find burdensome.

Tackling TSAs head onA seller that overlooks transition services agreements can limit the number of bidders for the business and end up tangled in complex relationships with the eventual buyer. A seller is often better off if it understands exactly what services it will provide, when, how, and for how long.

When divesting a business, there are a number of pitfalls and landmines that must be avoided. Anything that causes a delay can make the transition more complicated than it has to be, or obscure the true value of what the seller has to offer, which can directly impact its ability to achieve the goals for the divestiture. The five practices outlined in this paper can help sellers avoid those pitfalls:

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About AccentureAccenture is a global management consulting, technology services and outsourcing company, with 257,000 people serving clients in more than 120 countries. Combining unparalleled experience, comprehensive capabilities across all industries and business functions, and extensive research on the world’s most successful companies, Accenture collaborates with clients to help them become high-performance businesses and governments. The company generated net revenues of US$27.9 billion for the fiscal year ended Aug. 31, 2012. Its home page is www.accenture.com.

About Accenture Management ConsultingAccenture is a leading provider of management consulting services worldwide. Drawing on the extensive experience of its 17,000 management consultants globally, Accenture Management Consulting works with companies and governments to identify and deliver value by combining broad and deep industry knowledge with functional capabilities to provide services in Strategy, Analytics, Finance & Enterprise Performance, Marketing, Operations, Risk Management, Sales & Customer Services, Sustainability, and Talent & Organization.

About the AuthorsSanjiv Mehta is a member of Accenture’s Corporate Strategy and Mergers & Acquisitions practice. He has been involved in over 30 deals across the M&A lifecycle in strategy, corporate development, management consulting and investment banking roles. He is based in Chicago.

sanjiv.mehta@accenture.com

Markus Rimner leads Accenture’s Corporate Strategy and Mergers & Acquisitions practice in the Nordics. He advises corporate and private equity clients through the entire M&A cycle, focusing on acquisition and alliance strategies, divestitures and carve-outs, commercial and operational due diligence, and integration planning. He is based in Gothenburg, Sweden.

markus.rimner@accenture.com

The authors would like to thank Kevin Quast, Jasen Judd, and James Skinner for their contributions to this article.

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