TAKING A JOINT VENTURE public can be a powerful way to unlock value for owners. For most JVs, preparing for an IPO is measured in years, not months. The requirements for an IPO are ones that necessitate Board alignment and deliberate action – as well as some adjustments in the JV operating model. In a previous insight, we outlined a set of practical guidelines for when – and when not – to IPO a JV. In this insight, based on our assessment of successful JV IPOs, we share the five building blocks boards and corporate parents should put into place when preparing to take a JV public (Exhibit 1).
PREPARING FORAN IPO
First, enable the JV to have its own independent strategy with sufficient running room for growth. The JV must have its own competitively viable strategy. A key issue here is enabling the JV to have enough running room – in terms of product market growth, technology, and pricing freedom – to be attractive to investors. The JV typically must graduate from depending on the owners for a large share of sales, and should preferably have a broad customer base with several product lines.
Second, separate the JV’s business system as much as possible from parent company support, and shift to true arms-length relationships between the JV and parent companies. To enable a future IPO, it is important to reduce the dependency of a JV on parent companies for technology, inputs, marketing/sales, and shared services. As an example, Spansion, whose Board decided to pursue an IPO, tried to develop a truly integrated JV business system, by transferring all related parent assets into the venture, and structuring commercial relationships with parents on an arms-length basis. By contrast, a JV whose profits or processes are compromised because of pre-existing agreements with parent companies will be less attractive to outside investors – and may run afoul of requirements for shareholder protection.
As a side note, corporate parents that are considering a partial IPO should beware of ending up “in the middle” – with neither a controlled entity, nor a company that can compete against fully independent players. The governance of partially public ventures – with two or more strategic owners and public shareholders – has a set of special challenges that must be carefully planned for and managed.
Exhibit 1: Preparing for a JV IPO
Practices that can facilitate a successful public offering
Third, the JV Board and owners should shift toward a “manager-managed” governance model, more like that of an independent company than the typical JV. This includes, for example, relatively high delegations of formal and informal power to the JV management team; a Board that spends most of its time on strategy, growth, investment decisions, and talent issues – not detailed performance management or operational reviews. In the “manager-managed” model, the owners may also add independent directors to the Board, and sharply reduce the typical long list of issues that require supra-majority voting. For example, Newedge, the billion dollar global brokerage JV between Société Générale and Calyon which planned to IPO, was structured as an independent entity with a high degree of operational freedom for its management team, and with an independent non-voting observer on its Board.*
Fourth, the JV Board should support the CEO in building a deep and independent bench of talent, with attractive and performance-focused incentive programs. The compensation of most JV CEOs – and that of JV executives in general – is lower than what is seen in public companies. As a JV prepares to IPO, the pressures for growth and performance increases, as do the requirements for the company to have its own full set of corporate capabilities including shareholder relations. While the IPO can provide a powerful growth story to attract managers, it is usually necessary to redesign the compensation system, shifting toward performance-based incentives, and adding a long-term incentive program. To attract strong executives, some JVs have added stock options for the top 5-10 managers as much as 5 years before an envisioned IPO, as a way to help build the bench at the venture and keep joint venture management focused on the requirements of the IPO.
In addition, JVs that wish to pursue an IPO would be well-served to have an outside CEO, to limit the number of secondees from the parent companies, and to build internal capabilities in strategy, business development, finance, legal, and external affairs.
Fifth, the JV should be managed so as to build a strong financial track record and balance sheet, or a very compelling case for future profitability and cash flow. Many JVs are run as assets, not businesses – and objectives may be defined in terms of capacity utilization, production volumes, or cost efficiency. To evolve toward an IPO, a JV should be a true P&L-focused entity, with strong cash flows. In general, the JV should be structured so that it is self-funding, or is able to show a strong case for sustainable cash flow. Usually, the amount of transparency will need to be dialed up from what’s mandated for JVs, in order to give outside investors confidence in its performance and prospects.
Three IPO paths illustrating the progression toward an IPO over time. For Genencor, Spansion, and Orbitz the path to IPO was characterized by a series of moves related to the strength and independence of their strategy and market, business system, governance and organizational models. By the time of their IPOs, each had evolved to be more independent and freestanding than most joint ventures. In Genencor, for example, the parent companies put in place a long-term incentive plan for management that had many independent-company features (Exhibit 2). Similarly, in Spansion, AMD and Fujitsu took steps to consolidate the full business system into the venture.
Exhibit 2: Charting the Journey of some JVs along the IPO Path: Genencor
It’s worth noting that many of these changes are good things to do – whether the parent companies in the end decide to go for an IPO or not.
We expect to see a lot more IPOs of JVs in the future. This will be driven by a number of converging factors: globalizing capital markets, the desire of emerging market governments to privatize current JVs that are partly owned by state-owned enterprises, and the coming of age of many JVs that are today in their adolescent years.
*Societe Generale acquired a 100% stake in derivatives brokerage Newedge, after buying out its joint venture partner Credit Agricole, the French bank confirmed on Wednesday May 7, 2014. Source: MetalBulletin
Read Part 1: When to Take A Joint Venture Public >>