Split Ends: How to Exit a JV by Untangling the Assets

  

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Split Ends: How to Exit a JV by Untangling the AssetsSAUDI ARAMCO AND SHELL recently announced their intent to divide up the assets of Motiva Enterprises – one of the world’s largest joint ventures. The announcement marks a relatively harmonious end to a 50:50 JV formed in 1998 that refines, distributes, and markets petroleum products under the Shell brand in 26 U.S. states. Recent public data shows Motiva has more than 3,500 employees and generates more than $50 billion in annual sales. Under the proposed split, Shell will receive two older refineries located near a Shell chemical plant plus a slate of gas stations, while Saudi Aramco will gain ownership of 26 fuel terminals and a modern refinery in Texas that is the largest in North America. All that remains is to agree on a cash equalization payment from Aramco to Shell in return for the larger asset share.

Motiva is not alone in divorcing and dividing the jewels. Our database shows a number of prominent joint ventures, including Goodyear Sumitomo, Takeda Abbott Pharmaceuticals, and ST Ericsson, have been successfully unwound by untangling their assets and returning a portion to each shareholder.

Given this, it is puzzling that few dealmakers consider “unscrambling the eggs” as a legitimate option for structuring the exit provision in a potential joint venture transaction. Instead, most companies follow the classic JV dealmaker playbook down one of three exit paths: A potential buy-out by one partner, a third-party sale, or liquidation.

This is a missed opportunity.

Imagine going into JV negotiations with a much larger partner whose deep pockets and regulatory connections make the outcome of a traditional buy-sell exit provision a fait accompli. Wouldn’t it be better to have a way of leveling the playing field by ensuring continued ownership of least some of the JV’s business in an exit? Or what if your company was consolidating a key back office function or service into a JV to gain scale, and could not effectively compete in the market without that support. Wouldn’t it be better to have a way to claw back enough capacity in an exit to keep the business running, instead of facing the grim choice of losing it all or buying twice as much infrastructure as needed?

Untangling and splitting a JV’s assets is not always the right answer, and it can destroy value when performed on a single, tightly-integrated business. But there are situations where it is an attractive supplement to the boilerplate exit approach.

Exhibit_1_Partnership_Structure.pngThe purpose of this note is to briefly illustrate four structures successfully used by dealmakers to enable an exit that untangled the JV’s assets.

Structure 1. Right to acquire specific assets.

In 1997, Schnitzer Steel Industries, one of the largest scrap metal recycling businesses in the United States, gained an ownership position in a series of joint ventures with Hugo Neu Corporation (Exhibit 1) through the purchase of Proler, another industry player. The partnership initially included three JVs that operated scrap metal processing facilities at export yards on the east and west coasts of the United States, and was later expanded by establishing a fourth 50:50 trading JV to source scrap metal globally.

In 2004, Schnitzer Steel and Hugo Neu mutually determined that the overall partnership was restricting their ability to grow their wholly-owned scrap businesses, control operating cash-flows generated by individual venture entities, and tap into certain export markets. Senior dealmakers from both companies met, and concluded that in the event of exit, each company would prefer to own some of the assets of the partnership rather than being forced into a full sale or purchase of all of the assets. Enabling this unwind scenario was the initial decision to establish separate legal entities for each geographic business, rather than grouping all assets into a single venture.

Exhibit 2: Unwind StructureOver the course of six months, the companies defined principles related to the asset split, including that each company should exit with an equal share of value, each should be able maintain bi-coastal presence, and each should be able to further its export strategies. The discussions culminated in a draft Master Separation Agreement that specified which jointly-owned entities would be transferred to which partner, and which geographic operations within the trading venture each partner would receive (Exhibit 2). It also stipulated that the asset division needed to be consistent with a then-current valuation.

When the partners started formally unwinding the partnership in 2005, the historical earning trends did not cleanly support the pre-agreed division of assets. As a result, the parties negotiated for Schnitzer to receive an equalization payment of $52 million in cash and a Hugo Neu wholly-owned Hawaiian recycling facility to balance the asset allocation.

Structure 2: Right to purchase up to proportionate share of assets...

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