Extracting value before sale

When a business with owned real estate changes hands, the buyer is acquiring two assets, an operating company and a property portfolio, but typically pays for them at a single multiple. The gap between what the real estate is worth through a sale and leaseback and what it contributes to the earnings multiple presents an opportunity for value creation. Please see Sale and Leaseback as a Tool for Value Creation for more detail. Before exiting, a seller needs to consider capturing this value, otherwise it is left on the table for the buyer to claim.

What are the options?

There are two different approaches. The seller can crystallise the value before the exit process starts or the business can go to market with the real estate on balance sheet but the monetisation opportunity fully worked up (price, indicative structure and due diligence) in the hope that a buyer reflects it in the offer.

Crystallising before exit

Executed cleanly, a pre-exit sale and leaseback converts the real estate arbitrage into cash on the seller's side of the transaction. Proceeds can de-lever the business, fund a final period of growth, or be distributed.

Careful consideration needs to be given to the lease structure as any buyer will underwrite the lease that is now in place. Poorly structured terms including unaffordable rent and restrictive change-of-control clauses can destroy more value than the transaction created. Please see Structuring Your Lease to Support a Future Exit for more detail.

There's also a timing consideration. A sale and leaseback process can take months to complete and receipt of proceeds can also be delayed further by pre-emption rights in certain European jurisdictions. The process needs to begin well ahead of exit preparation to avoid pressure that comes from transacting under time pressure.

Presenting it rather than executing it

The alternative is to leave the real estate on the balance sheet but present the monetisation opportunity as part of your sales process by including: indicative pricing, a considered view on covenant and lot size, and, clean title and diligence. Capcore have seen this approach in numerous CIMs recently and can assist with compiling this information pack.

This approach provides a considered future value creation lever which potential buyers can underwrite as part of their bid. It also avoids locking the next owner into lease terms they did not negotiate which might be preferred for certain assets and opportunities. However, the clear limit is that buyers are very unlikely to pay full value for optionality they must execute themselves. The buyer bears the risk of undertaking the transaction and crystalising the arbitrage. Outside of a very competitive process, this approach is highly unlikely to capture the full value on offer. It is better used when the seller doesn’t have time to execute the sale and leaseback before exit but wants to try capture some value.

What this means for a sponsor

This decision should be made whilst planning an exit, not during the exit process itself. By the time an information memorandum is being drafted, only the weaker of the two routes is still available and is unlikely to capture the full potential value.

Two key questions should be addressed as part of the decision. What would the real estate attract on a net lease basis? How would a buyer price the lease that gets left behind? The answers will differ depending on the opportunity, type of real estate and likely buyer of the company.

The final word

Owned real estate on the balance sheet at exit typically provides an opportunity for value creation. As the use of sale and leaseback continues to grow amongst PE Sponsors in Europe, many buyers will be aware of this potential value. Sellers should try to execute the sale and leaseback before exit as this is the only way to capture full value. Sponsors who make that decision deliberately, ahead of the process, tend to fare best.