🤔EY: Split or No Split?
EY's plans to split its audit and consulting arms have been put on hold - what led to the sudden shift?
“EY is splitting up.”
This news shook the entire accounting and consulting world last year.
In fact, the news of this split got people more curious than celebrity divorces do!
A more shocking news:
EY is not splitting up anymore.
Why this doglapan now? And why was it even splitting up in the first place?
Grab your popcorn and ReadOn!
🤷♀️ The Division Dilemma
Breakups may be messy and complicated but sometimes they are necessary to help you move forward in life.
Ernst & Young (EY), one of the Big Four accounting firms, realised this bitter truth last year.
Since then, it has been working on the separation process.
But just like every high-profile split, there is one problem: the division of assets.
Confused? Wait, let’s give you some quick context on why EY is splitting.
🧐 Context: Why is EY Splitting?
For years now, EY and the other Big Four firms (KPMG, Deloitte, and PwC) have been minting money by providing both advisory and auditing services to companies.
Now, both regulators and investors are not happy with their dual roles. Why?
Imagine if your school teacher was also your tuition teacher.
To ensure that you keep coming back to their tuition, they would check your paper leniently and give you more marks.
That's what people think these firms are doing.
To make sure that their consulting business keeps booming, they apparently go easy on clients when they are auditing.
This has led to a lot of companies failing miserably and investors losing loads of money.
One prime example of this is Enron.
The company's auditors failed to identify its pile of debt and bad assets, paving the way for the company's fall in 2001.
Its share price went from $90.75 at its peak to $0.26 at bankruptcy!
And that's when regulators decided to make it difficult for firms that audit to give advisory services to the same clients.
Because of these regulations, these firms' consulting operations have become severely limited.
The problem? Consulting is where the real money lies.
Because of these restrictions, many firms that offer both services are losing business.
Many clients are turning to firms that offer consultancy services.
For instance, Accenture reported a consultancy revenue of $27.3 billion in FY21, double that of EY's advisory sales.
So, EY wants to split up and tackle both audit and consulting for these clients.
Its $18 billion audit arm is set to keep the EY name, while the consulting arm will get a new name and an IPO in which it will dilute a 15% stake to external investors.
The company expects an additional $10 billion every year in revenue just for its consulting services after the break up.
🤓 Back to our Main Story
Now, the split did look messy ever since it was announced.
It is the first of its kind and involves 13,000 partners and over 3,65,000 employees! The audit arm could be in significant trouble because its revenue was set to decline.
Um, why would its revenue decline?
You see, companies have to change auditors after they have served two consecutive five-year terms.
Earlier, the consulting income was enough to keep it flush with money even when it lost auditing clients due to this rule. But now, losing clients could have a much higher financial impact.
But EY’s CEO had claimed that the split would not face major troubles.
His exact words: “We don’t view this as a big risk.”
Turns out he was wrong.
What’s the problem?
Sab tax ka chakkar hai (it's all about tax).
You see, EY had planned to bring most of the tax division to the consulting side (because it is probably seeing it as the main money minter). The tax division was only set to make 14% of the audit division.
But both the auditing and the consulting division want a bigger pie of the tax division.
There are two main reasons for this:
The tax division is useful for both. The audit division wants the tax department for compliance. The consulting division wants it to help clients avoid taxes.
The tax division earns a lot of money. It earned $11.4 billion of the firm’s $45 billion in revenue in FY2021-22. Each EY tax employee generated on average around one-fifth more revenue than audit employees in 2021.
Now, who should get the tax division? Arguments on both sides make sense, no?
Like us, EY is also indecisive.
So, like with any difficult decision, EY has paused this decision-making. It has paused its split plans until it figures out a fair split of the tax division.
Plus, the firm still needs to get approval votes from 13,000 partners: a plan that has been delayed for over six months now. The voting was due in April, but it is unclear if it will happen now,
What’s more, retired partners in the US are also causing trouble for EY.
Apparently, they are against the deal as they are worried about their own pensions.
So, what will happen to EY?
Will the split go through?
No one knows yet. Some people think the split could be resolved in two weeks. But this issue has dragged on for over six months now.
However, all of this will benefit the other three Big Four firms.
They can poach clients from EY while it is busy extinguishing internal fires. They can steal EY’s clients who may not like where they are posted.
And most importantly, if EY is successful, they could steal its formula of splitting up without going through the hassles again.
Yes, the first to come usually suffers the most. It also unintentionally creates a playbook for the other players that come late to the party.
What do you think the future holds for EY? Split or no split?
Share this with your friends via WhatsApp and help them become financially smarter! See you tomorrow :)
If you are coming here for the very first time: Don’t forget to join us on WhatsApp to get daily updates! 👇