Divestitures and M&A deals are vital strategies for companies to allocate resources and manage their portfolios efficiently. While M&A deals focus more on expanding the company’s operations and capabilities through strategic acquisitions, corporate divestitures aim to shed a company’s non-core assets.
Both deal types lie at the basis of agile business portfolio management, bringing powerful results when carried out properly.
This guide details divestitures by reviewing divestment types, their objectives, and explains how to run the divestiture process with maximum efficiency.
A divestiture, also called a divestment, is a company’s strategy of partial or complete disposal of a business unit, subsidiary, or asset through sale, exchange, closure, or bankruptcy.
In many cases, a divestiture transaction follows management’s decision to cease the operation of a particular business unit that no longer fits the company’s core competencies. Most companies eliminate assets that do not contribute to the core business operations. These can be intellectual property, human resources, business units, and other company resources not critical for core activities.
Often, divestitures are associated with unfavorable circumstances like bankruptcy or economic recession. However, corporate divestitures can be a part of strategic planning for optimizing business, corporate restructuring, or improving the company’s portfolio.
According to McKinsey, companies that practice disciplined execution of divestitures and acquisitions regularly tend to outperform those that don’t:
What are the most common reasons for divestiture?
The term “divestment” commonly refers to business downsizing. However, numerous corporate divestitures are made strategically as a part of organizational or individual investment strategies. Here are some critical reasons for divestment.
|Raise cash||Companies experiencing operational and financial troubles can initiate a divestiture to raise funds and reorganize the business for better performance.|
|Unlock value||Sometimes investors are willing to pay more for separate business entities than the entire company. It is a common situation during business liquidation. In that case, the executive vice president or another decision-maker can break the company into two or smaller entities to unlock the potential value and increase the attractiveness for investors.|
|Underperformance||By managing numerous corporate divestitures, a company can eliminate a business division that underperforms to improve overall business efficiency and resource management.|
|Strengthen the balance sheet||The statement of the company’s chief financial officer about strengthening the balance sheet means that the organization is going to pay off debt. For this purpose, the organization can announce the completion of the divestiture of assets or divisions to get enough funds to pay the debt.|
|Competitive pressure||In some cases, divestiture may be necessary to keep up with or stay ahead of competitors. For example, companies divest non-core or other business units that underperform to free up resources to invest in areas that will help them increase market value and stay competitive.|
|Strategic focus||A company may divest a business unit or asset no longer aligned with its core strategy or long-term goals. Divesting can allow the company to focus its resources on business development and profitability growth.|
|Regulations||Sometimes divestiture activity is initiated in the regulatory environment. For example, if a company’s numerous acquisitions result in a monopoly in the local market, the local government may initiate the company’s breakup, set certain limitations on using acquired resources, or block mergers by a court order. In response, the company will have to initiate the divestiture process to address the antitrust concern.|
|Lower volatility||Fundraising through divestiture takes place to address potential troubles with assets or divisions that imply risks to the core business.|
|Bankruptcy||Managing numerous corporate divestitures can help cut financial losses in bankruptcy cases. Additionally, divesting after bankruptcy allows businesses to address an urgent need to lower operational costs and increase cash flow.|
Divestitures lead to numerous acquisitions that stimulate the cash flow within the industry. Divesting creates a cash injection into the company, which may have multiple positive effects on both buyer and seller.
The main types of divestiture
Divestments differ in their purposes and needs, and here is detailed guidance on the five main types of corporate divestitures.
These are tax-free non-cash transactions when a parent company decides to distribute shares of its division or subsidiary to its shareholders. The new business entity becomes a separate company with its own shares.
Such corporate divestitures are typical for corporations split up into two or more distinct businesses with different operations, risks, and resource bases. The parent company can spin off 100% of a subsidiary’s shares — or retain a percentage of shares.
Shareholders in the parent company are offered shares in a subsidiary, with a need to choose whether they continue holding shares of the parent company or switch to holding shares of the subsidiary.
With these types of corporate divestitures, holding shares of both the parent company and subsidiary is impossible. If a shareholder chooses to switch to shares of the divested business unit, they must swap the parent company’s shares for the subsidiary’s.
Such corporate divestitures imply the selling process of shares in the subsidiary to the public via an initial public offering (IPO). This way, the parent company establishes a new set of shareholders in its subsidiary. Unlike spin-offs, the parent company receives a cash inflow in carve-out divestments. Most often, such transaction structure implies offering up to 20% of the subsidiary’s stock in an IPO.
Trade sale means the company sells the controlling interest in the asset to a particular buyer for a previously agreed amount of cash. Usually, the parent company searches for a buyer among companies operating in the same industry.
The company negotiates with multiple buyers that fit the business unit being sold and chooses the offer with the best purchase price and terms. The purchase agreement includes transferring key employees in strategic positions, intellectual property, trade secrets, and other resources associated with the divested unit.
Such divestitures include sell-offs of the company’s assets separately to generate cash. Divestiture practices employed as an exit strategy to liquidate a particular business help pay off its debts and close down the business with as few financial obligations as possible.
With divested assets, the company management aims to generate maximum value from the company’s assets being sold or passed in shares and use the acquired funds for business growth.
Divestiture best practices
Divestiture transactions are often related to mergers and acquisitions. Companies need to sell non-performing assets to optimize their business performance and structure, and often acquire new resources to stimulate growth.
This way, divestiture planning is a vital part of the company’s corporate strategy and one of the key goals in the financial leadership experience. Here is a detailed guide to establishing an effective divestiture process.
1. Proactive portfolio management
Companies that face resource-allocation decisions need to prioritize their business units or assets regarding the value they bring to a company. In other words, responsible managers who take the leading financial management roles need to sort out the assets that can bring the company the most value from divestiture and the ones that should remain under the company’s ownership.
Such portfolio reviews should be performed regularly. McKinsey offers a structured approach for determining the assets for divestiture:
To keep up with the market changes, the frequency of asset reviews needs to match the pace of industry changes. It depends on how often various competitive factors emerge, like new market entrants, disruptive technologies, and other industry changes.
2. Value optimization planning
To maximize value from selling the asset, management should design a thorough plan to make it as attractive as possible before selling. Establishing an outline six to twelve months prior to the sale is an optimum timeframe. Set a phased disclosure process to share more information with shortlisted buyers to enhance their interest and involvement in negotiations.
While the company still owns assets, it can improve its value, demonstrate various benefits from future acquisition to potential buyers, and set a higher deal price.
3. Buyer value creation
The decision to divest doesn’t mean getting rid of assets entirely. Every corporate acquisition or divestiture affects the company’s image and shareholder value.
Take a thoughtful, structured approach to organize the divestment process to ensure the deal’s effectiveness. The reverse due diligence process helps negotiate the best deal terms and define the optimum transition period and deintegration plan.
For instance, in case of carve-out, create a list of potential buyers whose capabilities would help your business thrive after the deal closure. The best deals are the ones in which all parties win. That is why the divestiture team should choose the most suitable buyers and demonstrate to them the value they can acquire from your divestment.
4. Strategic planning
After the corporate divestitures are done, it’s time to revise your strategic positions and focus on your core corporate development priorities. The value generated from divestments must be properly allocated according to your business goals.
Based on the financial leadership experience of the best-performing companies, it is better to prepare comprehensive internal and external communication plans, optimize the operating model of the remaining company, and review the infrastructure for the future portfolio.
A structured approach in continuous portfolio management is one of the best practices employed to maximize value from divestiture activity and acquisitions.
Examples of divestiture
The right divestiture strategy emphasizes disciplined execution and reaching maximum benefit from potential divestiture value. The recent Bain & Company review reveals key reasons behind divestiture success:
Here are a few examples of different divestiture types that led to numerous acquisitions among global business leaders and brought the parties success.
1. eBay divested PayPal
The separation of PayPal from its parent company, eBay, is one of the best examples of spin-off divestiture.
In 2015, eBay announced its plans to spin off PayPal into a separate, publicly traded company. This was done to allow PayPal to focus on its own business development and innovation while also providing eBay with greater flexibility to pursue its own strategic priorities.
The spin-off was completed in July 2015, with PayPal becoming an independent company listed on the NASDAQ stock exchange. Since then, PayPal has continued to grow and expand its services, while eBay has focused on developing its own marketplace and enhancing its customer experience.
2. Philip Morris Inc. (Altria Group) divests Kraft Foods
One example of a successful split-off divestiture is the separation of Altria Group’s (formerly known as Philip Morris Companies Inc.) Kraft Foods subsidiary in 2007.
Altria, the parent company of Kraft Foods, had been facing pressure from investors to divest non-core assets and focus on its tobacco business. In response, Altria decided to spin off Kraft Foods into a separate company through a split-off divestiture.
As a result, Kraft Foods became a separate publicly traded company in March 2007. The divestiture was successful, with Kraft Foods’ stock price increasing by nearly 10% in the days following the split-off.
3. Delta divested landing slots due to antitrust concerns
Sometimes a corporate acquisition can directly lead to the disciplined execution of divestiture. An example of regulatory divestiture is the merger of Delta Air Lines and Northwest Airlines. In the post-merger integration, the U.S. Department of Justice required the combined company (named Delta) to divest certain landing slots at airports to address antitrust concerns.
In the case of Delta and Northwest, the Justice Department was concerned that the merger would reduce competition and lead to higher consumer prices on specific routes where the two airlines had a significant market share.
To address these concerns, the Department of Justice required Delta and Northwest to divest landing slots at airports, including LaGuardia in New York and Reagan National in Washington, D.C.
In 2009, Delta announced that it had reached an agreement to sell some of these slots to other airlines, including US Airways and AirTran Airways.
Here are the main divestiture best practices employed by companies to increase the likelihood of success:
- Involving different financial management roles to conduct a thorough analysis of the assets to be divested
- Establishing clear goals and objectives for the divestiture
- Communicating the rationale for the divestiture to stakeholders and carefully managing the transition process