Divestiture is a strategy that dealmakers and business owners can use to improve business performance and drive growth. The Deloitte 2022 Global Divestiture Survey confirms this, with 41% of respondents reporting that the value they received from their most recent divestiture exceeded their expectations.
This article will explore divestiture as a strategy for business growth, the different types of divestiture, the pros and cons of divestment, and the main stages of asset divestiture.
- Divestiture is a partial or full disposal of the company’s business units or assets through sale, exchange, or bankruptcy.
- The main reasons for divestiture are cash generation, the sell-off of redundant business units, the desire to increase market value, disposal of non-core assets, political issues, and court orders.
- The main four types of divestitures are sell-offs, spin-offs, split-offs, and carve-outs.
Among some big-name conglomerates that used divestiture as a strategy are Thomson Reuters, AT&T, and General Electric (GE).
What is a divestiture?
Divestiture (or divestment) is a partial or full disposal of the company’s assets or business units. This process can involve sales, closures, exchanges, or bankruptcy. Assets sold in divestitures can be tangible, such as real estate or business divisions, or intangible, such as intellectual property or exploration rights.
The divestiture definition is usually seen as the opposite of an investment or acquisition. However, it serves as a pathway to improve financial position. Companies may divest assets to improve their financial position, enhance business performance, and increase their market value, ultimately creating opportunities for new investments and growth.
Understanding the divestiture of assets
The divestment process typically happens when a company understands that its particular business unit underperforms or no longer corresponds to the core corporate strategy.
A corporate divestiture of assets typically happens when a company needs to keep up with the market competition. When an organization sees a substantial and prolonged drop in competitiveness, the sell-off of certain underperforming business units might be the best solution as it allows for cash generation and further financing of the new line development.
By divesting underperforming business units or non-core assets, companies can cut costs, reinvest, focus on the core business directions, pay off debt, and streamline their operation. As a result, this approach can increase shareholder value.
Note: Divestiture of assets is especially common for conglomerates. As large companies grow, they often notice they have acquired too many business subsidiaries—some of which are not profitable. This is when a company sells or closes its operational units, which allows for focusing on more profitable lines and improving business performance.
How does a divestiture work?
There are four main stages of the divestment process:
1. Monitoring business portfolio
As a part of corporate development, company management regularly reviews its business portfolio to ensure every business unit is performing well, is profitable, and corresponds to the current company’s strategy. If management identifies any underperforming business division or asset, a divestiture is then considered.
2. Identifying a buyer
After concluding that divestiture is a good strategy, the next step is to identify potential buyers for the selected business unit. Finding an appropriate buyer is crucial since the price of the divested business asset should at least be equal to the opportunity cost of not selling it.
3. Performing divestiture
The divestment itself is a complex process that implies many aspects: business valuation, change of management and ownership, and staff retention and termination.
To achieve a successful divestment, financial modeling, and discounted cash flow (DCF) analysis are used for business evaluation.
4. Managing the transition
After the divestment completion, an entire company receives a large cash injection. Therefore, managing that capital influx is important.
A company can use the money to grow existing business divisions to gain better performance and increase earnings, or open new business lines and grow its area of operations. However, often, the money raised is used to pay off debt.
It’s also important to understand how to manage such leftover processes as IT, infrastructure, and technology after the divestment—either integrate into the existing business operations or spin them off.
6 reasons why divestitures occur
The main motive behind the divestiture of assets is the company’s need to dispose of unprofitable business assets. Below are the main 6 reasons why a company might have such a need.
1. Disposal of underperforming business units
Most companies opt for selling a part of their core operations if they’re underperforming or if profits no longer meet expectations. This allows the company to focus on the well-performing divisions and boost profitability.
2. Cash generation
Divestment is frequently part of corporate strategy for companies that need to raise capital without extra financial obligations. That cash is usually used for other acquisitions, debt payoffs, or licensing intellectual property.
3. Resale value increase
The company considers divestment if liquidating assets individually brings more value than the market value of its combined assets. This way, the company gains more by divesting one business unit than by retaining existing assets.
4. Compliance with regulatory requirements
Divestiture also happens when a court order requires the sale of a business asset to improve market competition. This is regulated by the Federal Trade Commission as a part of antitrust laws and aims to prevent monopolies.
5. Disposal of the non-core assets
With the company’s growth, the number of operating business lines increases. However, some of those lines might be not 100% in accordance with the business’s strategy. Management then decides to divest non-core assets to focus on those that correspond with the company’s business objectives to bring it back up to profitability.
6. Ethical or political reasons
This is especially common for cross-cultural businesses. A company may decide to divest certain business units based on geography if the business’s principles and goals don’t align with the local practices and policies.
When should a business not be divested?
Obviously, if each of the business divisions is performing well and is profitable, and this is proved by regular portfolio reviews, the company should then consider other types of deals for growth.
Types of divestitures
There are main four types of divestiture:
The spin-off takes place when a parent company sells a specific division that then forms a new, independent company. The existing shareholders are given shares in that new company
These divestitures are also often called split-ups. This type is similar to spin-offs, with the difference that shareholders are given the option of either keeping their shares in the parent company or getting shares in the new company that appeared from the divested business unit
During a sell-off, the parent company receives cash proceeds in return for the divested business asset
Equity carve-out takes place when a parent company sells off a part of its core operations through a stock market offering to new shareholders. The parent company and the new subsidiary that is formed after divestiture then operate as separate entities, but the parent still retains full control and management over the subsidiary
Note: Some experts distinguish one more divestment type—liquidation. It happens when a company sells its assets separately for cash generation. Liquidation usually takes place as a part of a bankruptcy proceeding.
The connection between M&A and divestitures
The M&A divestiture connection lies in its investment nature. However, the M&A process differs from divestiture.
The main reason behind mergers and acquisitions is the need to buy or merge with other companies to grow and improve business performance. Whereas the main motive behind divestiture is to divest certain assets or business units to grow and increase market value.
Simply put, in an M&A deal, the company is supposed to perform better when acquired by or merged WITH another company. In contrast, after divestiture, a company is supposed to perform better WITHOUT a certain asset.
Pros and cons of divestitures
Divestiture of a business unit comes with advantages and disadvantages.
- Value generation
By partial or full disposal of particular business units, a company can increase shareholder value and, thus, secure new investments or expand
- Improved business performance
When divesting non-core assets, a company can focus on the business units that correspond to the company’s strategy and are profitable. As a result, the company’s business operations usually improve
- Cash generation
By selling-off underperforming business assets, a company generates cash for corporate acquisitions that align better with the business strategy
- Direct costs
Divestitures often come with direct costs such as managing the legal transfer of assets, conducting evaluations, and making staff termination payments
If a company doesn’t communicate the reasons for the divestment of assets effectively, potential investors may wrongly assume that the company is going through financial problems and won’t be interested in investing in them
- Difficult evaluation
Evaluating divested assets can be challenging as they were not previously an independent company
Before divesting a business unit, every company should carefully consider its strategy. For this, they should primarily focus on three main questions: when, why, and what.
- When. The key part of the divestiture strategy is finding the perfect timing. That is why it’s important to perform regular portfolio reviews to identify underperforming assets in time. The quality analysis of the external factors also helps to timely detect the need for divestiture.
- Why. When considering divestment as a part of a corporate strategy, a company should also be sure of what they will do with the value, cash, and improved business performance without a particular asset. That is why it’s crucial to understand the reason for the divestment of certain business units.
- What. It is crucial to clearly specify what is being sold when divesting a company. For instance, the company must clearly define whether the sale involves only the assets or the assets along with employees. In the case of the latter, it is essential to have a clear plan for how the human resources will be distributed between the parent company and the divested subsidiary.
Note: It’s critical for a business to have a roadmap that clarifies what will happen after the integration process. It includes information on how the generated cash will be used and how the resources will be allocated.
To conduct a divestiture transaction, a company should perform the following steps:
- Define the asset to divest and the deal perimeter
Though this sounds simple, this step can get complicated because of the shared resources. The parent company must specify what equipment, real estate holdings, furniture, computers, and other essential assets and materials will go with the divested division and which will stay under the parent company’s management.
- Prepare their finances
Before selling a business unit, a parent company will need to prepare financial statements that reflect the unit’s potential as a separate business entity.
- Look for a buyer
If a company already knows potential buyers, then it should reach out to them with a proposition and initiate due diligence. If not, the best way to find interested buyers is to hire an investment bank.
- Identify employees that will go with the asset for sale
The next step is to decide how the staff will be distributed between a parent company and a sold asset. For this, a parent company needs to communicate its intention to sell the business unit to its employees.
- Perform due diligence
When all the above steps are completed, the interested buyer can initiate due diligence and review all the required documents to decide.
Examples of companies using divestiture strategy
Below are 3 companies that turned to divestiture.
General Electric (GE)
In 2015, General Electric decided to divest its financial services division—GE Capital. The company sold its business unit as a part of the restructuring plan. The reason behind divestiture was a conglomerate’s desire to focus on the industrial core.
As a part of its efforts to divest its financial services divisions, GE said it signed $157 billion in transactions in 2015.
In July 2016, Thomson Reuters, a Canadian multinational conglomerate, announced its intention to divest its Intellectual Property and Science business division to Onex and Baring Asia for $3.55 billion.
The main motive behind the divestiture was to reduce the amount of debt on the company’s balance sheets.
AT&T’s divestment is the perfect example of court-ordered divestment that took place in 1982.
The US government determined that AT&T, an American multinational telecommunications holding company, controlled too large of a portion of the American telephone service market and brought antitrust charges against it. As a result, the company split into seven different companies, including one which retained the AT&T name.