The Secret to a Successful Divestiture

Divestiture Strategy

Divestitures and investments are two sides of the same coin, but it would be incorrect to say that they’re similar. Divestitures bring a set of risks distinctly different to those present on the buy side which need to be understood.

Also, unless the acquisition is being heralded as a merger between the two entities, the circumstances in which both occur also tend to be markedly different.

Given the above, the strategy that underpins divestitures will, in its nature, be different. That is, if there even is one.

Bear in mind that the leaders of most companies rarely even consider divestitures, let alone putting together a strategy. This is reflected in the literature on M&A, which is heavy on buy-side M&A strategy but very light on sell-side strategy.

We at DealRoom help companies organizing their divestiture process and this article is an attempt to make a small contribution to the latter. Let's start with definition.

What is a Divestiture

A divestiture is the disposal by a company of an asset, a business unit or the company itself. The easiest way to think about a divestiture is as being the opposite of an acquisition. Whenever a company buys a long-term asset of some form, the seller at the other side of the transaction is making a divestiture.

How to Value a Divestiture

The process should begin with an evaluation of what a hypothetical divestiture might look like.

That is, what kind of buyers would be interested in the asset and under what set of circumstances would the owner of the asset wish to sell (for example, if the asset became distressed or if the owner perceived the offer price to be significantly over what the inherent value of the asset).

In each case, the owner would compare the benefit of selling the asset against continuing to hold it.

Undertaking this relatively simple exercise alone - perhaps in the form of a decision tree - allows the asset owner to take some control of the process.

Eventually a divestiture may become a real option for them, so it makes sense to first evaluate it in this context.

And whether it’s a relatively small asset such as a product in the company portfolio or a larger one, such as a divestiture of the company itself, the divestiture strategy should align with that of the overall corporate strategy.

Considerations here include

the strategic fit of various components of the business with the company’s overall objectives,
the financial performance of service lines, products and business units
and the impact of the individual component on the value of the overall entity from the perspective of financial markets if the company is listed.

It’s not unusual for large conglomerates to divest “non-core” assets and generate significant shareholder value, even when those same assets are cash flow positive.

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Transaction Planning

When a decision has been taken to divest of an asset, steps are taken to ensure a smooth management of the transaction process.

This involves planning for which elements of the business are retained (e.g. patents, employees, etc.) and putting together a divestiture team.

In broad terms, the steps at this stage include the following:

developing selling materials (teasers, investment memorandums, due diligence materials, etc.),
preparing a data room for the information,
identifying the profile of potential buyers (and conversely, competitors that the asset cannot be divested to),
and a plan for removal of the assets from the entity while maintaining ‘business as normal’ as much as is possible.

This last step tends to be one of the most difficult of all for companies to execute. Even non-core assets have a tendency of becoming entangled in the greater organization.

A divestiture can also free up resources elsewhere, giving the company spare capacity.

For example, if the asset being sold is a product in the company’s portfolio, marketing, management, finance and possibly even manufacturing will all have one less product to oversee after the divestiture has taken place.

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The Divestiture Team

The divestiture team will usually consist of members of the corporate development team, but this isn’t a necessity.

As with investments, divestitures are best planned through the participation of a cross-functional team.

This usually works better with an external agent - an investment banker or lawyer - who is familiar with demand that exists on the market for an asset like that being divested.

The first step here is to create a virtual data room so that everything concerning the eventual divestiture is organized in a structured fashion.

Divestiture team members should anticipate questions and documents which eventual buyers are likely to request. Being on the divestiture team also demands a different set of skills to those required on an acquisition team.

Instead of asking questions, the role involves answering them. Some team members will also quickly realize that their own roles will be under threat as a direct consequence of the divestiture.

The structure of the team will resemble something like the following:

In smaller companies, some, or indeed most of, these resources won’t be available, so company management may have to undertake some of the tasks alone, or draft in external specialists to assist.

For example, a hired attorney might assist with the legal aspects of the transaction, while an investment banker would assist in bringing the finance and accounting aspects of the business in line with what’s expected (e.g. calculation of seller’s discretionary earnings).

The Transaction Process

The transaction process involves informing other businesses - including intermediaries such as investment bankers - of the intention to sell.

Involving intermediaries in the process usually entails fees of some kind, including retainer fees and commissions, so an estimate should be made as to how marketable the asset is, how long it is likely to remain on the market, and whether the fees inherent in that estimation can be justified.

The process is repetitive but the feedback from each potential buyer or intermediary can be looked at as an individual data point.

It’s common for sellers to over-value their asset only to find that buyers in the market en masse view it value as being considerably less. This may require the divestiture team to rethink the transaction and whether it could justify selling at a price significantly below their previously estimated value of the market.

Conclusion

Divestitures are just as much a part of corporate strategy as acquisitions, and thus should be treated with the same level of attention.

Executed well, the transaction could generate value for the selling company and the acquirer.

If managers at the top companies rethought divestitures as part of an ongoing strategy, rather than just a part of restructuring, as currently seems to be the case, one suspects there could be enormous value unlocked from these transactions.