Divestitures are part of the M&A world, but they often do not get the attention that traditional mergers and acquisitions do.
While divestitures can raise challenges and spark fear in some sellers, they also yield powerful results when carried out properly.
In fact, Forbes magazine cited a report by Bain and Company which examined 2,100 public companies; the study found that
“companies focused on divestment outperform inactive companies by about 15% over a 10-year period.”
The results were even more impressive when companies had robust M&A practices.
Dozens of companies use DealRoom as a platform for divesting so we have some expertise in that and in this article we want to share our knowledge with you.
So let's start from the beginning and look at the definition of divestiture.
A divestiture takes place when a company sells an asset such as a service, piece of property, or product line. Divestitures allow companies to generate cash flow, eliminate a business segment that doesn’t fit their main objective, lower debt, and increase shareholder value.
Businesses get rid of assets all the time for various reasons.
The most straightforward explanation is bankruptcy, where the company needs to liquidate all its assets to receive some cash in return. But aside from this worst-case scenario, divestitures should be thought of as an integral part of a company’s ongoing M&A strategy.
Generating value is equally possible by divesting as it is through acquiring.
And just as the decision to acquire can be motivated by several different factors, so too can the decision to divest. Knowing when to let go of a business is important for generating value. Assets are always better sold at the top of the economic cycle rather than the bottom.
Similarly, a parent company that decides to divest an asset when they don’t need to, rather than we they do, is likely to achieve more in the transaction.
There are a lot of reasons why companies go about a divestiture, however in general terms, the reasons to divest tend to fall under one of the following:
This is the most commonly cited reason among managers for divesting of assets, at least in part because it’s the best reason to divest: Essentially, the parent company is moving in a different direction and the asset is no longer a fit with its corporate strategy. (i.e. it’s a non-core asset).
Typically, these assets are located in markets which have become less of a strategic focus for the company. A recent example is provided by GE’s decision to divest its share of Baker Hughes, the oil field services company.
The need to generate additional funds - and avoid the need to sell shareholder equity or issue debt - is a common reason for divesting. There is an obvious overlap between this reason and reason 1 if the additional funds are required to make an acquisition.
Currently, companies such as Aryzta in food, Tata Power in energy and Takeda in pharmaceuticals are looking to divest of non-core assets, readily admitting in each case that the motive behind the divestments is to reduce their debt.
This is one of the less obvious reasons for divesting a business, but the global talent shortage hints that it may become more popular in the coming years. This is more common in service lines, where a lack of human capital may impinge on the company’s ability to continue providing the service, forcing them to divest the business unit in question.
The example of publicly-listed British funeral services firm, Dignity PLC, which has been able to acquire hundreds of funeral parlours and crematoriums in the UK, often family-run businesses, is a case in point.
Another common reason for divesting an asset is because an attractive offer is received from a third party - usually another company from the same industry, or a private equity company. The fact that the asset wasn’t being marketed for sale should put the selling company in a better position during negotiations and typically leads to a higher selling multiple. Iconic assets, including brands and real estate, often attract vanity purchases. That is to say, the buyer is looking to acquire for ego-related reasons rather than strategic ones.
This is common in property portfolios with iconic buildings. In 2008, 90% of the New York’s Chrysler building was divested for $800 million - extremely over-valued, even by New York’s inflated prices. But it did allow for a huge value generating divestment for its then owner.
P.S. - In 2019, the building sold for $150 million.
The specific regulations around a certain industry or product category may mean that the company decides that a divestiture is the best decision. This can be seen where an industry is placed in a higher tax band, or becomes a ‘strategic (read: protected) national industry’, changing its value for the parent company.
Some of the consequences of the ongoing US-China trade feud can be seen in mergers and acquisitions - and specifically, forced divestments.
A recently created organ, the Committee on Foreign Investments in the U.S., has already forced several Chinese investors to divest of their U.S.-based assets. It’s probable that these actions will be met by similar reactions on the China side and we can expect to see divestitures by U.S. investors in China in the relatively near future.
There are numerous motives for divestitures. Establishing a ‘why’ for divestments is just as important as it is for acquisitions.
Selling an asset too soon, or the corollary, holding onto it for too long, both have the potential to destroy value for the parent company. Value creation comes from determining both as soon as possible.
A range of transactions can fall under the divestiture category. The most common examples of divestiture types include:
With a spin-off, a company separates the part of the company to be sold (the subsidiary) and makes it its own unit - a completely new company; therefore, investors are given shares of the new company. Spin-offs tend to generate value for the shareholders, though they do not generate cash. Typically, spin-offs are a part of an organization’s larger strategic exit plan.
As the name implies, a split-off shares similarities to a spin-off because a new business entity (not controlled by the parent company) is once again created, but the key difference lies in the fact that the shareholders may decide to take shares in the new entity.
A carve-out occurs when the seller, or parent company, sells off a piece of the company that is not part of its main operations. This means shares are sold through an IPO (initial public offering), and a new set of shareholders is established. While the parent company and the subsidiary are two separate legal entities, unlike with a spin-off, the parent company of a carve-out will usually still take an interest in supporting the subsidiary. Carve-outs are considered the most complex type of divestiture.
In a trade sale the seller turns over a piece of the business, the subsidiary, to another company. A trade sale is considered an easier divestiture by many practitioners (they tend to be quick and are the most popular type of divestiture), but the money made by the seller is subject to taxes which creates some additional financial legwork.
A liquidation of assets often entails the selling of a company in pieces for the value of the assets. It is used more as an exit strategy from a particular business.
Divestitures, when implemented well, can add as much value as acquisitions.
Think of them as enabling the divesting company to remove itself from a non-strategically important area of business, and use the cash received to invest in a core strategic area, where it can add more value.
Some of the most well-known examples of companies implementing divestitures include the following:
Finnish Oil company Neste Oil changed its name to Neste to reflect a new focus on renewable energy, in 2015. Since then, the company has divested most of its oil and gas-related assets, reinvesting the acquired funds into renewable energy. The shift led to an 8-fold increase in its stock price in just five years.
Although Microsoft’s recent $68 billion acquisition of Activision Blizzard ranks as its biggest acquisition of all time, less than 20 years ago, the company was divesting video game manufacturers as it wasn’t part of their core strategy.
In 2003, the company sold DreamWorks Interactive - developer of the Medal of Honor series - to EA Games. EA Games is now Activision Blizzard’s biggest competitor in the games market.
A strategic and financial review of Procter & Gamble’s operations in 2014 showed its CFO that around a third of the conglomerate’s brands were generating 95% of its income.
The insight led to a series of divestitures including the sale of 43 beauty brands to Coty in 2015 for a combined $13 billion and the sale of its stake in Duracell to Berkshire Hathaway in exchange for shares in that company.
After Russia’s invasion of Ukraine in early 2022, several large international investors claimed that they would begin divesting their assets located in the former, citing a series of political and economic motives. These included the Norwegian Sovereign Wealth Fund, Shell Oil, and BP.
The moment divesting is considered, company leaders need to clearly communicate their intentions with each other, as well as with Human Resources. The more ahead of the game sellers can get, the smoother the deal and the more control of the narrative they have with employees.
Identifying potential buyers who can maximize the capabilities being divested will help drive the price. It should be noted, however, sellers should be weary of divesting to strong competitors if this divestment will hurt the remaining business products/services.
What things will the buyer need to have up and running on Day 1? Predicting the answers to these questions will help the sell-side prepare for divestiture and divestiture diligence.
For instance, carve-outs perform well when the parent company remains active and maintains a larger ownership percentage, while spin-offs are known for alleviating marketing and management issues as well as boasting tax benefits.
When companies keep assets that no longer serve them, the assets tend to lose value.
In a recent M&A Science interview, Rhonda Rein, Director of Corporate Development at Thomson Reuters, summed up the challenge of divestitures very eloquently:
“It can look simple, but when you start getting into the details it can get very complicated very quickly.”
The divestiture process is one of constant evaluation: of core assets, non-core assets, and opportunities and threats that blur the lines between the two.
This requirement for constant analysis is aided by a good checklist that can be referred to and updated on an ongoing basis.
Here is a great podcast about "How to Plan a Successful M&A Divestiture Process".
See HR's view on divestitures "How to Plan & Execute a Divestiture from HR's Perspectives".
And finally check out "A Comprehensive Guide to HR's Role In Divestitures"
Before divesting, the seller must have a clear objective of what he/she is hoping to get out of the deal. First, which assets does the seller want to sell? Why? What are the capabilities related to these assets? This is often referred to as “baseline assessment” or “strategic planning.”
As the strategic planning continues, and based on the review of the above data and the company’s objectives, the seller will next need to determine the appropriate type of divestiture (carve-out, spin-off, or a trade sale).
As soon as divestiture becomes a thought in the seller’s mind, HR needs to become involved. HR is critical to the success of divestitures and carve-outs for a variety of reasons (could link to one of the other blogs here), but mostly because the people involved in the deal are generally what makes the asset successful and valuable. Characteristically, this entails HR working with Corporate Development during the strategic and opportunity analysis phases. HR will also produce a living document of employees essential to the value of the asset being divested. This document is open to change as it usually begins broad in scope and narrows down until it needs to be set in stone at the time of the announcement. HR’s critical role continues throughout the life cycle of the deal, as seen below. Read also How to Move Employees during Divestitures & Carve-Outs
Being a prepared seller not only helps a company maintain its integrity during divestiture, but also leads to more successful deals. Preparing for the sale involves including HR in early conversations to identify key employees and to begin gathering employee-related data and documents. Additionally, if the seller has ever been a buyer, it can turn questionnaires and surveys used in the past in the buyer role on themselves and predict what the potential buyers will ask. Moreover, as the seller cultivates relationships with buyers, it should keep track of all the questions the suitor buyers ask in a FAQ document.
When a buyer is identified, a letter of intent will be produced, which commences the actual performing of the divestiture.
Conduct divestiture due diligence - Just like in traditional mergers and acquisitions, information on the target must be gathered and analyzed. Again, being a prepared seller can make this intense process a bit easier.
While due diligence is being conducted, the purchase agreement should be created. HR is responsible for reading over these agreements and adding input related to employees and their various benefits. The PA encompasses everything from the purchase price and payment details to reps, warranties, and closing conditions.
Ring Fencing is a term used by HR practitioners that speaks to the need to retain employees key to the divestiture. As mentioned previously, HR wants to identify this group early on and continue to narrow it down. HR will communicate with the employees in the fence that they are ring fenced and cannot apply for other positions throughout the company. Ring fencing protects deal value and the seller’s reputation.
Communication with employees and stakeholders is key, but so is communicating with clients.
TSAs or Transitional Service Agreements, allow deals to proceed even if the buyer is lacking some infrastructure to hit the ground running on Day 1. Again, here HR plays a vital role in communicating with the buyer and considering employee needs. HR will generally develop the TSA, which allows the seller to provide transitional services for about a year.
Divestments are on the rise, and the best strategy for managing a successful one is preparation.
Preparation spans multiple functions across the sell-side and forces the seller to be clear with its overall strategy and communication.
The one function that spans multiple parts of the divestiture life cycle and gathers information from multiple functions of the parent company is Human Resources.
Ultimately, to truly disrupt the market, divestitures must be grounded in sound strategic reasoning and nonpareil respect for the value employees bring to an asset.