Urge to Purge– Business Divestiture, Spin-Off, Crave-Out… Shrink to Grow: Value-Creation…

Shrink-to-grow is a basic justification for business divestitures… a divestiture is a strategic restructuring option for partial or full removal of a business unit… and, depending on purpose of restructuring, it can take different forms of execution, such as; sell-offs, spin-offs, equity carve-out…

Companies offer several common reasons for a divestiture, e.g.; removing an under-performing business units… or, focusing on the core business through the selling-off of unrelated business units… or, government regulatory authorities might use legal action to demand a business divestment due to antitrust, anticompetitive practices…

According to EY; leading companies view divestment as a fundamental part of their capital strategy, and an important vehicle for funding growth. More than half of companies surveyed in the 2015 EY Global Corporate Divestment Study expect the number of strategic sellers to increase in next 12 months…

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Also the study reports; 74% of firms are using divestment to fund growth… 66% saw an increased valuation multiple in the remaining business after their last divestment… 45% of executives say shareholder activism influenced their decision to divest… 50% of executives say that closing deals quickly and with certainty is more important than waiting longer to secure higher price…

But regardless of the form or specific motivations behind it, a divestiture is almost always undertaken to do one thing: maximize the value of invested capital. It provides an exit mechanism to convert invested capital back into a negotiable form of assets, usually cash, shares, or some other debt instrument. These assets, which are freed from their previous application, can then be applied to some new form of investment…

In the article How The Best Divest by Michael C. Mankins, David Harding, Rolf-Magnus Weddigen write: Research shows that the most effective ‘divestors’ follow four rules: 1.) Set-up a dedicated team to focus on divesting… 2.) Avoid holding on to businesses that are not core to their portfolio– no matter how much cash they may generate… 3.) Make robust de-integration plans for the businesses they intend to sell… 4.) Develop a compelling business unit exit story to use in taking the– buyers’, employees’, other stakeholders… perspectives very much into account…

To identify the right divestiture, the best divestors apply two criteria: Fit and Value. To determine ‘fit’, management asks: Is keeping the business essential to positioning the company for long-term growth and profitability? And, to judge ‘value’, management must work out whether the business is worth more held in the company’s portfolio, than it’s anywhere else…

Conventional wisdom is that companies should sell only businesses that are not critical to the core business… in addition, a business that has more value to another firms, other than their own. In making divestiture selections, the best companies are studiously unsentimental, and prepared to jettison businesses with long and storied histories… Whatever form the divestiture takes, good divestors are meticulous about planning how it will unfold– just as savvy acquirers are diligent about post-merger integration…

Divestors start by comprehensively defining the boundaries of any divested business considering issues, such as: Which products and assets will be included? Which customers? Which facilities? Which management and employees? They consider tried-and-true methods for dealing with– shared overhead costs, brands, patents, trademarks… They consider how to carefully unravel cross-company systems and processes (or even share them, by both companies, during transition period) to ensure effective separation…

A common method to maximizes value is to structure the deal so that both, buyer and seller are winners, by taking actions that ensures the success of the divested business… According to Ted French; the underlying principle is simple; maximize the value of the business, facilitate a smooth transition, treat all affected management and employees fairly… Selling a business is rarely a one-off activity; research shows that companies that actively manage their divestiture portfolios in a selective and disciplined manner out-perform competitors that sit on sidelines…

These active companies, through experience and commitment to business strategy with divestitures, create an institutional capacity to spot and take advantage of divestiture opportunities, whenever they arise: The best divestors are ‘divestiture ready’ and able to consistently move– at the right time, in the right way– to create the most value for all stakeholders…

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In the article Corporate Divestitures From Strategy To Execution by PwC writes: The highly competitive business environment has increased pressure on companies to revisit their operational strategies to determine if divestiture solutions are a viable response to some of their most pressing business issues… But, a divestiture strategy is not for the inexperienced, and companies must be well-prepared to deal with many serious issues to be successful, or avoid disaster, e.g.; if sellers are not prepared, present less than compelling business case for the divestiture, buyers can rationalize uncertainty and the perception of unmeasurable risk, which can derail a potential deal…

These perceptions usually result when there are significant delays in closing a deal, if the deal gets closed at all… However, more often than not, management is working very hard and spending much time and resource trying to close a deal, and do not adequately attend to the operational needs of the overall organization, which then can result in some very serious issues, for example:

  • Employee turnover increases and productivity declines as staff members speculate about their future, weigh their options, and potentially leave the company for other opportunities…
  • Critical business investments and new products are often put on hold…
  • Competitors use the opportunity to attack the target business on its most vulnerable points, raising doubts among key customers, and making it harder to attract new business…

It’s a well-known fact that buyers must implement a sound due diligence and integration process if they hope to capture the value of an acquisition, but ironically many companies fail to recognize that a comparable process is vital when divesting a business… Hence, if companies expect to realize value on the sell-side of a company divestiture, they must understand that– value erosion begins long before a deal is completed, it’s imperative for sellers to prepare well, even before they identify a buyer: A thorough preparation process is crucial for a successful divestiture…

Such a process arms a seller with critical information needed to present the business most effectively, address deal issues early on, answer challenging questions so as to boost value, for example; a few basic principles:

  • Plan for all aspects of the divestiture process: Outline the transaction objectives, key value drivers, boundaries, risks…
  • Present tailored financial information for the transaction: Develop detail financial information for the target business, such that the information is– true, verifiable, compelling, appropriate, and builds buyer confidence in the process…
  • Prepare, prepare, prepare: Identify critical issues, upside opportunities, develop detail operational information that justifies the asking price, prepare sell-side due diligence before marketing the deal…
  • Position for the exit and execution: Actively manage all aspects of the divestiture; develop a post-divestiture separation plan for internal support functions, identify key people who are affected by the divestiture, develop a time line, responsibilities, and the key ‘to do’ list for final execution…

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In the article Divestitures Are Harder Than You Think by Gerald Adolph and J. Neely write: In a highly competitive business environment, it’s clear that many companies are taking the opportunity to divest non-core businesses… It’s an active market and there are plenty of buyers, both financial and strategic that are sitting on hordes of cash and looking for attractive deals… However, before moving to ‘cash-in’ on a business divestiture, it’s worth taking a hard look at the process…

Whether an outright sale or a spin-off… splitting-off pieces of a business is much harder than it appears; it can have an impact, not only on the divested entity, but the entire seller organization… Breaking-up a piece of a business may be harder than you think, especially if the target piece is well-integrated in the overall organization…

For example; consider how well the business information systems are integrated and how they can be separated, how are support services shared, how is R&D shared, how are administration and financial issued shared… there are many challenges working against the divestiture process. That is not to say divestitures should be abandoned, the point is this: It’s critical to fully understand the major impediments to unraveling a business unit before making the decision to sell… The trick is to be aware of challenges in advance… There are many assessments to be made, e.g.; How much of the business to sell? Which is better; divestiture or spin-off? By truly understanding all relevant issues the seller is in a better position to get the very best deal, and find a good home for the divested piece…

In a study McKinsey & Company found– companies that actively manage their business portfolios through acquisitions and divestitures create substantially more shareholder value than those that passively hold their businesses, and they also found that there are significant differences in management performance, e.g.; management that balance the strategy of ‘acquisitions and divestitures’, performed much better than those who focused more narrowly on either, ‘acquisitions or divestitures’…

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Unfortunately, most corporations divest either, too little or too late, and most divestitures are rarely purposeful, and in many cases they are viewed as a sign of desperation… In fact, many divestitures are perceived as a sign of a company’s weakness and management  failure; whereas, acquisitions are usually viewed as a mark of a strong company with growth-focused management… Reality shows that either of these assumptions are necessarily true; divestiture is not a symbol of failure and, if executed properly, it can be a badge of smart, strategic-oriented management… whereas, an acquisition may be a fool-hardy attempt to save the company…

According to Lee Dranikoff, Tim Koller, Antoon Schneider; divestitures can be used to strengthen and rejuvenate a company but only if management looks beyond the stigma that is often associated with selling off businesses and embrace divestiture as vital to their strategies… According to Allan Cunningham; having a solid understanding of the value of a company’s assets and evaluating which assets have greater value, both for within the company fold, and those that are best elsewhere– is critical…

Management must maintain a balanced, realistic assessment of its strategic outlook, and not be influenced by aggressive investor activism, which shows no sign of abating…Ultimately though disposing of an appropriate company assets is about ‘value-creation’, and often companies must– shrink to grow…