Businesses and companies hope to succeed in their business. But what if the new business units don’t deliver the expected results, there should be a contingency plan of getting rid of that unit. That’s what divestiture strategy is all about. Today, we’ll discuss divestiture, its types, and reasons with examples;
What is Divestiture?
Divestiture is a process of shutting down your business units or departments through closure, exchange, bankruptcy, or sale. It usually happens when the management decides to stop the operations of a certain department or unit because it doesn’t serve the company’s core ideology.
A divestiture also results when a certain unit or department is not useful to the company after the merger or acquisition, or the court orders to sell them in order to improve the company’s market position, or it could increase the sale value of the business.
In other words, we can say that divestiture means selling a company’s assets so that you could manage its portfolio. When companies and businesses expand their operations, then they come up with several lines and categories that they have to shut down in order to focus on their core profitable business. Many conglomerates usually come up with such issues.
Companies and businesses also sell off some of their business lines when they’re under financial distress or pressure. For instance, an automobile company experiences a drop in sales, the management decides to sell its finance or other departments to generate funds for the growth of the new line.
The divested units and departments become separate and independent companies rather than remaining bankrupt. Sometimes the merger or acquisition requires the sale of some of the company’s assets. The government also divests her interests and asset to promote the private sector.
The divestiture allows companies to cut down their cost and expenses, repay their debt, smoothen business operations, and provides them sufficient funds to reinvest into other ventures. It improves the share value of the company’s stock.
How Does Business Divestiture Work?
Your company launched a product/service that hasn’t generated sufficient profit that you were expecting it. You invested some capital in the marketing and promotional campaigns to target and attract more customers, instead of finishing it. You realized that investing more capital was a bad idea and it isn’t working anymore.
It’s important to mention here the concept of sunk cost. People usually think it’s logical to invest more resources on a project that isn’t working, and they’re right to some extent.
But the concept of divestiture is completely different. It means you get rid of the product line or category completely. It means you aren’t going to waste money on the product that isn’t selling and getting rid of the inventory that isn’t moving.
While divesting a product line or unit, it may feel like a loss, but when you gather around resources after selling it. You’ll get free time and resources to think about the needs and wishes of the customer what they want. It would improve the share and remaining bottom line product.
Business divestiture isn’t a random decision and the management should consider it out of desperation. Rather it’s a part of business financial planning.
Therefore, you should have a chat with the professional of your financial department. They would help you to see what things are working and what aren’t. For instance, the underperforming units, you should cut it down.
Reasons to Consider for a Divestiture
Businesses and companies follow the divestiture strategies for the following reasons and they’re as follows;
Antitrust legal issues compel businesses to divestiture. For instance, the US Justice Department found Bell System guilty of monopoly in 1982. The government ordered the company to divestiture the conglomerate, many small companies came into existence including AT&T.
When certain departments and units of the company aren’t performing well, then the management follows the divestiture strategy and eliminates those departments.
For instance, some of Target’s stores hadn’t been generating profits and fulfilling the customers’ needs in Canada. The company decided to shut down all of its stores in Canada in 2015.
Sometimes companies follow the divestiture strategy in order to split into two or more companies based on the values. It usually happens at the liquidation stage.
For instance, the investors prefer a different part of the company and they’re willing to pay more for the equipment, parts, patents, and real estate, instead of buying from one company.
Strengthening Balance Sheet
When the management decides to strengthen the company’s balance sheet and it requires them to pay off the debts.
For instance, General Electric started the divestiture process of the BigPharma unit in 2020, and GE got 20 billion dollars. The Chairman and CEO of the company, H. Lawrence Culp Jr. said in a press release that the company planned to strengthen its balance sheet and stabilize its financial position with that capital.
Earning & Profitability
Often companies follow the divestiture strategy to earn profit and they use the same profit to stabilize their bottom line unit.
For instance, Philips divested its semiconductor division NXP in 2006, because it wasn’t generating sufficient profit and hurting the brand’s stock value.
Defocused to the Core
Some divisions are out of the focus of the company’s core identity and values, and the management decides to divest those divisions in order to focus on the primary line.
For instance, WeWork Corporation decided to divest its software and content marketing business, because it was diverting the company from its primary renting and sharing workspace business.
Companies and businesses also follow the divestiture strategy to raise capital, especially when they’re facing financial difficulties.
For instance, Sear Holdings’ sales were decreasing and having cash flow issues. The company finally decided to sell its real estate holding division in 2014, so that the brand could focus on its consumer retail business.
Companies find themselves on the verge of bankruptcy when they’re facing the financial and operational problem, and following the divestiture strategy is a part of business planning.
Types of Divestiture
Some of the main types of divestiture are as follows;
Spin-offs in the process of separating a part of the company and making it the company’s subsidiary unit by selling its shares to the investors. It creates value for the shareholder, but it doesn’t generate cash. Spin-offs is the exit plan of larger organizations.
Splits offs is like a spin-off because it results in the creation of another entity which isn’t under influence and control of the parent company. But the difference is that the shareholders have a choice whether to buy the shares or not.
Equity carve-outs is when a parent company sells one of its parts that aren’t following its core operations. The company sells its shares through an initial public offering (IPO), and it creates new shareholders. The parent company has some level of influence in the subsidiary company in the carve-out. It’s the most complicated type of divestiture.
A trade sale is when a company sells its subsidiary company to another company. it’s the simplest and easiest type of divestiture.
Consideration Before You Divesting
Here are some of the following points you should consider before implementing the divestiture strategy;
You should consider and answer this question whether divestiture is temporary or permanent. If you’re trying to solve a temporary solution by divesture, then a particular unit or division would go away permanently. It’s not the best way to solve temporary problems with long-term impacts. Therefore, you should have one eye on the future before applying divestiture.
You should perform the profitability ratio analysis of the particular division or the product line that you’re planning to divest. The gross profit margin and sale volume comparison of the business/product divisions is very good profitability measuring tool. If the profit margin is higher, then it would be better for the company.
A product goes through various stages during its product lifecycle. It starts from the introductory, growing phase, and maturity to the declining stage. However, the best time to finish a product/division when it has reached its maturity or the declining stage.
You should perform a break-even analysis of the location, asset, or product that you’re planning to divest. However, the break-even analysis means that your initial investment and profitability are equal. If your product or division is closer to the break-even analysis point, then you should wait a bit longer.
You should carefully study the assets in your balance sheet. If your assets are easily liquefiable or the current asset, then you could easily sell them.
As we know that divestiture could take many forms, the most obvious form is to sell your company’s divisions in order to improve the financial position. A Canadian media and information multination company, Thomson Reuters divested its science and intellectual property divisions in 2016. The goal was to decrease the leverage in the balance sheet.
Onex and Baring Private Equity bought the division for 3.55 billion dollars. However, the division booked sale value in 2015 was 1.01 billion dollars. Approximately 80% of the divisions’ sale was recurring, and it made the division very attractive to the private equity firms. The divesture of the division was only one-quarter of Thomson Reuters’ entire business, and it never represented the company’s whole valuation.