The year 2014, which is already drawing to an end, was marked by M&A. Headlines were filled with news not only about big mergers—think of General Electric and Alstom or O2 and E-Plus—, but also about divestments. Philips separated from its traditional Lighting & Consumer Electronics division, Ebay said goodbye to Paypal, and HP recently announced to split up into two businesses, one for PCs and printers and the other for corporate hardware and services. Investors reacted positively to these decisions pushing up the stock prices of the companies. Strategic divestment management, according to the findings of two recent studies conducted by the consulting firms Boston Consulting Group (BCG) and EY, is gaining in popularity both with CEOs and investors.
Strategic Divestment Management as “Value-creating Weapon”
While in the past divestments were commonly viewed as a “short-term tactical tool to raise cash or pay down debt” (EY), today more and more businesses consider strategic divestment management a “value-creating” tool (BCG). That’s one of the key takeaways of the two studies. Active divestment management is increasingly seen as a growth opportunity. In most cases, both the seller and buyer profit from the transaction. “The truly strategic question any company or CEO needs to ask is whether one company’s assets could have a higher value for another company […]. For all kinds of companies, the answer increasingly is yes.” (BCG, p.13)
The BCG study investigated 6.642 divesting companies since 1990 and found out that selling assets or business units which no longer fit into the company’s strategy leads to improved operational performance. The EBITDA margin increases by more than one percentage point between the announcement of the divesture and the end of the fiscal year. In case of distressed companies, EBITDA margins go up by even 14 percentage points. In addition, the EBITDA multiple expands by an average of 0.4 times.
„Investors anticipate these increases by bidding up divestment companies’ share prices immediately following an announcement.” (BCG, p.17) The stock price of the average seller increases by 1.4 percent within 24 hours after the announcement. However, divestments don’t create value per se. While 55 percent of the divestures created value, 45 percent did the exact opposite. Whether divestments are rewarded by the stock markets depends very much on the right strategy and its execution.
Based on interviews with 720 executives from various industries and regions around the world, the EY study identifies three leading practices for portfolio and divestment management:
- Knowing the core business
Companies should have a good understanding of what their core competencies are, what differentiates them from competitors, and how they want to position themselves in the future. As market conditions change, companies need to review the definition of their core business regularly and use it as a basis for portfolio reviews, which should take place in regular intervals as well. That’s the only way to ensure that divestments are aligned with the strategic priorities of the company. "Eighty-five percent of companies that updated their definition of core operations in the last 12 months saw increased valuation multiples in the remaining business following their last divestment of a non-core business." (p.2)
- Making better-informed decisions
Companies need the right infrastructure to make effective portfolio decisions. Setting up a dedicated team has proven to help in this respect. In order to work successfully, the team should consist of both internal and external experts from various fields such as strategy, finance, sales, and operations. Moreover, it should have access to comprehensive and accurate industrial, financial, and organizational information. The objectives and agenda of portfolio reviews as well as the key performance indicators should be set by the executive board. Almost half of the respondents believed that setting up a dedicated team improves the portfolio review process.
- Taking action
Even when companies do realize the strategic need for selling certain assets or businesses, in most cases they still don’t act accordingly. The main reasons for this are the fear of loss of synergies/economies of scale with business units (45%), difficulties to separate operations (39%), and valuation gaps between buyers and sellers (31%). However, effective divestment planning can help overcome such challenges. In times of hyper competition, "doing nothing is no longer an option," the authors argue.
The authors of the BCG study also stress that focusing on the core activities of the company and, thereby, reducing complexity is an important success factor, and generally well-received by the markets. Another important factor to derive maximum value from divestures is the choice of the right exit strategy. Here, companies have three basic options: a trade sale to another company, a spin-off to the company’s shareholders, or a crave-out where parts of the company are sold, but the parent company remains the (partial) owner. The results of the study show that spin-offs are rewarded the highest by investors. Which exit strategy to choose, however, ultimately depends on the situation of the parent company, the attributes of the asset in question, and the market environment at the time.
Kengelbach, J., Ross, A., & Keienburg, G. (Sep. 2014). Don’t miss the exit: Creating shareholder value through divestures. Boston Consulting Group. https://www.bcgperspectives.com/content/articles/mergers_acquisitions_divestitures_creating_shareholder_value_divestitures/
EY (2014). Global corporate divestment study: Strategic divestments drive value. http://www.ey.com/GL/en/Services/Transactions/Global-corporate-divestment-study