What Are the Reasons Divestures Occur?
In the financial industry, a divestment or divestiture is the transfer of ownership of an asset through a sale, exchange, or liquidation. Non-core assets are commonly sold off as part of the merger, acquisition, or consolidation process. Combining two businesses, for example, may result in service duplication.
Through divestment, the firm can boost production while decreasing costs. However, there are a number of reasons why firms sell assets, and not all of them are beneficial to the corporation.
Asset sales are a regular part of the bankruptcy process that many businesses must go through due to operational and financial challenges. As a consequence of the sale, the company may be able to cut costs, increase cash flow, and avoid bankruptcy.
In 2009, for example, GM filed bankruptcy and closed eleven unproductive assembly sites. The corporation sold off unprofitable brands such as Saturn and Hummer as part of its reorganization.
The need for quick cash is a common reason for selling anything. This is critical for organizations who are experiencing operational and financial difficulties. Sears Holdings, for example, saw its revenue and earnings plummet and incur losses.
In 2014, the business announced the sale of its real estate holdings as part of its survival plan. The money would go toward the company’s ongoing retail business reorganization.
Despite the fact that it has liquidated hundreds of stores and used the proceeds from its divestments to pay down some of its debt, Sears, which also owns Kmart, has struggled since emerging from bankruptcy in 2019.
Many businesses sell off subsidiary activities known as divestments in order to focus on what they do best. Union Carbide, a significant manufacturer of industrial chemicals and plastics, sold its consumer goods sector in 1989 in order to focus on its core skills.
WeWork Corporation, which rents out shared office space, faces financial troubles in 2020. As a result, the company’s executives have opted to divest part of its software and content marketing divisions.
Divestment often improves a company’s financial stability. Earnings are synonymous with net income or profit. In 2006, Philips, a major Dutch technology business, divested its NXP Semiconductors semiconductor branch.
The sale of NXP was motivated primarily by the negative impact on Philips’ stock price that the chip business’s high volatility and unpredictability were having on profitability.
Strengthen the Balance Sheet
When a firm’s senior executives state that they wish to take actions to strengthen the balance sheet, they typically mean that they aim to lower the amount of debt that the company carries.
General Electric Company (GE) is one example. In 2020, it announced the completion of the divesture of its BioPharma unit, for which it received about $20 billion in cash. GE chair and CEO H. Lawrence Culp Jr. stated in a news statement that the purchase helped “de-risk our balance sheet and continue to protect our financial position.”
When a business’s value can be unlocked more efficiently as two or more firms rather than as one, the parent company will usually split into those new companies. This is especially important throughout the liquidation process.
It is common known that when a company’s real estate, equipment, trademarks, patents, and other intangible assets are sold separately from the rest of the firm, investors are willing to pay a premium for them.
It is typical practice for firms to sell off underperforming segments. These sales may be directed towards subsidiaries or divisions that aren’t fulfilling expectations.
Target, a large American retailer, is an excellent example of a business that effectively sold itself of a non-core asset. Target stores in Canada failed to flourish due to low local demand. Target announced in 2015 that it would end operations in Canada and begin shutting or selling its stores.
Companies may be required to sell assets for legal reasons, such as antitrust concerns. Bell Systems was a famous example of a corporation that was compelled to divest owing to governmental restrictions in 1982.
To contest Bell’s monopoly in the telecommunications industry, the US government compelled its breakup, resulting in the development of various other corporations, including AT&T.
How is a Divesture Carried Out?
Businesses frequently divest in order to better manage their assets. There are several approaches that may be taken to properly carry out the disposition.
1. Partial sell-offs
Businesses frequently sell off non-core sections in order to acquire funds and reinvest it in their core activities.
2. Spin-off demerger
The procedure of forming a new corporate organization from an existing division or unit.
3. Split-up demerger
The original corporation no longer exists once a company has been divided into multiple units.
4. Equity carve-out
Corporations utilize an initial public offering (IPO) to sell a stake in a wholly-owned subsidiary while maintaining total control over the company.
Divesture Process – Seller Benefits
A successful divestiture enables the parent company to handle a common difficulty for market leaders: lowering costs and refocusing on the company’s core business.
If the merger or purchase is poorly executed, the value of the combined business is less than the value of the independent firms; hence, the two entities would be better off continuing to operate independently.
“Negative synergies” arise when shareholder value reduces following a transaction as a result of the acquisition of enterprises without a long-term plan for integration.
As a result of the sale, the selling parent company may be left with:
- Increased Profit Margin
- Streamlining That’s Both Functional and Efficient
- Sales Revenue Boosted Cash Flow
- Focus has been adjusted to better suit core functions.
As a result, divestments are a method of cutting costs and restructuring operations; also, the divested business unit may be able to release “hidden” wealth creation that was inhibited owing to bad management on the side of the parent organization.
How to Decide If a Divesture Is Worth It
When deciding whether or not to sell an asset, a company’s long-term objectives should be addressed.
Even if a company is low on cash right now, it should keep a profitable subsidiary with tremendous development potential. If the estimated return on investment is minimal, it may be profitable to sell the subsidiary or asset.
Another factor that organizations examine is the product’s estimated lifetime. If an asset is still in the introduction or growth phase, this is an excellent sign of whether it is worth keeping on to. If it has attained maturity or is decreasing, it may be time to sell.
The most liquid portion of a company’s balance sheet is its current assets. Businesses should use profitability data, gross profit margin analysis, and break-even analysis when deciding whether to sell.
When a company sells its present assets, this is referred to as a divesture. A divestiture might be triggered by the underperformance of an asset, the bankruptcy of a corporation, or the need to close a store.
Divestments include spin-offs, demergers, partial sales, and equity carve-outs. Before beginning a divesture, elements such as life cycle, long-term goals, asset kind, and profitability are considered.
Divesture vs Carve-Out
A carve-out is often referred to as a “partial IPO” since the parent company sells a portion of its equity stake in the subsidiary to public investors.
The parent’s ownership of a significant (typically more than 50%) interest in the new entity distinguishes carve-outs.
Following the completion of the carve-out, the subsidiary became its own autonomous legal entity with its own set of leaders and board of directors.
The initial carve-out plan may specify that the cash proceeds from the sale to third-party investors be shared equally between the parent and the subsidiary, or equally between both.
Relation to Mergers And Acquisitions (M&A)
It is usual practice to list divestment transactions with M&A activity. Most people identify M&A with the buyer (acquiring a firm), but sellers (companies unwilling to maintain underperforming or non-essential assets) are actively looking to optimize their operations through M&A as well.
The constant process of reviewing and upgrading the firm’s asset portfolio is an essential component of every successful business plan.
Corporate Development And Investment Banking
The most actively involved financial experts in the actual sale of assets and business units are investment bankers and corporate development executives.
Investment banking and corporate development professionals utilize financial modeling and other approaches to evaluate the value of a disposed asset.
The process of selling or otherwise transferring ownership of an asset is referred to as “divestiture.” Divestment is often spelt “divestiture” or “divestment.” Asset disposal can be accomplished for a variety of reasons and in a variety of ways.
To keep things simple, suppose a car manufacturer believes it would be better off without its experimental aviation division. The logic for this decision is that the experimental aviation division is more valuable on its own, and the vehicle production industry would profit from concentrating on its core skill.
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