When (and how) to let go
Creating value through divestment isn't automatic: the gains depend heavily on the right approach, says Greg Morris, CEO of MICROmega Holdings.
It can be hard to let go. So when the time comes to decide whether to sell certain assets, particularly those that have become 'non-core' to the business, many company executives hold on for too long.
Others are simply more focused on acquiring and, as a result, fail to prune non-core assets or to divest poorly performing businesses, says Greg Morris, CEO of MICROmega Holdings.
Enter divestment, the opposite of investment, and the process of selling an asset for financial, social or political goals. Assets that can be divested include subsidiaries, business units, property, equipment, etc.
But creating value through divestment isn't automatic; the gains depend heavily on the right approach. Here's some insight.
Why would a company divest?
A company would divest for various reasons, including the poor performance of an asset, changes in strategic direction such that an asset becomes non-core, or even the belief that it's a good time to cash in on behalf of shareholders. There's also the possibility that an aggressive buyer emerges; someone willing to pay over the top for an asset.
Now, a company that is both buying and selling companies is likely to be an adaptive company that moves with the times.
Companies that focus solely on acquisitions may land up chasing earnings growth for their shareholders, becoming reckless with capital allocation and even overpaying for future earnings. These companies can create a buying environment in which sellers push up their prices; hurting the return on capital invested. A company that isn't divesting may also be carrying lazy assets that would be better in different hands.
What are the divestment types?
Different types of divestment include the following four:
1. Direct sale of assets: When a holding company sells an entire subsidiary.
2. Spin-offs: When a parent company distributes shares of its subsidiary to its existing shareholders on a pro rata basis (almost like a special dividend). The subsidiary becomes a stand-alone company and existing shareholders benefit by holding shares of two separate companies, instead of one.
3. Split-offs: When shareholders in the parent company are offered shares in a subsidiary, but they have to choose between these and the shares of the parent company.
4. Equity carve-outs: When the parent company sells a certain percentage of equity in its subsidiary to the public through a stock market. The parent company normally retains the controlling stake in the subsidiary.
Is there a right time/way to divest?
If, as a seller, you are desperate to be rid of an asset and would therefore accept a poor price, it indicates incorrect timing. Like all investments timing is imperative, try to "buy low, sell high". Because if you wait for the downturn to sell, the balance of power no longer sits with you.
Rather than divesting in reaction to changes in business conditions, try to divest when it is best for the parent and subsidiary.
Let's say, alternatively, that you're trying to milk a business for what it is worth but can't fund the investment required to grow it in the long term. You're then faced with a balancing act between taking short-term operational profits and eroding long-term acquisitive value.
What's the answer? Continuously evaluate the value of your assets/verticals from both the sell-side and the buy-side perspective. You can even set up a dedicated team to do this, based on the strategy of the group as a whole.
Then, develop a compelling exit story to use internally and externally. This is crucial - because divestment by its very nature involves a large number of stakeholders who will be differently affected by the transaction.
In the face of the buyer, a compelling exit story significantly enhances your bargaining power. When it comes to employees, it's important to make them fully aware of your reasons for the disposal and how it will affect them. Certain targets may also need to be met to achieve a certain transaction value, so employee buy-in can be crucial to the success or failure of the greater deal.
Additionally, you have to convince shareholders that selling is in their best interests and you have to remember that, for publicly listed firms, a compelling exit story can directly affect the share price.
What's the bottom line?
The most successful companies are those that take a thoughtful, disciplined approach to divestitures; not only sharpening their strategic focus on their core but also creating more value for shareholders.
At least, that's what a Bain & Company study found in an analysis of 7 315 divestitures by 742 companies over a 20-year period (cited in Harvard Business Review, 2008): An investment of $100 dollars in the average company in 1987 would have been worth roughly $1 000 at the end of 2007, but a similar investment in a portfolio of the "best divestors" would have been worth more than $1 800.