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Corporate Divestiture- Focus on Core Business Lines, Increased Efficiency and Additional Growth Capital

Corporate Divestiture assumes significance during this Covid 19 period as it will help companies to improve efficiency by focusing on what it does best and  also will help to raise growth capital or restructure existing debts to meet cash flow problems.

A divestiture (or divestment) is the disposal of company’s assets or a business unit through a sale, exchange, closure, or bankruptcy. A partial or full disposal can happen, depending on the reason why management opted to sell or liquidate its business’ resources. A divestiture most commonly results from a management decision to cease operating a business unit because it is not part of a core competency.

As companies grow, they may decide that they focus on too many business lines, so divestiture is the way to remain profitable. Divestiture allows companies to cut back on costs, repay their debts, focus on their core businesses, and enhance shareholder value.

Example

Thomson Reuters, a Canada based multinational mass media and information company, sold its intellectual property and sciences (IP&S) division in July 2016. The company initiated the divestiture because it wanted to reduce the amount of leverage on its balance sheet.

The division was purchased by Onex and Baring Private Equity for $3.55 billion in cash. The IP&S division booked sales of $1.01 billion in 2015, and 80% of those sales are recurring, making it an attractive investment for the private equity firm. The divestiture represented one-quarter of Thomas Reuters’ business in terms of divisions but is not expected to alter the company’s overall valuation.

Key Objectives

  1. To sell off a business, division or assets that are not part of its core operations so that it can focus on what it does best. Examples include Eastman Kodak, Ford Motor Company, Future Group and many other firms have sold various businesses that were not closely related to their core businesses.
  2. To generate funds for growth/ expansion or to pay-off existing debts of the firm because it is selling one of its business in exchange for cash.
  3. To enhance stability or survival by divesting a part of a company. Instead of closing down or declaring bankruptcy, selling a business unit will provide a solution.
  4. To eliminate a division which are under-performing or even failing.
  5. Sometimes the sum of a firm’s individual asset liquidation values exceeds the market value of the firm’s combined assets. Under such circumstances, divestment is done to get the advantage of higher liquidation value.
  6. To create competition, regulatory authorities may demand divestiture.

Advantages of Divestiture

  • Divestiture helps lower operating debts
  • It helps increase organizational efficiency
  • Some firms can obtain funds, allowing them to pay off other debt and obligations and use their capital in other areas.
  • Reduce employment risk
  • Enhance shareholder value

One potential disadvantage of divestitures is the negative impact on a company’s cost structure. If a company has spread its fixed costs – including rent, maintenance, personnel allocation and administrative support – over two or more business units, the remaining business units must now absorb those costs.

In addition, companies may encounter difficulty re-allocating personnel, as some employees may perform work for more than one business unit.

Types of Divestiture

Companies divest in order to efficiently manage their asset portfolio. There are multiple options to go about the process and effectively execute the disposition.

1. Partial Sell-off

A sell-off, which is by far the most common type of divestiture (and the type usually referred to as such), is the sale of one or more company units to another company to raise capital and apply the funds to more productive core units instead.

2. Spin-off

A spin-off is a series of transactions through which a company divests or “spins off” one or more units – typically a small portion of its business with some common theme – by turning them into an independent company and selling the company’s shares to the investing public.  Examples include Sara Lee Corp.’s spin-off of its apparel business (as Sara Lee Branded Apparel Americas / Asia) in 2005.

3. Split-up demerger

When a company splits-up into one or more independent companies, and consequently, the parent company is dissolved or ceases to exist.

4. Equity Carve-outs

Equity carve-outs are referred to a percentage of shares of the subsidiary company being issued to the public through initial public offerings or IPOs and still retains full management and control.

Dileep K Nair

dileep.nair@unifinn.com 

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