Divestitures

The market views divestment positively as an event, even though management usually avoids such decisions.

However, divestment does not always create value and can sometimes result in negative outcomes. According to McKinsey’s research, the speed of the process is particularly important. For example, in cases where the process was completed within six months, the excess profit averaged 6%, while in cases where the process took 13-24 months, the loss averaged -11%.

Preparation in advance and a systematic approach are of particular importance. For example, research on 200 large companies shows that those that actively manage their portfolio of business units strategically and engage in frequent transactions achieve better results than companies that rarely and reluctantly divest unprofitable business units.

Research on 690 large companies from 2000-2013 reveals that 60% of companies did not have a single year in which the value of divested business units exceeded 5% of their total capitalization, while 20% of companies had only one such year over 14 years. Additionally, a study of 200 companies showed that in 75% of divestment cases, the initiative arose due to pressure on management.

Why, then, does management resist divestment if the positive outcomes are often evident?

Below is an example table. It discusses a scenario where a company divests a business unit with a high ROIC but low growth potential, with a premium of 100 million. There are three versions: 1. Cash remains on the balance sheet; 2. Debt is repaid; and 3. Shares are repurchased.

In all three cases, despite the decrease in EPS and sales, the P/E ratio increases, creating value for shareholders.

What increases this value? The general formula is:

Value Created = Price Received – Stand Alone Value of Divested Business – Lost Synergies – Disentanglement Cost – Stranded Costs

In many cases, value is created by reducing the burden. When the synergetic effect is negative, the business consumes significant management time and moral resources, and unnecessary costs arise simply because the business unit is under the company’s umbrella. Thus, we return to the idea of the “best owner” – at different stages of development, the best owner of a business unit is a different entity, so it is better for it to change hands…

Source:

Valuation, Measuring and Managing the Value of Companies – by McK.&Co, T. Koller, M. Goedhart, D. Wessels