What is a Divestiture?
A divestiture (or divestment) is the disposal of company’s assets or a business unit through a sale, exchange, closure, or bankruptcy Bankruptcy Bankruptcy is the legal status of a human or a non-human entity (a firm or a government agency) that is unable to repay its outstanding debts to creditors. . A partial or full disposal can happen, depending on the reason why management opted to sell or liquidate its business’ resources. Examples of divestitures include selling intellectual property rights, corporate acquisitions and mergers, and court-ordered divestments.
What are the reasons behind a divestiture?
There are many reasons why a corporation may decide they need to sell an asset, a business unit, or the entire company. Some of the most common reasons include:
1. To sell off redundant business units
Most companies decide to sell off a part of their core operations, if they are not performing, in order to place more focus on the units that are performing well and are profitable.
2. To generate funds
Selling a business unit for cash is a source of income without a binding financial obligation.
3. To increase resale value
The sum of a company’s individual asset liquidation value exceeds that of the market value of its combined assets, meaning there is more gain realized in liquidation than there is in retaining existing assets.
4. To ensure business survival or stability
Sometimes, companies face financial difficulties; therefore, instead of closing down or declaring bankruptcy, selling a business unit will provide a solution.
5. To comply with regulators
A court order requires the sale of a business to improve market competition.
How is a divestiture carried out?
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-offs
Selling a business subsidiary to another company to raise capital and apply the funds to more productive core units instead.
2. Spin-off demerger
A business strategy wherein a company’s division or unit is separated and made into an independent company.
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-out
A corporate approach wherein the company sells a portion of its wholly-owned subsidiary through initial public offerings or IPOs and still retains full management and control.
Relation to mergers and acquisitions (M&A)
Divestiture transactions are often lumped in with the mergers and acquisitions process Mergers Acquisitions M&A Process This guide takes you through all the steps in the M&A process. Learn how mergers and acquisitions and deals are completed. In this guide, we'll outline the acquisition process from start to finish, the various types of acquirers (strategic vs. financial buys), the importance of synergies, and transaction costs . Most people think of the buy-side of these transactions (buying businesses) but corporations also actively look to sell non-performing or non-core assets to optimize their business.
Constantly reviewing a company’s portfolio of assets and optimizing it for the best performance is an important part of corporate strategy.
Example: GE divests GE Capital
In 2015, parent company GE decided it would divest its GE Capital business as part of a restructuring plan. According to an article by Fortune, investors liked this transaction for three main reasons:
- Investors don’t like conglomerates (i.e., there is a “diversified discount” applied to their valuation)
- Earning a return on capital above your cost of capital creates value (a reason to sell GE Capital)
- Share buybacks may be a better use of capital (if the price is right)
To learn more, read Fortune’s article on the sale of the business and subsequent restructuring of the remaining operations.
Corporate development and investment banking
The finance professionals most actively involved in carrying out the sale of assets and business units are investment bankers What do Investment Bankers do? What do Investment Bankers do? Investment bankers can work 100 hours a week performing research, financial modeling & building presentations. Although it features some of the most coveted and financially rewarding positions in the banking industry, investment banking is also one of the most challenging and difficult career paths, Guide to IB and corporate development Corporate Development Corporate development is the group at a corporation responsible for strategic decisions to grow and restructure its business, establish strategic partnerships, engage in mergers & acquisitions (M&A), and/or achieve organizational excellence. Corp Dev also pursues opportunities that leverage the value of the company’s business platform. professionals.
When analyzing a divestment, analysts in investment banking or corp dev will perform a valuation of the asset using financial modeling and other techniques.
To learn more about valuation as it related to M&A, check Finance’s online financial modeling courses.
To keep learning and advancing your career as a financial analyst, Finance has created a vast library of resources to help you on your way. Additional resources include:
- Free intro to corporate finance course
- Free Excel crash course
- Financial modeling guide Free Financial Modeling Guide This financial modeling guide covers Excel tips and best practices on assumptions, drivers, forecasting, linking the three statements, DCF analysis, more
- The Analyst Trifecta The Analyst Trifecta® Guide The ultimate guide on how to be a world-class financial analyst. Do you want to be a world-class financial analyst? Are you looking to follow industry-leading best practices and stand out from the crowd? Our process, called The Analyst Trifecta® consists of analytics, presentation & soft skills