This week we cover the flipside of acquisitions – divestitures which is perhaps counterintuitively a very attractive way to create value. This post is also partly a book review of the excellent new book Divestitures by Emilie R. Feldman, Professor of Management at the Wharton School of the University of Pennsylvania. The book is packed with case studies and practical issues to consider. A truly excellent guidebook on the subject.
The questions all management teams should be asking themselves (and the ones the book addresses): does diversification create or destroy value? Does owning specific divisions continue to make sense? Could your portfolio do with a refresh? If management’s job is the efficient allocation of capital, does it still make sense to allocate capital to divisions that are not adding value? Could these underperforming businesses scale better under a different parent?
As always with our blogs, we like to turn a problem into a set of practical actions to add value! We will follow the path taken by Emillie’s book and add some thoughtful insights from recent experiences.
We start with a discussion on the factors influencing your divestiture strategy, then assuming divestiture makes sense, we review the options and then finish with some implementation guidelines. This can only be an executive summary given the complexity of the topic (Emilie’s book is 215 pages).
We recommend as part of your annual strategic review process (not the annual budget cycle) that divestitures should be on the agenda. It’s healthy to consider if all of your businesses whether homegrown or brought in by acquisition are still relevant to your cause. Can you really be remarkable at all of these businesses? Can you invest the time and energy required to scale them all and maintain a leading position in the marketplace?
Checklist of questions to help shape your strategy:
- Do you own prior acquisitions that are not meeting the deal objectives?
- Are you in sectors that have become commoditized?
- Do you lack the size to compete on a global scale?
- Strategically as you consider your current positioning and look across your landscape of activities, ask yourself does everything fit? Your focus changes over time, technology undermines your position in the market, analysts don’t understand your story, employees wonder why you acquired x. These are all pointers that a subsidiary may have become non-core.
- If you are a serial acquirer (even a few deals per year) it may be inevitable that part of your acquisition was non-core from the start. Is it time to tidy up that non-core activity as part of the post-acquisition integration strategy?
- Of course, with the current US administration’s aggressive stance on antitrust behavior, you may be forced to consider divestiture. Should you be working on a divestiture strategy for parts of acquisition targets that are already in play?
- Has legislation or regulations on sustainability, trade compliance, or quality standards transformed the competitiveness of certain divisions?
A common theme the book addresses is resistance to change. All of the questions above may point to the need for a divestiture strategy. However, don’t underestimate the resistance to selling off problem children. Emilie showcases many failed acquisitions (our favorite topic) that required a divestiture strategy, however in reality it took about 10 years before action was taken post-acquisition. Why so long? As the book points out, reasons include: perceived to be uneconomical to divest, behavioral biases by executives, and historical connections to the past.
There are a surprising number of options worth considering beyond selling a non-core subsidiary using a covert controlled auction process. Options include Sales, spinoff, equity carveout, Reverse Morris Trust, joint venture, and tracking stock. Each option has upsides and downsides as highlighted in the book.
Checklist of questions to help decide the best divestiture option:
- Do you need to generate cash to reinvest in your core businesses?
- Would a sale trigger an unacceptable tax charge?
- Would potential acquirers create conflicts with the remaining businesses within the group?
- Do you want to share in the upside if the subsidiary being divested, successfully launches a breakthrough product?
- Could you merge the non-core business with a competitor and take a minority stake?
- Could you share future capex needed with another industry player?
There are significant practical considerations that will influence the best option for you. For example, it is possible to execute a tax-free transaction if the divesting company sells less than 20% of the non-core subsidiary’s shares and then later executes a tax-free spinoff of its remaining shares at a later date (Eli Lilly’s divestiture of Elanco).
Finally, the book examines implementation challenges in executing a divestiture. Having just completed a divestiture of a non-core business from a public company last year, I’ll add some practical guidance from that case study.
Questions to help your implementation strategy:
- Which resources will follow the divested business down to each employee?
- Which resources will be shared with the divested business and at what cost?
- What arrangements are being made to allow the divested business to relocate?
- What’s your policy on employees who refuse to transfer?
- How are IT systems being handled? Does the new owner use the same ERP system as the divested business?
- Assuming the divested business is located in a shared facility how are you handling the following post-closing:
- Crisis Management
- Office furniture
- Internet & email
- Communications strategy
- What’s the story to divested employees?
- What’s the story to retained employees?
- How will you handle the negative press surrounding the divestiture?
- How will you set up the divested company for success?
- How will you handle stranded costs in the divested company? Are you resizing the divesting group because of the divestment?
- Does the post-divestment period present challenges for you because of access to markets, locations, and relationships?
- Specifically, when constructing Transition Service Agreements (TSA) the objective is to allow the divested company to operate as normal from Day 1. There will always be a gap post-completion before the new owners have set up all the required services. Therefore, consider the following TSA pointers:
- Design a fair and open recharge system for all services and agree the cost, the resources, and the timeframe.
- Which services are needed by the divested company (especially if sharing a facility with the divesting group for a reasonable period) including:
- Finance, AR, AP, payroll
- Logistics and fulfillment
- Software packages
- IT help desk
- Phone systems
- Reception desk
- Ensure there is a change order system to allow for the expansion or contraction of TSA services. Build an escalation protocol if services are not being delivered as planned
- If sub-leases are involved please give yourself plenty of time to put in place a new sub-lease with the divested company including obtaining landlord consents.
- Finally, appoint a TSA leader to conduct bi-weekly a steering group review which will contain representatives from both sides. This keeps everyone on point and allows for problem resolution quickly.
Divestitures are an essential tool to execute your strategy. They require forceful leadership, careful planning and meticulous implementation to achieve success.
TPP assists clients design, plan, and execute their Divestiture strategy.