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Divestitures : A Strategic Perspective

Divestitures, Carve-Outs, Spin-Offs, Asset Sales, M&A

22Jun

All views expressed are my own and have do not reflect views of FTI Consulting in any way.

Divestitures are generally not as well understood as acquisitions. Stakeholders use a variety of terminologies, have different expectations from value and the time to value etc. Many people consider divestitures a symmetrical mirror image of acquisition which is not the case when we look at practical considerations around both transaction strategy and execution.

There are multiple factors to consider while creating a divestiture strategy as investors will often scrutinize the position of the parent company, more specifically areas such as :

  • Capital structure
  • Financial strength
  • Profitability
  • Execution capability
  • Operational impact
  • Overall strategic direction of the company
  • Attributes of divested entity

In addition to the above, it is important to understand the different types of divestitures, their implications on value creation, the timing behind these and how capital markets would view them.

Direct Business Sales : Typically Quick, Easier to Execute and Lower Risk Profile

This is the most common type of a divestiture which entails the straightforward sale of a business unit to another Corporate or PE buyer. They typically generate cash which can be used to enhance the rest of the business, deleverage, return to shareholders or buy companies closer to the core. They are less complex to execute, have lower business and execution risk and can be executed quickly. Capital Markets scrutinize the driver behind the sale and reward the parent in situations where debt is paid off. A good exit mechanism in times of high market volatility making the case uncertain for IPO exists and even in times of higher valuations in general.

Spin-offs : IPO transaction, Distribute Transaction Value to Shareholders, Longer Time to Execute with Higher Risk Profile

The key driver is to increase focus on the portfolio by exiting a non-core business, these types of transactions do not produce cash but are tax advantaged and have high completion security. They can create significant shareholder value for new stakeholders if executed in the right manner. Capital markets reward spin-offs because they indicate the focus of resources and management attention, they would view a spin-off as a red flag if a highly leveraged business embarked on a spin-off with no cash returns. Spin-offs take longer to execute, have to be timed in order to minimize market risk and are generally much larger in terms of revenues (5-6X) than direct business sales.

Carve-outs: Possible Hybrid Position, More Complex, Longer Time to Execute with Medium to High-Risk Profile

These can come in a pure operational separation to a financial buyer or in a hybrid model creating some complexities. Typically used as a transaction vehicle to sell an undervalued asset or a non-core business, could involve IPO of some % of the business with parent retaining the rest. Given the possible hybrid nature of the transaction, they could generate some cash but also allowing the parent company to have vested interests in future performance, capital markets generally like the parent being involved. If hybrid, they can be complex, can take a longer time due to operational disentanglement and need for a certain capital market window.

Investors generally reward all forms of divestitures, but spin-offs have been rewarded the most even though they do not generate cash proceeds and take longer to execute. There are several reasons behind this, such as :

  1. No financing requirements, capital constraints and reduce conglomerate discount with shareholders having control on the future of the asset
  2. Tax advantages - no tax until securities are sold
  3. Larger size creates higher impact on value
  4. Freedom from parent conflicts, ability to independently create value organically or through M&A

Spin-offs are usually never the automatic choice and divestiture strategy depends on a number of factors. The decision to divest and the path to value i.e., carve-out vs spin-off vs business sale is only part of the value creation equation impacting millions (or billions) of dollars when timed correctly. Other factors playing important roles in value creation are parents financial and operational posture, the driver behind the sale, type of buyer (PE vs Corporate), market conditions, attributes of the divested entity and ability to operationally separate the asset quickly.

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