What is Divestiture? – Saurabh Investments

by | Jun 23, 2021 | Investing, Investment Banking | 0 comments

Divestiture

Meaning

Divestiture (or divestment) is when a company sell its business assets that are not performing well or supporting the company’s overall mission.

It is a method of raising funds by eliminating waste to perform better in future. Example include selling corporate acquisition and mergers, or selling intellectual property.

Hence, it is an important means of creating value for company in the mergers and acquisitions process.

How does business divestiture work?

Suppose a company has a product which is not bringing enough profit to the business. Instead of marketing for it and finding right customers for it, company decides to finally eliminate the product from the market. Later the remaining assets and other raw materials for production is being sold to other business to recover the losses.

This helps manage a company’s investments by drawing back from those that didn’t pay off a good value.

It often follows after a merger or acquisition when the owners feel like an asset doesn’t meet the new company’s strategic goals. If the procedure is not carefully planned, they may often be forced to bankruptcies.

What are the Reasons for Divestiture?

There are many reasons why a company go for the process of divestiture, and not all of them have a positive impact on the company.

1) Bankruptcy

Companies often go bankrupt due to their financial problems, during this hard time, divestment strategy can help the company to reduce costs, improve cash flow, and convert a poor business into a healthier business.

For example, in 2009, General Motors filed for bankruptcy and closed at least 11 unwanted factories to meet the required finance. It divested brands like Saturn and Hummer, which were unprofitable for the business.

2) Raise Cash

Another good reason for divestiture is to raise cash. If a company has a plan to launch a new and improved model of a product in the market, it divestiture their old models to raise some cash for the production of new ones.

For example, in 2014, Realty Income, a U.S. based company practiced a divestiture process of its real estate business to raise funds to continue reorganizing their retail business.

3) Non-core Businesses

Companies sometimes divest businesses that are not part of their core daily operating activities. It sells all the resources that are not useful for the business so they can focus on their primary lines in business.

For example, in 2020, WeWork Corporation, which is best known for sharing rental spaces, faced financial difficulties. As a result, the management team announced divestment of its non-core businesses, such as software businesses and content marketing services.

Steps in Divestiture Process

1) Watching the Portfolio

For a company who decides for a divestiture process, management team performs a regular check on each business units and its relevance to the long term business strategy.

2) Identifying the Buyer

Once a business unit has been selected for divesting process, management team needs to find suitable buyer(s) for the valuable deal.

3) Analyzing the target’s business

Buyer’s business is analyzed inside out by the management team to know why and how the unit is useful for his business, this helps the seller to convert a deal into more profitable price.

4) Performing the Divestiture

In this step, legal papers are signed by both parties and payment is done by the buyer to complete the process.

5) Managing the Transaction

After divestiture process is completed, the company may look for strategy and costs as the two main key to move their business further. A company loses a business unit and in return gains a large cash inflow, now the management team will make decision on – where an how to use this money.

Types of Business Divestitures

1) Need of Cash

A business might sell some unprofitable assets to solve a cash flow problem. For example, a company that need urgent cash, might sell or license some equipment or intellectual property (copyright, trademark, or patent) that belongs to it.

2) Selling Subsidiaries

Some companies have gathered up other smaller businesses as subsidiaries. If this subsidiaries doesn’t fit well with the rest of the company, selling or spinning off makes sense.

3) Selling Under-performing Assets

The most common type of divestiture process is done by selling business product or service that isn’t working well. The new model always replaces the old model, thus getting rid of previous models is the main aim of divestment done by businesses.

4) Closing Locations

Some business have more than one location, places where customer demand is less than expected is being closed by the company, and the land is used for the divestiture.

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Reference

Book Reference

  • Book Name :

    THE LITTLE BOOK OF VALUATION

  • Writer Name :

    Aswath Damodaran

  • Book Name :

    Portfolios of the Poor: How the World's Poor Live on $2 a Day

  • Writer Name :

    Daryl Collins , Jonathan Morduch , Stuart Rutherford and Orlanda Ruthven

Audio Book Reference

  • Book Name :

    Audio1

  • Writer Name :

    Saurabh Kamale

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