Divesting
The sale of subsidiary assets, investments, or other divisions of a firm to maximize the value to the entity.
Divestment is the sale of subsidiary assets, investments, or other divisions of a firm with the goal of maximizing the value to the entity that owns those assets. Divestment is also referred to as divestiture and is essentially the opposite of an investment.
The process is usually performed when a company's subsidiary asset or division is underperforming. In other cases, a company is obligated to sell assets due to legal or other regulatory actions.
Divestment is used for companies to realize different goals, including strategic business, financial, social, and political ambitions.
Individuals also divest when they, for example, sell stocks or other securities from their portfolios.
Key Takeaways
- A divestment happens when an entity (corporation, individual, etc.) decides to sell some or all of its assets or subsidiaries.
- Most divestments are deliberate attempts to facilitate business operations. However, regulatory or legal actions force the sale of a company's assets. An example of this would be bankruptcy.
- There are three types of divestments: spin-offs, equity carve-outs, and direct sale of assets.
Understanding divestment
The main goal of an investment is usually to improve a firm's value, increase operational efficiency, and/or gain a return on the investment. Many companies utilize divestment strategies to sell assets, allowing management to refocus their efforts on their essential business.
Divestment may be a strategy for corporate optimization, or external factors could cause it. For example, when a company's investments are reduced or when companies leave a location or industry because of current political or social pressures.
For instance, the COVID-19 pandemic had a significant social impact, leading to remote work and increased technology use that ultimately affected offices and commercial real estate.
A subsidiary, a business department, real estate, property, equipment, and financial assets are all examples of items that can be divested.
A company carrying out a divestment typically uses the proceeds to pay down debt, make capital expenditures, finance working capital, or pay a company's shareholder a special dividend.
Regardless of whether a company's divestment is planned or if it is forced upon them through regulation, the sale of assets will create revenue that the company can use elsewhere in its operations.
The short-run effect is an increase in revenue that allows a company to put the funds into another division that may be underperforming.
Typically, a divestment is carried out within a company's restructuring and optimization activities framework. However, if divestment is forced, the company could face a loss of revenue if it had to divest an asset or division that was profitable.
Types of divestment
There are typically three types of divestment: spin-offs, equity carve-outs, and direct sale of assets.
Divestitures have a wide variety of transaction structures; however, these are the most common:
1. Spin-off
Spin-off transactions are both non-cash and tax-free. They occur when a parent company allocates subsidiary shares to its shareholders. Through this process, the subsidiary converts into a stand-alone company. This new, independent company's shares can be traded on the stock exchange.
Companies often use spin-offs when they are made up of businesses with two separate and unique growth and risk profiles.
2. Equity carve-out
This type of divestiture occurs when the public buys a percentage of a parent company's equity in its subsidiary through a stock market offering.
These transactions are often tax-free and result in an equal trade of cash for shares. The parent company typically holds on to a controlling stake in the subsidiary. Thus, equity carve-outs are most often used by companies that require funding for growth opportunities for a subsidiary.
Equity carve-outs also allow companies to set up trading channels for the shares of their subsidiaries. This type of divestment will later typically discard leftover stakes under the appropriate circumstances.
3. Direct sale of assets
In the case of a direct sale of assets, a parent company will sell its assets (e.g., real estate, equipment, intellectual property, etc.) to another agent. If the parent company sells the assets at a gain, a cash transaction will typically result in tax consequences for the parent company.
This type of divestment can occur through coercion and/or end in a fire sale when assets are sold below book value.
Motivations for divesting
There are numerous reasons a company may decide to divest some of its assets or a portion of its business.
These are some of the most common reasons for divestment:
1. Eliminate under-performing, non-essential businesses
Most often, companies use divestment to eradicate businesses that are non-performing or non-essential. Particularly, conglomerates (or other large corporations) typically have multiple business units that engage in separate industries.
Managing all these unique business units is often quite challenging and may distract a company from its core competencies.
2. Free up time and capital
Through divesting a non-essential business unit, a company's management can utilize both time and capital to hone in on its primary operations and competencies.
For example, in 2014, General Electric (GE) divested its non-essential business unit through the sale of Synchrony Financial. This divestment is an example of a spin-off on the stock exchange.
3. Obtain funds
Divestment is also a method to obtain funds. A company can gain value through a divestment through the disposal of an underperforming subsidiary or a response to regulatory requirements.
Legally, a company going through bankruptcy is often obligated to sell off portions of its business.
4. Social or political obligations
A company may also decide to divest a portion of its company for social or political reasons. For example, a company may sell assets that are worsening climate change.
Examples of divestitures
A few examples of divestitures are corporate mergers and acquisitions, selling of intellectual property rights, as well as legally-enforced divestments.
During the 1970s and 1980s, several multinational businesses divested from South Africa in protest of the apartheid regime. These corporations included Eastman Kodak, International Business Machines (IBM), Coca-Cola, General Electric (GE), and Xerox.
Additionally, in 1987, California divested from South Africa by restructuring its investments. Through this process, $90 billion was divested from business operations in South Africa.
Another example of divestment due to political motivation was in Sudan in 2006. At this time, there was ongoing genocide in Sudan, so several states in the U.S. decided to pass laws requiring divestment in businesses operating in Sudan.
Several U.S. colleges and universities also divested their portfolios of investments conducting business with Sudan.
An example of a famous forced divestiture is the 1982 breakup of the former AT&T. This divestment was court-ordered, as the U.S. government decided that AT&T dominated too large a portion of the U.S. telephone service industry.
Due to AT&T's antitrust charges, it was forced to divide into seven different companies. One of the companies kept the name AT&T. Several new equipment manufacturers were also created.
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