Divestment
Refers to a company selling off an asset considered to be mainly non-core in terms of the asset structure of the business.
What is Divestment?
Divestment, often called divestiture, refers to a company selling off an asset considered to be mainly non-core in terms of the asset structure of the business.
While it may bring liquidity, it also serves as a part of the overall corporate strategy.
Disinvestment is the opposite of investment. It is a part of the common advisory mandate of investment banks. It is the reverse of acquisition and could happen because of a particular division not achieving the targets or not operating at its highest efficiency.
Divestiture can include selling real estate, business, properties, or facilities.
It includes a company selling some of its assets to improve operational and overall efficiency. For example, large conglomerates divest because of operational optimization or political and social pressures.
This action might occur for optimization or to increase efficacy, except for selling off profit-making divisions due to societal or political pressure.
In addition, companies might be selling off their assets to increase revenue, eliminate nonprofitable divisions, or react to business regulators.
Regardless of any reason, disinvestment helps the company's overall liquidity, which will help it focus more on its core activities.
Key Takeaways
- Divestiture is the partial or complete sale of a business's poorly performing divisions or subsidiaries.
- It is a part of the corporate restructuring of the company.
- There are advantages as well as limitations to divestiture.
- There are three basic types of divestments - Spin-Off, Equity Carve-Out, and the Direct Sale of assets.
- Direct selling costs and Signaling are the various costs related to the divestment process.
- In the past various MNCs took the route of divestiture because of political and social pressures.
Reasons for Divestment
It might not make sense for a company to initially decide to sell one of its assets or business divisions. Still, there are a few reasons why divestment might benefit the company.
- Monopoly - In many countries, governments lay out mandates to avoid monopoly in an industry, abide by the rules, and maintain healthy competition companies divest.
- For example, in the 1980s, an American telecommunications company, AT&T, was forced to divest to allow other competitors to enter the market.
- Better Investment Opportunities - A company may lay off a business division generating less ROI to focus on or bring together other divisions that will provide better investment opportunities to the business.
- Socio-Political Reasons - A company might divest from political and social turmoil regions. Divesting brings out liquidity and investment opportunities in that region and, as a result, might help bring a democratic government that works in the best interest of the citizens.
- More Focus - Companies observe that some non-core activities hamper their focus on the activities of their expertise which affect the business in the short and long run. Management decided to lay off the company's subsidiaries or assets to focus on their core activities.
- Liquidity - In times of financial inadequacy, the management decides to divest their non-core assets. Instead of investing in the new divisions or subsidiaries, the business sought to lay off the non-performing divisions to bring in liquidity to avoid probable insolvency or future shortcomings.
Advantages And Disadvantages of Divestment
The benefits of divestment may include-
- An increase in the rate of returns. Different units or divisions of a business may report lesser or increased returns rates than the average or overall profits of the business as a whole, owing to different risks and factors.
- It helps in re-focussing the core activities, which generally lie in the area of expertise of a company.
- It is an opportunity to unload the burden of debts.
- Ultimately it brings more profitability to the shareholders of the company.
Despite the advantages, divestment has its limitations.
- In the case of improper or lack of communication of the strategy, the investors might presume the company to be in adverse financial condition. Because of this reason, they may pull out the funds due to the fear of losing a chunk of their investments.
- Clients and vendors can lose trust in the organization and may shift their trust and supply towards the competitors.
- It is a very cost-intensive process where a company has to pay off the professionals a very heavy amount and for the various other transactional and transitional costs.
Types of Divestments
The various kinds of divestitures are:
Spinning off is a part of selling off or reducing the shares to make a company more independent. For example, an entity creates a spin-off expecting that it will make it worth more as a separate entity.
Carve-Out refers to selling a minority stake in its subsidiaries to outside investors. It is a form of partial divestment where a company relinquishes control of a business by giving up its entire equity. Losing control of part of its business might help an entity to focus more on its core activities.
Direct Sale Of Assets leads to the selling up of entire subsidiaries of a business, properties, divisions, or facilities. This type of disinvestment involves using cash and may lead to tax consequences if the assets are sold again.
Mergers, acquisitions, and disinvestment may change the structure of at least one company by purchasing or selling the entity or its assets.
Acquisition leads to gaining possession of another company that ceases to exist as a legal entity. The purchasing corporation assumes all the rights, obligations, and privileges of the target company.
Acquisitions are the combination of any two companies where one of them is completely absorbed by the other.
After the acquisition, the merged company ceases to exist as an independent body and becomes a part of the acquiring organization.
Divestitures are the flip side of corporate growth involving mergers and acquisitions. Divestiture refers to the partial or complete selling of its assets or subsidiaries to reduce the entity's size.
A court may require a divestiture in a merger to avoid monopoly or any violation of the anti-trust.
Divestment Process
The disinvestment process takes place by the professionals working in the corporate development department of an entity.
Divestiture involves a few steps-
- Monitoring Of The Portfolio: If a business is active with its divestiture activity, it constantly reviews the divisions. It makes decisions on whether they are relevant to the long-term strategy of the company or not.
- Identifying The Buyer: After a decision has been made to take out a division for disinvestment, a possible buyer must be identified as the price of the division must be estimated such that it is more than or equal to the opportunity cost of operating the business.
- Performing The Divestiture: Divestiture involves performing and identifying various aspects of the business such as valuation, legal ownership, retention of the present employees, as well as change of management.
- Managing the transition: After the disinvestment, the company may look forward to the strategy and cost related to the business. After selling a division, a company must appropriate the amount liquidated and make a decision pertaining to the usage of the money towards writing up the company's debt, growing up with the business, or starting up with a new division.
Divestment Cost
Some costs related to the divestments may be related to the transaction and transition costs associated with the divestment activities. This includes hiring professionals and using tools to make the divestiture process possible.
There is another cost related to the divestments as at the time of it; a company may sell a division of the business because they might want to use their resources optimally.
Due to this process of events, the shareholders of a business might get a false signal that a
A company might need liquidity urgently as they are in trouble. As a result, those shareholders might start selling their shares, further supporting the rumors.
Ways to avoid the shareholders getting negative signals about the company's prospects or the current position require open communications with the shareholders regarding any corporation decisions.
There is information asymmetry at times of divestiture, and the external investors of a business might get misapprehended about the company going through a transition.
Challenges Faced During Divestment
Compared to M&A (Mergers And Acquisitions), divestiture is more labor-intensive.
Process along with some time constraints.
It requires decision-making, planning, and execution to carry out the process before the transaction closes. Hence, the organization faces various challenges when laying off its assets or business subsidiaries.
- Operational Challenges - The company's finance department has to ensure accurate account keeping as their primary function is to measure the effects of the company's net profit or net earnings.
- Carving Out Statements - One main task at the time of divestiture is to carve out the financial statements of the parent organization of the division or subsidiary. These statements mention the divested organization and the costs of laying off.
- Calculation Of The Accounts - One last task before the divestiture is to calculate certain metrics, such as the division's total debt or the asset assigned to the buying organization. Calculating an appropriate capital structure also takes the place of the laid-off entity.
Corporate Divestment Transactions
For decades, firms such as Goldman Sachs, Citi Group, etc., have been catering to the needs of Russian firms. However, in 2022 the turmoil due to the Russian-Ukraine war led to the exit of these firms from the Kremlin.
The government of India decided to sell the loss-making Air India to streamline the cost and operations of the airline, which will help cut the burden on taxpayers who pay for the daily losses of Air India.
In the 70s and the 80s, businesses and the government all around the world protested against the apartheid white-led government in South Africa. As a result, many Multinational Corporations (MNCs) like IBM (International Business Machine), Xerox, Kodak, and much more partially or fully divested their operations from South Africa.
MNCs like PepsiCo, Texaco, and Hewlett Packard divested from Myanmar (Burma) to protest against the Military led government during the 1990s.
In South Africa and Myanmar, these MNCs were encouraged to return and reinvest only after ensuring the election of democratic governments in both countries.
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