Divestiture

What is Divestiture?

Divestiture refers to the partial or outright disposal of a company's assets or a business unit through sale, exchange, closure, or bankruptcy, contrasting with investment in reallocating resources.

The most common reason for a business to liquidate is when management plans to stop operating a unit that is not part of its core competency.

It can also happen if the unit is regarded as obsolete or redundant after a merger or acquisition, if the disposal increases the company's resale value, or if the court orders the sale of that unit to increase market competitiveness.

It helps a diversified firm, such as a huge conglomerate, focus and increase profitability. It also allows companies to reduce costs, pay off debt, and increase shareholder value.

For instance, if a firm is in the computer business but also sells headphones, it may want to focus on the computer business if it is not very profitable. It can do this by selling it to an outside firm that only sells headphones or by downsizing or discontinuing the headphone business altogether.

If the computer business is more stable than the headphones business, investors would prefer the company if it divests its headphones division.

The government also divests PSUs, called privatization, to raise funds or increase the firm's efficiency by making it private and increasing its competitiveness. A divested division that becomes an independent company is called a spin-off.

Understanding Divestiture

Divestiture is the strategic act of selling off a company's assets, divisions, or subsidiaries. This is often done to streamline operations, raise capital, or comply with regulatory requirements.

It can help companies refocus on core activities, optimize their portfolio, or address antitrust concerns by reducing market concentration. Divestitures can also occur when a company wants to improve or change its public image.

For instance, a firm may choose to divest from fossil fuel companies or environmentally harmful ventures to portray itself as environmentally friendly and align with its strategic goals or respond to market shifts.

Divestment can also occur if the firm is under financial pressure. For example, if a conglomerate faces financial losses in the fashion division, it can divest and reinvest in a more profitable electronics division.

Types of Divestiture

The most common types of divestiture are as follows:

1. Sell-Off: In this type of divestiture, the parent company sells the divested asset to another company in exchange for cash
2. Spin-offs: In a spin-off, the parent company sells a division or subsidiary to create a new independent firm, and the existing shareholders are given shares in the new firm. For example, in October 2012, Kraft Foods Inc. spun off Kraft Foods Group, its North American grocery business, which caused the shareholders of Kraft Foods Inc. to get one share of Kraft Foods Group for every three shares of the parent company
3. Split-Ups: A split-up and spin-off are similar, except that in the first one, the shareholders can either keep shares in the parent company or get new shares in the subsidiary. The spin-off of Du Pont and Conoco is an example of this
4. Carve-Out: In a carve-out, the parent company typically sells a portion of the subsidiary to outside investors, while it may choose to retain some equity in the subsidiary, although this is not always the cash
5. Liquidation: In liquidation, all the assets are stripped, and the business is dissolved. This scenario usually happens in bankruptcy proceedings

What are the Reasons Behind a Divestiture?

Some of the most common reasons for divestiture are as follows:

1. To Sell Off Redundant Business Units: A company may sell a business unit that is part of its core operations if it is not performing well to focus on profitable operations. Firms also sell units not part of their core business to focus on their primary business, like Ford Motor Company and Future Group
2. To Generate Funds: Divestment generates funds without creating any financial obligation. For instance, CSX Corporation divested to focus on gaining additional funding to repay debt. In the case of financial difficulties, selling a business unit also helps more than the company declaring bankruptcy
3. To Increase Resale Value: Sometimes, the firm's value without the asset under consideration is greater than its value, stimulating firms to liquidate the unit as the value is much greater in selling it off than in retaining it
4. To Comply with Regulators: The court can also order the firm to divest. One of the most famous examples of this occurred in 1982; regulatory pressure led to the division of the Bell System into AT&T and other small units known as "Baby Bells"
5. Cutting Back on Locations: Some companies, especially those in the retail sector, like fashion and food businesses, may find they have too many locations and not all are profitable, which leads to the sale of those units
6. Selling Losing Assets: It is better to sell off an underperforming unit as it can cut the company's profit
7. To Enhance Stability: Volatile units can cause stock fluctuations in an otherwise stable business and can be considered risky by investors
8. So, companies may sell off a unit to increase stability. For example, Philips divested NXP, its chip division, to reduce volatility
9. Pressure from Shareholders: Shareholders can pressure the firm to divest or disinvest for various reasons, including social concerns such as disinvestment from South Africa during apartheid, from Israel by critics, from Russia due to geopolitical events, or from industries like tobacco

Divestitures Benefits

Divestiture helps the parent company to maintain a strategic focus on its core business. Firms also divest underperforming assets, which frees other related assets. The sale generates cash that can be invested in the core business to increase profitability.

The cash generated from divestment can be used to pay off the firm's debt, potentially improving its creditworthiness. This can create opportunities for the company, such as strengthening financial stability and enhancing its ability to negotiate better terms with suppliers for raw materials.

Divestment generates cash, which increases the firm's quick ratio. It is beneficial as the company will no longer depend on debt for its financial needs. If a division generates losses, it is better to divest to reduce the burden of redundant costs on the overall business.

Rather than incurring undesirable expenses on poorly performing assets in the hope that they will turn around, it is advantageous to divest them. The efficiency increases as the costs of holding a loss-making business are eliminated.

Examples of Divestitures

A few of the examples are:

1. Thomson Reuters

In July 2016, Thomson Reuters, a Canadian multinational media and information company, sold its Intellectual Property and Science (IP&S) to Onex and Baring Private Equity for $3.55 billion in cash. 

The division was divested as part of a strategy to refocus the company's operations rather than directly reduce its balance sheet debt. The newly formed company is known as Clarivate Analytics.

2. American Telephone and Telegraph (AT&T)

1974, the Department of Justice filed an antitrust lawsuit against the company under the Sherman Antitrust Act. In 1982, AT&T divested its local operations, and the newly formed regional units were collectively called "Baby Bells," with one firm retaining the name "AT&T."

The divestiture, among other impacts, provided consumers with more choices and contributed to reductions in the prices of long-distance services and phones. 

The breakup was criticized mainly because many consumers were delayed in receiving high-speed internet. However, the divestiture proved successful, leading to notable outcomes such as increased competition and expanded consumer options.

3. General Electric Co

In 2015, as part of a restructuring plan, parent company GE decided to divest its GE Capital business for $157 billion to focus on its core businesses: power, aviation, renewable energy, and healthcare.

Divestment Vs. Disinvestment

To understand the difference between the two, let's take a look at the table below:

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