What is a divestiture?
A divestiture (or divestment) is the disposal of company’s assets or a business unit through a sale, exchange, closure, or bankruptcy. A partial or full disposal can happen, depending on the reason why management opted to sell or liquidate its business’ resources. Examples of divestitures include selling intellectual property rights, corporate acquisitions and mergers, and court-ordered divestments.
What are the reasons behind a divestiture?
There are many reasons why a corporation may decide they need to sell an asset, a business unit, or the entire company. Some of the most common reasons include:
- Redundant business units – most companies decide to sell off a part of their core operations if they are not performing, in order to place more focus on the units that are performing well and are profitable.
- Generate funds – selling a business unit for cash is a source of income without a binding financial obligation.
- Increase resale value – the sum of a company’s individual asset liquidation value exceeds that of the market value of combined assets, meaning there is more gain realized in liquidation than there is in retaining the existing assets.
- Business survival or stability – sometimes companies face financial difficulties; therefore, instead of closing down or declaring bankruptcy, selling a business unit will provide a solution.
- Regulatory agency interference – a court order requires the sale of a business to improve market competition.
How is a divestiture carried out?
Companies divest in order to efficiently manage their asset portfolio. There are multiple options to go about the process and effectively execute the disposition.
- Partial sell-offs – selling a business subsidiary to another company to raise capital and apply the funds to more productive core units instead.
- Spin-off demerger – a business strategy wherein a company’s division or unit is separated and made into an independent company.
- Split-up demerger – when a company splits-up into one or more independent companies, and consequently, the parent company is dissolved or ceases to exist.
- Equity carve-out – a corporate approach wherein the company sells a portion of its wholly owned subsidiary through initial public offerings or IPOs and still retains full management and control.
Relation to mergers and acquisitions (M&A)
Divestiture transactions are often lumped in with the mergers and acquisitions process. Most people think of the buy-side of these transactions (buying businesses) but corporations also actively look to sell non-performing or non-core assets to optimize their business.
Constantly reviewing a company’s portfolio of assets and optimizing it for the best performance is an important part of corporate strategy.
Example: GE divests GE Capital
In 2015, parent company GE decided it would divest its GE Capital business as part of a restructuring plan. According to an article by Fortune, investors liked this transaction for three main reasons:
- Investors don’t like conglomerates (i.e., there is a “diversified discount” applied to their valuation)
- Earing a return on capital above your cost of capital creates value (a reason to sell GE Capital)
- Share buybacks may be a better use of capital (if the price is right)
To learn more, read Fortune’s article on the sale of the business and restructuring.
Corporate development and investment banking
When analyzing a divestment, analysts in investment banking or corp dev will perform a valuation of the asset using financial modeling and other techniques.
To learn more about valuation as it related to M&A, check CFI’s online financial modeling courses.
To keep learning and advancing your career as a financial analyst, CFI has created a vast library of resources to help you on your way. Additional resources include: