Article 3: Triggers of a divestment
Christophe Van-Gampelaere
This article is the third in a series of six devoted to restructuring/divestitures.
A divestiture can have various reasons, they are part of a corporate process. In this article we break down the four main reasons why a divestiture can be desirable.
3. Triggers of a divestment
Divestitures are part of a corporate process, they don’t happen in a vacuum. We see divestments happening following a strategic review. Triggers include:
- part of the business is deemed to be not strategic enough to warrant full future ownership
- to comply with anti-competition rules
- to satisfy shareholder demands or
- to raise cash for investment in more profitable or strategic activities,
or any combination of these.
3.1. Divesting following a strategic review
A divestment may be triggered as it becomes clear that a business activity is no longer strategic to the parent company.
The starting point for a good discussion on what is strategic, and what is not, is a shared understanding of what a business model actually is.
The Business Model Canvas
The Business Model Canvas provides a useful framework to describe a company’s business model. It is a model that facilitates description and discussions. It allows all individuals involved in the company to talk about the same things and have a shared understanding of the company.
The Canvas describes nine basic building blocks that show the logic of how a company or business unit intends to make money. The nine blocks cover the four main areas of a business: its customers, its offer, the infrastructure needed to realize the activities and the financial viability.
Below is graphic representation of the Business Model Canvas, with its 9 building blocks clearly laid out:
Fig. 2. The Business Model Canvas
Each of the blocks can in itself presents a rationale for a carve-out. When a company overhauls its business model and plots it on the canvas, areas that are no longer compatible become visible. That is where action needs to be taken.
Customer segmentation
When market barriers and challenges make it too cumbersome and costly to serve customers, companies may choose to exit certain geographies. Canada’s Eldorado Gold, a mining company, partially divested its Chinese operations in 2014 and first placed them into a new company listed in China. Two years later had completely divested all its Chinese operations.
Some customers segments deliver higher margins than others. Depending on the guidance from the shareholders and board, the company may decide to make a move from mass to niche market products, or vice-versa. It may move from diversification to focus, or the other way around – and sell off what’s no longer needed.
Customer relationships
A fresh focus on the business plan often leads to a shift in customer focus. Companies in a growth phase may first focus on customer acquisition. In these scenario’s, it is a core activity to get customers on the network (telecoms), to establish a broad customer base (acquiring ‘eyeballs’ for internet companies). In a later stage, customer retention may become more important. By then, customer acquisition may have become so routine that it can be spun off. Ricoh, the Japanese printer manufacturer, has done just that, and now offers its expertise to the wide world.
Upselling to the existing customer base is the next rung on the customer relationship ladder. However, as a consequence of focusing on the upselling customer relationship model, certain BU’s may no longer adequately served by the parent company. Left as an orphan, the unit may linger, not get the management attention needed, and overall drag the parent’s results down. When the Belgian chemical giant UCB sold its amino acid arm in 2000, it was to get rid of a marginal activity, generating low margins to customers to whom UCB thought you could no up-sell. 15 years later, the company had increased revenue and EBITDA tenfold.
Customer channels
Sometimes, the mother company is not able to make its customers aware of some products and services; channels through which customers want to be reached may not be cost-effective, or cannot be integrated with the parent’s others channels. Sometimes the after-sales effort of the target is not effective. If these problems cannot be solved within the parent, a carve-out of certain business activities may be the best way forward.
Value propositions
When the Target’s core business offering is no longer a strategic value proposition for the Parent, such as in the UCB case mentioned above, the Parent may decide to sell the unit. The same is applicable if the bundling of the Parent’s services or products no longer include the Target’s, or if the product or service moved along on the BCG matrix from ‘cash cow’ to ‘dog’. After the carve, the Parent improved flexibility will allow it to pursue its goals.
Key activities and resources
The key activities and assets form a company’s central infrastructure to make its business model work. These assets can be physical, intellectual, financial, and human. For a microchip manufacturer, a capital-intensive production facility is a key asset. A microchip designer focuses on human resources.
Example of reasons for selling off key activities and assets
- changing business model – As a company’s business model evolves over time, certain activities may no longer be regarded “key”. Firms may choose to reduce dependency on in-house teams, to spread risks, or reduce uncertainty. This can result in outsourcing of production, or technological platforms, or complete IT departments. Where Apple first produced its own computers, it now outsources production to others. Its key activity no longer lies in the production of hardware.
- Llack of high-quality management – Sometimes there’s just not enough high-quality management around to manage all business units effectively, such as in the example where UCB sold of its amino acid activities.
- failure of integrating a previous acquisition – studies suggest that 50-75% of all acquisitions fail to reach their stated objectives so there is no lack of examples of Parents selling failed acquisitions, that is – if they are lucky enough to find someone to buy the Target. Daimler was still able to sell Chrysler to Cerberus, but Hewlett-Packard had to write off $8.8 bn of its $10.2 billion acquisition of Autonomy. Since its $25 billion Compaq merger, where HP lost half of its market value, the company has endured numerous problems with failed acquisitions (3COM, EDS, Palm, Autonomy).
- Most reasons for selling key activities have a financial aspect. They may improve return on capital employed, maximize value, clean up non-operating assets, or improve working capital.
3.2. Divesting to comply with anti-competition rules
Such divestments usually coincide with a major acquisition or mergers. In some territories covered by a merger, the combined company may have a monopolistic or oligopolistic market position, and the anti-competition authorities may only clear a merger upon certain conditions.
Example here is the acquisition of SABMiller, the world’s second largest brewer, by AB InBev It was cleared 2016 by the European Commission under the European Union merger regulation ,. The clearance is conditional on AB InBev selling practically the entire SABMiller beer business in Europe.
3.3. Divesting to satisfy shareholders
One reason behind divestitures could be that a certain part of the business has a different risk/return structure compared to the Parent company. For example, a high-growth company offering higher potential returns at a higher-than-average risk may choose to divest moderate growth activities to make itself easier to evaluate for shareholders.
The performance of certain business units can have a disproportionate effect on a company’s share price. Philips sold its semiconductor activities in 2006 to a private equity consortium as semiconductors are typically sensitive to the mood swings of economic booms and bust cycles. Philips timed its exit well, selling the business at the top of the market. The buyers heavily leveraged the deal, and pushed the debt down into the target company, as of then called NXP Semiconductor.
3.4. Divesting to raise cash
Sometimes, companies are forced to sell strategic activities in order to remain able to honor their debt repayment obligations to banks. This happened in 2012, when RCS Media Group sold its very well performing book publishing business Flammarion to Editions Gallimard.
As to the example of NXP Semiconductors: even though continued growth was projected in the company’s business plan, the economic cycle turned downwards again. Two years later in 2008, the company had to sell off two major business units in order to raise cash, honor the bank covenants, and stay independent.
Summary
Divestitures happen because of a variety of reasons, they are part of a corporate process. In this article broke down the four main reasons why a divestiture can be desirable:
- because of a strategic review,
- to comply with anti-competitive rules
- to satisfy shareholder demands and
- to raise cash.
Christophe Van-Gampelaere is Co-Founder of Global PMI Partners. With 23 years of executive experience in the areas of audit, corporate finance, working capital improvement, investment management, international restructuring, change management, implementation of ERP platforms and people management. Christophe has published several articles, presented seminars, conducted workshops and is a trainer on integration management and M&A.
