Divestiture is not a dirty word. But all too often, companies view divestiture as the mark of failure. As such, they devote inadequate thought and resources to the endeavor.
In reality, divestitures play a critical role in effective portfolio management and should be viewed as an essential means of re-evaluating, reallocating, raising and preserving capital. According to Ernst & Young LLP's U.S. Capital Confidence Barometer, the number of divestitures is on the rise in the U.S., with 34% of respondents expecting to execute a divestiture over the next 12 months, a 70% increase from April 2010. Spinoffs are also increasing. According to Spin-Off Advisors LLC founder Joe Cornell, the 2011 value of U.S. spinoffs was $94.01 billion, more than double 2010's total, while 2011 totals are projected to jump significantly in 2012.
Companies tend to emerge from the divestiture of noncore businesses both stronger and more efficient. So as opposed to a necessary evil, a divestiture should instead be viewed as a strategic opportunity. Senior executives need a strong sense of when an individual component may no longer fit or is of greater value to another potential owner. To effectively analyze a portfolio for potential divestiture, consider these 10 practices:
1. Understand how each business fits into your strategy. Executives should periodically, if not continuously, distinguish between core and noncore assets. The latter become the focus of additional, divestiture-minded financial analysis.
2. Scan the external environment. Even if a business fits strategically and generates healthy returns, it may be worth more to someone else. Be on the lookout for buyers with synergistic profiles, and keep track of market valuations. Also, monitor industry developments, including new entrants, regulatory changes, demographic shifts and technological breakthroughs.
3. Communicate a value creation model supported by appropriate metrics. Companies need an array of reliable, meaningful financial and nonfinancial metrics. Core financial metrics include return on invested capital, contribution margin or economic value added. Nonfinancial metrics include quality, market ranking or customer satisfaction.
4. Calculate threshold values for each business. Companies should periodically renew a threshold value for keeping each business. This helps determine if a business is worth more to another owner and enables a board of directors to respond quickly to any unsolicited interests.
5. Capture appropriate information. IT systems and accounting policies should be evaluated in terms of their ability to deliver timely, reliable and appropriate information for asset valuation and decision making. Outputs should include consistent, economically rational cost allocations, reliable balance sheets for each business and details of each entity's tax attributes.
6. Take action sooner, not later. Assets may fall out of favor before any decision to sell. Rather than deprive an about-to-be-divested asset of management resources, smart sellers have teams that know how to take swift steps to reduce costs, increase sales margins and optimize the quality and value of earnings.
7. Consider tax-free spinoffs. When no traditional buyer or tax-efficient structure surfaces, companies should look at nontraditional means of isolating an asset such as a tax-free spinoff. Recognize, however, that these can be complex.
8. Devote appropriate resources. Senior executives should be involved early and well briefed -- able to detail the value proposition for any buyer. Also, avoid losing value unnecessarily by ensuring essential resources, such as a transition management office for responding to information requests, are in place.
9. Think like a buyer. Once tagged for sale, businesses must be viewed from a buyer's perspective. Sell-side due diligence anticipates buyers' questions, addresses ever-tougher lender standards and helps eliminate surprises that could jeopardize a deal.
10. Develop carve-out financial statements. The preparation of accurate carve-out financial statements can be complex and time-consuming, but tends to improve overall divestiture outcomes.
Corporate strategy often relies heavily on M&A for growth. But the most sophisticated executives also realize that a divestiture is as essential to stewardship and strategy as an acquisition. Divesting well -- always with an eye to raising, preserving or optimizing capital -- builds value. Savvy leaders therefore view divestiture as an essential core competency of an organization and embrace its role in portfolio optimization.
Paul Hammes and Rich Mills are partners with Ernst & Young LLP's Transaction Advisory Services who advise clients on divestiture transactions.