What Are the Reasons Divestitures Occur?
In finance, divestment or divestiture is defined as disposing of an asset through sale, exchange, or closure. A divestiture is an important means of creating value for companies in the mergers, acquisitions, and the consolidation process. For example, a merger might create redundant operations and businesses. Through divestiture, the company can improve operational efficiency and reduce costs. However, there are many reasons why companies engage in divestitures, and not all of them have a positive impact on the company.
Key Takeaways
- In finance, divestiture is the process of disposing of an asset through a sale, exchange, or closure.
- A divestiture is an important means of creating value for companies in the mergers, acquisitions, and the consolidation process.
- Through divestiture, a company can eliminate redundancies, improve operational efficiency, and reduce costs.
- Reasons why companies divest part of their business include bankruptcy, restructuring, to raise cash, or reduce debt.
Understanding the Reasons for Divestitures
Companies that divest a portion of their business might do so by selling a subsidiary or a separate business that operates under the parent company. Divestitures are common with large publicly-traded corporations since they typically have more business units and are more likely to engage in acquisitions of companies outside their industry. Acquisitions involve the purchase of a company or a specific business unit.
Although there are numerous reasons why companies divest assets or part of their company, below are some of the more common scenarios in which companies engage in divestitures.
Bankruptcy
Companies often undergo bankruptcy due to their operating and financial problems, and divestiture is almost always part of this process. The divestiture can help the company reduce costs, improve cash flow, and emerge from bankruptcy as a healthier company. For example, General Motors filed for bankruptcy in 2009 and closed at least 11 unwanted factories. It divested some of its unprofitable brands, such as Saturn and Hummer, as part of its reorganization plan.
Raise Cash
Another common reason for divestiture is to raise cash. This is especially important for companies experiencing operating and financial difficulties. For example, Sears Holdings, a consumer retail company, struggled with declining sales and negative cash flows. In 2014, as part of its survival plan, the company announced a divestiture of its real estate holdings to raise funds to continue reorganizing its retail business. However, Sears, which also owns Kmart, has struggled since emerging from bankruptcy in 2019 even after closing hundreds of its stores and using the cash from its divestitures to pay down some of its debt.
Non-Core Businesses
Companies may divest businesses that are not part of their core operations so that they can focus on their primary lines of business. In 1989 Union Carbide, a well-known manufacturer of industrial chemicals and plastics decided to spin off its non-core consumer group business so it could focus more on its core business matters.
In 2020, WeWork Corporation, which provides office sharing spaces for rental, faced financial struggles. As a result, the management team announced divestitures of its non-core businesses, including its content marketing and software businesses.
Earnings
Companies often divest to improve their bottom-line stability. Earnings are synonymous with net income or profit. In 2006 Philips, a Dutch diversified technology company decided to divest its chip subsidiary, NXP Semiconductors. The primary reason for selling NXP was a high volatility and unpredictability of earnings for the chip business, which was hurting Philips' stock value.
Strengthen the Balance Sheet
When the executive management of a company states that they're taking measures to strengthen the company's balance sheet, it typically means that they want to pay down debt.
For example, in 2020, General Electric Corporation (GE) announced the completion of the divesture of its BioPharma division in which GE received approximately $20 billion in cash. According to the press release, the GE chair and CEO H. Lawrence Culp Jr. stated that the sale helped to "de-risk our balance sheet and continue to solidify our financial position."
Unlock Value
A firm often breaks up into two or more companies to unlock value believed to be greater for separate entities than that of a consolidated company. This is especially important during liquidation. For example, investors are willing to pay much more for different parts of the company separately, such as real estate, equipment, trademarks, patents and other parts, than to buy one single company.
Underperformance
Companies often divest parts of their business that are not performing up to their expectations. These divestitures can involve eliminating subsidiaries or divisions that are underperforming.
A notable example of such a divestiture was done by Target, a large consumer retailer. Target's stores in Canada did not perform well due to Canadian customers' lackluster demand. In 2015, Target decided to exit its Canadian line of business by shutting down its stores or selling them to interested parties.
Regulations
Divestitures sometimes happen for regulatory reasons such as antitrust concerns by regulators. A prominent example of divestiture required by the regulatory authorities involved Bell Systems in 1982. Due to Bell's monopoly position in the telecommunication industry, the U.S. government ordered the company's breakup, creating many smaller companies, including AT&T.
FAQs
Divestiture is a partial or full disposal of the company's business units or assets through sale, exchange, or bankruptcy. The main reasons for divestiture are cash generation, the sell-off of redundant business units, the desire to increase market value, disposal of non-core assets, political issues, and court orders.
Why do divestitures happen? ›
Divestiture is a partial or full disposal of the company's business units or assets through sale, exchange, or bankruptcy. The main reasons for divestiture are cash generation, the sell-off of redundant business units, the desire to increase market value, disposal of non-core assets, political issues, and court orders.
What is a common reason for organisations to pursue divestiture? ›
Through divestiture, a company can eliminate redundancies, improve operational efficiency, and reduce costs. Reasons why companies divest part of their business include bankruptcy, restructuring, to raise cash, or reduce debt.
What is the main purpose of a divestiture strategy? ›
A divestiture happens when a company decides to sell or spin-off part of its business into a new entity. Companies may divest in order to focus on a core competency, raise cash, or reduce exposure to an underperforming business segment.
What are the three kinds of divestitures? ›
Below are common divestment strategy types:
- Sell-off: A company sells the unit, asset or other property to another company. ...
- Spin-off: A company separates or spins off one department or unit into a separate company. ...
- Split-up: A company splits itself into several smaller companies, and the parent company ceases to exist.
Reasons for divestment at the institutional level may be political, legal, financial, or ethical in nature. These often overlap one another. A company may respond to shareholder or consumer pressures and close down its operations in a country with a poor human rights record, doing so for financial and ethical reasons.
What is a real life example of divestiture? ›
In 2008, at the cusp of the global financial crisis, Ford Motor Company divested itself of its luxury brands, Jaguar and Land Rover, selling them to Tata Motors for $2.3 billion. The move was part of Ford's broader restructuring strategy to focus on its core Ford brand and to free up capital.
What are the benefits of divestiture? ›
By divesting some of its assets, a firm can reduce its costs, repay its outstanding debt, reinvest and focus on its core business(s), and streamline its operations. This, in turn, could increase shareholder value.
What is the risk of divestiture? ›
When companies divest business assets, there is always the chance they will inadvertently transfer data or assets and/or provide access to information—confidential customer data, intellectual property, or market-specific financials—that were not included in the terms of the sale.
What is an example of divestment? ›
An example would be Ford Motor Company selling off some of their businesses to focus on their core operations. Companies don't prefer to invest in subsidiaries or non-performing units during financially distressful times. It's much better to sell off the assets and save money to prevent insolvency.
What it means: The concept of divestment appears fairly simple at face value — an investor or institution sells off its shares of a company to avoid complicity in activities they deem unethical or harmful.
What is divestiture in simple words? ›
A divestiture (or divestment) is the disposal of company's assets or a business unit through a sale, exchange, closure, or bankruptcy.
What happens to employees in a divestiture? ›
Employees will transfer automatically to the buyer at the time of the share sale. In an asset sale, however, a buyer and seller will negotiate the specific assets, liabilities and people that the buyer will take on.
What companies use divestiture strategy? ›
Examples of famous companies using divestiture strategies
In 2021, General Electric, Johnson & Johnson and Toshiba all announced plans to disband into several smaller companies.
What are the key considerations of divestiture? ›
Of all the priorities to juggle during the divestiture process, the four most essential considerations, as ERP Suites sees it, are as follows: Transition service agreements, system integration/IT transfer/data migration, security concerns, and financial reporting and analysis.
How long does it take to divest a company? ›
How long does it take? If you have already identified the buyer, a corporate divestiture can go quickly. However, most divestitures require at least 4 to 6 months, and some may require considerably more time.
What is the point of divestment? ›
Divestment, which is also called divestiture, is the process of selling subsidiary assets, investments, or divisions of a company to maximize the parent company's value. It is done when: The subsidiary asset or division isn't performing up to expectations.
What is one of the reason for adopting divestment strategy by the firm? ›
In strategic management, an organization usually adopts a divestiture or divestment strategy when a business unit is under-performing. By divesting itself of that business unit, the company is able to shed dead weight or reorganize, and use the proceeds to repay debt or invest in something more profitable.
Does divestment actually work? ›
Stock prices remain steady: Research finds that there's very little correlation between divestment campaigns and stock value or company behavior, Witold Henisz, vice dean and faculty director of the environmental, social and governance initiative at The Wharton School of the University of Pennsylvania, told CNN.
