Divestment is one strategy that a corporation can use to unlock funds for future growth and create long‑term shareholder value. According to a recent E&Y study, a successful divestment must meet three criteria: (i) it must create a positive impact on the valuation multiple of the remaining company; (ii) it must generate a sale price above expectations; and (iii) it must close ahead of its timing expectations. Only 19% of the companies surveyed for the study met all three criteria. Considering that divestiture activities are likely to increase in 2016 (a more detailed discussion on 2016 divestiture outlook can be found here), it is critical for companies to analyze how they can maximize value through their next divestiture transaction.
The study looks to private equity firms, which have mastered the art of divesting. Some key lessons include:
- Be an active seller. Of the private equity respondents who have carried out high-performing deals in the past, 51% of them stated that the strategic trigger for the deal was shareholder activism. In comparison, only 31% of the respondents claimed the high-performing deals were triggered by an opportunistic buyer approaching the seller. Activist-fueled transactions bring higher value because they force management to review corporate assets and re-focus management attention on core strategy. Investors generally react positively to shareholder activism, especially if the activist has a reputation for unlocking value for shareholders. On the other hand, when an opportunistic buyer knocks on management's door to buy assets, the market perceives the transaction less positively because investors believe management undervalued the business and failed to generate maximum value with core assets. Companies need to act like activists to generate value, and they can achieve this by making bold divestment decisions in line with their announced strategy.
- Conduct frequent portfolio reviews. The study found a direct correlation between frequent portfolio reviews and divestment success. 48% of the respondents who have carried out high‑performing divestment transactions review their portfolio on a quarterly basis. The report proposes that companies should take the approach popular with private equity firms and conduct in-depth portfolio reviews once or twice a year; carry out quarterly benchmark reviews against competitors and internal business plans; and have real-time access to performance data in order to make better decisions faster.
- Always be prepared for execution. Companies should continue to create pre-sale value in a business targeted for investment as these companies are 75% more likely to receive a higher‑than‑expected sale price and 59% more likely to have a higher‑than‑expected valuation multiple post‑divestment. In addition, companies should be prepared to explain to a potential buyer how the divesting business can operate independently. For example, a selling company should prepare financial statements for the divesting business in order to create a compelling vision for the buyer as to how the divesting business can fit in its organization. Lastly, to generate more value, the study recommends that companies who are going through the bidding process should strive to demonstrate how the divesting business can create synergy for each bidder.
Companies that have divested strategically and followed the example of private equity firms are much more likely to carry out a successful divestment transaction. The report anticipates divestment activities will pick up among life science, financial services, consumer products and technology companies in the coming year, which will bring opportunities for both divesting companies and potential buyers to maximize value in well-considered transactions.
The author would like to thank Lucy Liu, articling student, for her assistance in preparing this legal update.
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