What is a Divestiture?

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Definition:

Divestiture is a process in which a company gets rid of a subsidiary, business unit, or other type of asset or investment.

🤔 Understanding divistitures

Divestiture is when a company sells, exchanges, or otherwise disposes of a subsidiary, business unit, or other type of asset. Divestiture can also occur as part of a closure or bankruptcy proceeding. Companies may decide to divest in a business or asset for several reasons. Management might pursue divestiture if it believes an asset or business unit is underperforming, or that an old investment is no longer a core competency in alignment with the company’s strategic vision. Divestiture can also take place as part of a merger or acquisition. Business units are sometimes disposed of to improve a company’s value, and redundant investments or subsidiaries are often sold after a merger takes place. In some cases, divestiture can be mandated via a court order in the name of market competition.

Example

Let’s say you run two different online stores: one in the United States and one in Ireland. Each store requires upkeep, funding, and lots of your time — but after 12 months, you realize your Irish online store isn’t making a lot of sales and is too expensive and time-consuming for you to maintain properly. As a result, you may want to divest yourself of the Irish store and sell your assets in Ireland so you can focus all of your time and energy on your profitable store in the U.S.

Takeaway

Divestiture is like selling a pair of jeans you don’t wear anymore…

It may have made a lot of sense to buy those jeans at the time, but it’s been five years and you’ve only worn them a handful of times in the past year. They’re just taking up space in your closet and being underutilized, so it makes sense to sell them onto somebody else. That way, the jeans will finally get worn the way they should be — and you’ll have cash in your pocket and space in your closet for something that better aligns with your current style.

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What is a divestiture?

A divestiture takes place when a company decides to dispose of assets, investments, or a business unit. Divestiture is also commonly referred to as “divestment,” and it can occur as part of a liquidation or sale, business exchange, closure, or bankruptcy proceeding.

Financial motivations for divestment could stem from a desire to shed underperforming assets to improve a company’s value. Or management might choose to sell a business unit after a merger because it’s been made redundant or no longer aligns with the company’s strategy.

Divestiture can also occur as a result of ethical or political pressures, or if a court orders a company to divest to address antitrust issues.

There are plenty of notable examples of divestiture.

In 1982, AT&T was forced by a U.S. court order to divest itself of its Bell System because the government decided the company had an unfair monopoly over the country’s telephone system. As a result, AT&T was broken up into seven separate and independent corporate entities.

The auto giant, Ford, decided to divest itself of its South African operations in the 1980s as a result of international condemnation of apartheid. The company sold its stake in its South African subsidiary, Samcor. Ford would later go on to repurchase its stake in Samcor in 1994 after the end of apartheid.

In 2006, Kodak decided to divest itself of its digital camera business and sell the operations to Flextronics. Kodak’s management said the move was driven by a new strategy to improve the company’s profitability and create a more efficient operating model, which is often one of the core motivations behind divestiture.

Why would a company divest its assets?

Businesses often choose to divest their assets or investments for a wide range of reasons, but you can typically break down the key motivations behind divestiture into several distinct categories.

Assets are underperforming

When a company experiences a particularly large and prolonged drop in demand for a type of product or service, it could decide to cease production of that product or service entirely.

By divesting itself of an underperforming product, service, or business unit, the company can then focus its time, effort, and funding on the things people do want to buy.

Bankruptcy

If a company runs into financial trouble and needs to file for bankruptcy, it may need to divest by liquidating its assets and selling off its businesses to repay creditors.

Court orders

If antitrust action is taken against a company, a court may end up ruling the company must divest itself of part of its business or certain of its assets to maintain a competitive business environment for other companies.

Ethical or political reasons

Some companies choose to divest themselves of certain assets on ethical grounds. For example, if the management of a company is uncomfortable with the way a government is running its country, the decision might be made to sell off corporate assets in that country and cease activity there.

How does a divestiture work?

When a company chooses to divest its assets or shed a business unit, it’s often a systematic process.

The process usually starts with a portfolio review. A company’s management will generally analyze its entire portfolio to assess each area’s performance. That performance can then be considered against the company’s long-term business objectives to gauge whether each area qualifies as a core part of the company.

A company’s management may then identify an underperforming asset that isn’t critical to the success of its business. If the company decides it wants to sell the asset, it must then identify a buyer.

This process typically starts by taking on the services of an investment bank or specialist firm that can develop a valuation for the asset and then connect prospective buyers with the company.

The next step is usually de-integration. Management will need to develop a de-integration plan outlining the rationale behind any divestiture to both internal and external stakeholders.

That plan will need to answer questions of legal ownership and intellectual property transfers, and retention or severance of any employees operating within the unit. This plan should also create an agreed roadmap with the buyer outlining when and how the assets will change hands.

Execution of a divestiture plan is often carried out via an internal project management team or specialist firm contracted to oversee the sale and transition. After a transaction has been negotiated and all approvals have been obtained, the transaction can be closed, and the assets are transferred as agreed. It may be helpful to follow completed divestiture transactions with a retrospective analysis exercise to figure out what went smoothly with the divestment and how the process could be improved next time.

What are the different types of divestitures?

There are three common types of divestitures: sell-offs, demergers, and equity carve-outs.

Sell-offs

This is a form of divestiture in which a company chooses to sell a business unit, asset, or subsidiary. Sell-offs normally occur because a company decides the unit is underperforming or no longer aligns with a company’s core business strategy.

Demerger

A demerger is when a company transfers some of its business activities to create one or more independent entities. There are two types of demergers: spin-offs and split-ups. A spin-off sees a corporate division break away to become its own company, while the original parent company continues to trade. A split-up is when a company breaks down into multiple independent companies, and the parent company ceases to exist.

Equity carve-out

An equity carve-out is a type of divestiture where a company sells part of a unit or subsidiary through an initial public offering (IPO). Although this divestment strategy entails selling portions of the company, the parent company will typically retain full control over management as a majority shareholder.

What happens when a company is divested?

What happens to a company after divesting depends on the type of divestiture.

For example, a company that’s sold an entire business unit will need to oversee a transition period and transfer of assets to the buyer — after which time the company will generate income from that sale to redistribute elsewhere.

A company that’s forced to divest by court order may be required to carry out a demerger creating multiple independent entities. As a result of the demerger, a parent company may cease to exist, and each separate business unit might become its own company.

What happens when a company is divested?

What happens to a company after divesting depends on the type of divestiture. For example, a company that’s sold an entire business unit will need to oversee a transition period and transfer of assets to the buyer — after which time the company will generate income from that sale to redistribute elsewhere.

A company that’s forced to divest by court order may be required to carry out a demerger creating multiple independent entities. As a result of the demerger, a parent company may cease to exist, and each separate business unit might become its own company.

What is a divestiture strategy?

A divestiture strategy is a concerted and purpose-driven effort by a company to divest its assets, investments, or business units.

A divestiture strategy typically centers on the type of divestment a company has chosen to pursue. It will follow the standard process, beginning with a portfolio review, followed by buyer identification, and then de-integration.

Critically, a divestiture strategy often will include a roadmap outlining what will happen after the de-integration process, such as how resources will be reallocated and how income generated from the divestment will be used.

What are the pros and cons of divestitures?

As with all major business decisions, any divestment will have its own set of pros and cons.

Divestiture often helps a business to generate cash. By selling off non-core units, investments, or assets, a company can create income to redistribute resources more effectively across other business units or areas.

Divestment can also help a business to create shareholder value by improving return on equity. By shedding underperforming assets, a company’s value often increases. This may help a business to secure new investment to expand elsewhere.

There are also drawbacks a company should bear in mind. There are direct costs involved in divestitures, including transaction and transition costs, such as the legal transfer of assets and possibly employee severance pay.

Signaling can also create a negative impact as part of any divestment activity. If a company decides to divest itself of a business unit, but the reasons behind the move aren’t communicated effectively, investors may wrongly assume the divestiture is signaling the company is in financial distress.

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The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

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