Divestiture Strategy For Growth Or Poor Performance
What is a divestment strategy?
A divestment strategy, also known as a divestiture strategy, is when a company divests itself (separates from, sells, lets go of) a part or parts of its business.
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.
Divestiture strategy advantages and disadvantages
There are lots of reasons why a company might adopt a divestment strategy. Some of these are outlined below. Of course there are also disadvantages or challenges associated with divestiture, some of which are also outlined. However, the pros generally outweigh the cons when the strategy behind divestment is sound.
Reasons/advantages
- Allows a company to shift its business strategy in response to market volatility, competition, and trends.
- Raises funds, which can be used to pay off debts and resolve insolvency issues.
- Delivers higher value to the business, because the sum of its parts is worth more than the value of the whole.
Challenges/disadvantages
- Any shared costs with the unit being sold must be absorbed by the remaining unit(s).
- Any employees working across multiple units, including the one being sold, must be reassigned.
- Legal documents, including contracts, containing any reference to the business being sold must be redone.
Learn more: Benefits of divestiture
Is divestiture a growth strategy?
Yes, divestiture certainly can be a growth strategy—especially for public companies. If an asset isn’t producing worthwhile earnings, or its margins are lower overall, divestiture can be a smart way to increase the value of the business and raise capital.
For example, if a subsidiary is not generating any earnings but is taking up capital, its value is minimal as part of the overall portfolio. However, selling it can generate significant funds, which can be reinvested into the business’ true growth area.
Learn more: Corporate divestiture process
Types of divestment strategies & why to adopt them
Generally speaking, there are the following types of divestment (or divestiture) strategies:
1. Carve-out
A carve-out is the partial sale of a business asset via Initial Public Offering (IPO). A non-controlling portion of shares are sold while the parent company also retains some investment.
When to choose a carve-out strategy:
- To create two separate entities with diversified core businesses.
- To capitalize on a business unit that isn’t part of core operations.
2. Demerger
A demerger could refer to a “spin-off” or a “split-up”. A spin-off is similar to a carve-out in that a portion of shares are sold, but they’re distributed to existing shareholders as opposed to new ones.
A split-up or “split-off” is when existing shareholders are offered the option to either continue holding shares in the parent company or exchange some or all of them for shares in the subsidiary.
When to choose a demerger strategy:
- After shares of the subsidiary have been sold via IPO through a carve-out.
- To increase returns for shareholders.
3. Trade sale
A trade sale or “sell-off” is when you sell your entire business or business unit to a trade buyer. It usually includes the shares, assets, and sometimes even the liabilities.
When to choose a sell-off strategy:
- For a partial or full exit from the business.
- To enhance the value of the buying business, which is of benefit to you if you retain shares in it.
- To receive a greater sum than if the assets were to be liquidated.
4. Liquidation
Liquidation is the process of “winding up” a business and selling its assets. It usually happens when a company is insolvent.
When to choose a liquidation strategy:
A fast exit strategy if the business is losing money.
Examples of famous companies using divestiture strategies
The COVID-19 pandemic has brought with a spate of divestiture activity of all types, as divesting remains an important strategy for companies navigating tumultuous business environments.
In 2021, General Electric, Johnson & Johnson and Toshiba all announced plans to disband into several smaller companies.
Example 1: General Electric
With GE stock having under-performed over the past 2 decades, the parent company announced plans to spin off into three separate units focused on aviation, healthcare and energy.
CEO Lawrence Culp cited the following reasons for the move:
- greater focus for each area
- tailored capital allocation
- strategic flexibility to drive long-term growth and value
In addition, GE is using proceeds from the sale of its aviation financing unit to pay off debt, which has plagued the business in recent years.
Example 2: Johnson & Johnson
In a similar move to GE, Johnson & Johnson announced in November 2021 the separation of its business into two “global leaders better positioned to deliver improved health outcomes for patients and consumers through innovation, pursue more targeted business strategies and accelerate growth.”
The strategy, which has been anticipated by Wall Street analysts for years, is not without risk, with investors uncertain of the independent earnings potential of the new entities.
Example 3: Toshiba
As well as separating into two standalone companies, Toshiba is also wholly divesting certain non-core business assets, including Toshiba Elevator and Building Systems Corporation and Toshiba Lighting & Technology Corporation.
Satoshi Tsunakawa, Interim Chairperson, President and Chief Executive Officer of Toshiba, said: “The refined strategic reorganization plan creates two distinctive companies that are well-positioned to take advantage of their unique strengths and business cycles. We will be able to deliver these benefits while providing a clearer path to completion, reducing the associated costs, maintaining tax-free status and keeping to our stated timeframe of completing the spin-off in the second half of FY2023.”