What is a Divestiture?
A Divestiture occurs when a corporation proceeds with either a partial or an outright sale of a business segment and the assets belonging to the unit.
Divestiture Definition in Corporate Finance
Divestitures in M&A are when a company sells a collection of assets or an entire business division.
Generally, the strategic rationale of divestitures include:
- Non-Core Part of Business Operations
- Misalignment with Long-Term Corporate Strategy
- Liquidity Shortfall and Urgent Need for Cash
- Activist Investor Pressure
- Anti-Trust Regulatory Pressure
- Operational Restructuring
The decision to divest an asset or business segment most often stems from management’s determination that insufficient value is contributed by the segment to the company’s core operations.
Companies should theoretically divest a business division only if misaligned with their core strategy, or if the assets possess more value if sold or operated as an independent entity than if retained.
For instance, a business division could be deemed redundant, non-complementary to other divisions, or distracting from core operations.
From the perspective of existing shareholders and other investors, divestitures can be interpreted as management admitting defeat in a failed strategy in that the non-core business fell short in delivering the originally expected benefits.
A divestiture decision implies that a turnaround of the division is not plausible (or not worth the effort), as the priority is instead to generate cash proceeds to fund reinvestments or to reposition themselves strategically.
How Divestitures Work (Step-by-Step)
After completing the divestiture, the parent company can reduce costs and shift its focus to its core division, which is a common issue that market-leading companies encounter.
If a merger or acquisition is poorly executed, the value of the combined entities is less than the value of the standalone entities, meaning that the two entities are better off operating individually.
More specifically, the acquisition of companies without a long-term plan for integration can lead to so-called “negative synergies,” wherein shareholder value declines post-deal.
In effect, divestitures could leave the parent company (i.e. the seller) with:
- Higher Profit Margins
- Streamlined Efficient Operations
- Greater Cash on Hand from Sale Proceeds
- Focus Re-Aligned with Core Operations
Divestitures are thereby a form of cost-cutting and operational restructuring – plus, the divested business unit can unlock “hidden” value creation that was hindered by being mismanaged by the parent company.
Activist Investors and Divestitures: Value Creation Strategy
If an activist investor sees a certain business segment has been underperforming, a spin-off of the unit could be pitched to improve the parent company’s profit margins and let the division thrive under new management.
Many divestitures are thus influenced by activists pushing for the sale of a non-core business and then requesting a capital distribution to shareholders (i.e. direct proceeds, more cash for reinvestments, more focus by management).