What is Divesting?
Divesting, also known as divestiture, refers to the sale or transfer of the significant assets, divisions, investment of the business due to some financial, political or social reasons such as a business can sell the department which is not a core part of the business and is not providing benefits to the company so that the business can focus on the units that can provide better earnings.
- It is exactly the opposite of acquisition, whereby instead of investing/acquiring; a business tries to exit from its existing investments or assets by selling the same. A company or government organization planning to divest its asset or subsidiary company may be doing so as part of its strategic move for the company.
- It can also be done to streamline the business units so that the business can focus on its main line of business or it can be done in cases where proceeds from the divesting process are invested elsewhere to earn a higher return on investment.
- This is basically the process of selling an asset. Usually, the assets divested are Noncore in nature i.e. those which are not directly used in the mainline of business. Non-Core Assets can take the form of any kind of asset such as real estate, commodities, natural resources, currencies or securities, factories, land, property, etc.
- It may also take the form of an entire subsidiary or a holding in another company. It is usually done by way of reduction of an asset or business through the sale, liquidation, or any other means for attaining certain financial goals or strategic goals. It acts as a great source of injecting cash in the business without affecting the regular business activities and is an important strategy in corporate restructuring and a popular tool used by businesses to retire debt and reduce leverage.
Asian Bank Limited is a Commercial Bank providing branch banking, investment banking, and payment services. The Bank is having a large investment in Land parcels and investments in various companies listed on the local bourses. The Bank decided to shore up its capital base to increase its lending capability and decided to divest its investment in Listed Companies and Noncore assets like land parcels.
By doing so, Asian Bank succeeded in raising capital. Thus we can see Asian Limited divestiture of its investments in Noncore assets to improve its capital base (injecting cash in the business) and focus more on its main line of business thereby deploying its assets to a more profitable avenue.
Purposes of Divesting
- It enables the business to focus on its core operations or the line of business where it holds expertise.
- This is an effective tool for monetizing the assets as Divestiture usually results in cash inflow for the business.
- It is an effective tool through which companies can evaluate the performance of their various divisions and divest those divisions whose internal rate of return is below the average/required rate of return of the business as a whole. Let us understand the same through an example Swiss Corp operates in three business divisions’ namely Clothing, Automobile, Real Estate. The company has an internal rate of return of 13%, 8%, and 15% respectively from its three divisions. Swiss Corp has a required rate of return of 12%.In such a case by Divestiture of its Automobile division which is generating an internal rate of return (8%), the company will be able to utilize the proceeds towards more profitable divisions which will result in a higher rate of return for the business as a whole.
- This is sometimes done to improve shareholder value or due to enforcement by regulatory authorities.
- Non-alignment of Noncore assets with the mainline of business.
- The sustained underperformance of business units which is denting the overall profitability of the business as a whole.
- The availability of better opportunities compared with the existing business lines also motivates management to divest the existing business lines and setting up of a new business line.
- It helps businesses to generate cash from its noncore investments which could be utilized for expansion of existing business, starting a new business line or for retiring the existing debt.
- It helps businesses to allocate their resources in its main line of business and generate higher returns for its shareholders by improving the Return on Equity.
How does the Divestment Process work?
Divesting is a systematic process and involves a commitment on the part of Management to make it value accretive.
- Review of Portfolio – Usually, it involves a review of the entire business portfolio which comprise of analyzing the performance of each business unit and its relevance with the long-term business objective.
- Identification of Suitable Buyer – Once a certain business unit is identified as part of Divestiture exercise a suitable buyer is identified by taking the services of an Investment Banking firm which assist in identifying the buyer and valuation of the business unit which is proposed to be part of divesting (It is important to note that the valuation exercise is undertaken taking into consideration that the price derived must be at least equal to the opportunity cost of not selling the business unit).
- De-integration – Once the same is finalized the organization must prepare a de-integration plan and convey the merits of such Divestiture clearly highlighting the purpose behind the divesting along with information regarding the benefits that will accrue to the organization to both internal and external stakeholders to ensure the positive signal is communicated.
Video on Divesting
This is unarguably an important strategic tool used by business, but knowing when to divest is extremely difficult to decide and can turn out to be an expensive mistake if not done correctly. In today’s business scenario, companies are usually starved of capital and divesting is seen as a sure-shot liquidity booster as it improves shareholder’s return by injecting cash in the business which can either be used for paring debts from the books of the business which ultimately improves the profitability of the business in question or for expansion of the existing business. Management must ensure that such decisions which turn out to be long-term value accretive for the business.
This has been a guide to what is Divesting and its definition. Here we discuss how divestitures work along with examples, purpose, and its advantages. You may learn more about M&A from the following articles –