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Many companies are poised to shed failed acquisitions -- but few want to talk about it.
Roy Harris, CFO Magazine
March 1, 2003
Amid the uncertainty about just when deal-making will resume in earnest, one thing is sure: the backlog of operations to be divested by companies is burgeoning. "If I were to open a business right now, I'd open a practice in divestitures, not mergers," says Prof. Thomas Lys, who teaches in the Merger Week program at Northwestern University's Kellogg School of Management.
Indeed, business divestitures — often a byproduct of mergers and acquisitions — are holding up well even in the current M&A lull (see "Bombs Away?" at the end of this article). And giant examples like AT&T's 2002 sale of its cable-TV business, or this year's proposal by Vivendi Universal to shed U.S. operations, may end up being forerunners, suggests David Barnes of merger adviser Houlihan Lokey Howard & Zukin.
"There's going to be an incredible flood of divestitures," predicts Barnes. After two decades of acquisitive buyers being stuck with overpriced properties, many acquirers "must divest themselves of certain noncore assets to reduce the amount of debt they've taken on during their acquisition binges," he explains. CFOs know this well. In fact, a just-released Accenture survey of 150 Fortune 1,000 executives showed a surprising 27 percent saying their corporate strategies would make "greater use of divestitures and portfolio management," compared with the past 18 months.
The problem, though, is that corporations generally do a poor job with such "details" as valuing the assets to be divested or selecting the proper form of separation. In the same Accenture survey, executives rated their companies as more successful at acquisitions than divestitures by a wide margin. And Justin Jenk, the London-based head of Accenture's M&A and corporate-restructuring practice, believes that the dichotomy exposes both a basic ignorance about divestitures and inattention to the nuts and bolts of divesting — which can be costly for selling companies. "Good deals are all about passion, whether you buy or sell," says Jenk. He says that it would be "great to know why there's this reticence among executives over divestitures."
Houlihan's Barnes thinks the answer is obvious: CFOs are embarrassed by having to divest operations. "It starts with the point of view that divesting means 'we blew it,' " he says. Some executives are afraid "they'll look like buffoons" if they have to sell off a business they earlier acquired. "So companies aren't real outgoing about discussing their divestiture programs."
The Silent Treatment
Tyco International Ltd., with acquisitive CFO Mark Swartz now gone, is quite publicly undoing a number of its purchases. But that's because the diversified manufacturer's involvement in numerous business scandals has forced new managers to call attention to past strategic mistakes. "Deals like its purchase of [financing unit] CIT just didn't make sense," says Barnes, pointing to Tyco's $9.5 billion acquisition in 2001. "More typically, Westar Energy, another prolific acquirer, now has started divesting assets because its debt has grown too high — and with far less fanfare." One unit that Topeka, Kansas-based Westar may divest: Protection One, a competitor of Tyco's ADT alarm unit.
Such reversals happen more often than many investors suspect, Barnes suggests. Even from a well-regarded acquirer like Cisco Systems Inc., "you don't hear about divestitures," he says. Of course, when Cisco discontinues an operation, it rarely seems to be axing a business it acquired. Acquired companies "disappear into the Cisco vortex," explains Barnes. (A Cisco spokesman says that the company won't discuss divestiture strategies for competitive reasons. In a statement, Cisco says it "reallocates resources as a normal course of business to focus on its profitable areas. Acquisitions by their very nature are risks, and Cisco will continue to take those risks. Cisco has been extraordinarily successful in making acquisitions work, but we also know that some won't.")
Bruce McEver, CEO of Berkshire Capital Corp., says a divestiture often gets slapdash attention from managers because it undoes a deal that "happened on someone else's watch," and represents "an urge to clean house." Berkshire often advises clients in financial-services divestitures that are designed to repair poor attempts to incorporate unfamiliar banking, insurance, or brokerage businesses.
Problems with divestitures run far deeper than embarrassment over the concept, of course. "Mechanically, it is often difficult to extract a business," says Barnes, who often helps the equity groups that kick off divestitures by proposing such an extraction. And in the case of an unwanted operation acquired and then marked for divestiture as "phase two" of a deal, the entire restructuring process bogs down, says Kellogg's Lys, who contends that "if you don't integrate fast and well, you're going to lose most of your value." Some companies got stuck in the '80s and '90s merger waves by using stock swaps that gave them both attractive and unattractive assets at once. It's better to "buy just the assets you want," says Lys, "but with an acquisition of stock, you have no choice."
Shrink, Fix, or Sell
There's nothing embarrassing about a divestiture if you do it well, according to Barnes. "And if you decide an asset is not core anymore, typically Wall Street will applaud, especially if you can get a nice price for it, and if you build up your war chest to do an even bigger acquisition."
Some companies — including the runaway leader in number of acquisitions, General Electric — consider disciplined divestitures a normal part of the growth cycle. And they have a regimen for treating divestitures as a value-creating part of a long-term business strategy. Indeed, all companies failing to meet GE's return-on-equity requirements enter what the company calls a "shrink, fix, or sell mode." GE's finance teams try to pay as much attention to what they sell as they do to what they buy, a spokesman says.
Another company with such divestiture discipline is DuPont, which currently is planning to dispose of its venerable $6.5 billion-a-year textiles and interiors business. The lines were part of DuPont "back when the earth began to cool," quips CFO Gary Pfeiffer. But after an analysis of all its business lines, DuPont found that increasingly, textiles and interiors weren't like its other operations. They "were absolutely superb businesses in their business space," the CFO says, but production was migrating rapidly to Asia, and slower growth and lower margins were recorded. "Our decision was that this business could create an enormous amount of shareholder value as a stand-alone company," says Pfeiffer. But it would be harder to build value within DuPont. Further, its sale would provide capital for acquisitions in higher-margin areas.
"We set things up to do it the right way," says Pfeiffer of the plan for separating the textiles and interiors business. "As we went through the evaluation last February, we actually had two competing teams operating independently," with a third view coming from Morgan Stanley. The assignment for about 150 DuPont people working on disposal planning, he says, is to "prepare for the most strenuous of separations." That would be an initial public offering, which requires the most financial data for legal and regulatory purposes. Says Pfeiffer, "If you can meet those standards, you can meet anything else."
DuPont has put the textiles and interiors assets into a new subsidiary, and plans to complete its disposition this year.
Professor Lys observes that one previous DuPont divestiture, the unraveling in 1998 of its 17-year ownership of Conoco, resulted from "a botched acquisition." But Pfeiffer believes that a carefully planned IPO — at the time the largest ever — helped DuPont escape well. "From a deal-structure standpoint, the Conoco separation was exceptional," he says. "It priced at the top of the range."
Whatever the reason for a sell-off, Accenture's Jenk advises companies to look beyond a "knee-jerk" sale, and to consider divestiture part of a long-term strategy "in which a company constantly reviews, replenishes, and trims its portfolio as its markets change." Guidance for divestiture-minded clients includes considering novel ways to disassemble operations before sale and studying varied exit strategies, from asset swaps to joint ventures.
Deals that represented a divestiture of operations. "Value" represents deals for which the value was disclosed, usually 40 percent to 50 percent of total deals.
Number of deals
An Acquisitive Lot
Companies doing the most acquiring.
Number of deals: 48
Ernst & Young
Number of deals: 24
Brown & Brown
Number of deals: 24
Number of deals: 52
Brown & Brown
Number of deals: 26
Number of deals: 21
Number of deals: 42
Number of deals: 32
Number of deals: 27