Companies undertake divestitures only after deliberate strategic consideration and meticulous planning — or do they?

A new study documents that more than half of divestitures — sales or spinoffs of subsidiaries or business units — are associated with below-market share-price performance for the seller.

Willis Towers Watson (WTW) and City University of London’s Cass Business School looked at more than 5,500 divestiture deals worth more than $50 million (combined debt and equity) by publicly traded companies worldwide from 2010 through 2018.

The research tracked changes in divesting companies’ share prices from six months prior to deal announcements to the end of the half-year following announcements.

The counterintuitive result: for 54% of such deals, the change in share price trailed the MSCI World Index performance across the period studied. The underperformance averaged 2.1% for those deals, translating to aggregate unrealized market value of $1.9 trillion.

Apparently, investor relations outreach communicating the strategies underlying divestitures is often unconvincing. “Investors punish companies whose strategies and execution they disapprove of,” notes Duncan Smithson, senior director of mergers and acquisitions for WTW.

On the bright side, the other 46% of sellers saw their market value exceed the global index level by an aggregate $2 trillion. In other words, there’s more to gain from a successful divestiture than there is to lose from an unsuccessful one.

Why, though, do a majority of divestiture deals fail to inspire investors?

Answers are necessarily speculative, although they may be informed by anecdotal experience.

“Over the period we studied, there were a lot of headlines with companies saying they wanted to refocus on core activities, and there are lots of good reasons why companies might want to do that,” says Smithson. But, he adds, they may be overmatched when negotiating deal terms with private equity (PE) firms, which acquire many divested entities.

“PE firms are professional deal makers with a track record of aggressive negotiating,” Smithson says. “The average corporate seller may not have people whose full-time job is doing transactions. There might be a couple of them in corporate development, but when finance, HR, and legal teams are up against PE buyers, they’re typically double-hatting.”

Also, he continues, management may underestimate the amount of work required.

Ideally, the company would “take a fairly deliberate and methodical approach to setting up a project management office or some other governance infrastructure to strategically guide the deal,” Smithson advises. At least some of the people on that team should be authorized to “put their day job on hold for a while,” he adds.

Such care should minimize disruption within the organization, he says. A classic example of disruptiveness arises when a sales team is selling products from both division A and division B, and it’s announced that division B will be sold.

“If there’s not proactive management of that sales force and communication of what the deal means in practice, inevitably there will be disruption,” Smithson explains. “They’ll see a client who’s interested in product B and wonder whether to steer the client [to] a division A product, or postpone or cancel [the discussion].”

Company executives often underestimate the impact such uncertainty can have on the organization, he adds. They’ve been involved in strategic discussions about the future of the business unit for months, probably. As such, they’re way ahead of mid-level managers, sales staff, and rank-and-file employees on the “acceptance curve,” as Smithson puts it.

Another factor is that companies typically consider both a sale and a spinoff upon deciding to divest a business or entity, and sometimes they change their minds midstream. However, Smithson notes, switching from a sale to a spinoff may be a particular recipe for disaster.

Spinoffs require much more work, because of the need to “stand up” an entirely new company and because there’s no buyer to share the work with.

“You can pivot from a spinoff to a sale fairly easily, even though there will be some sunk cost from all the work [expended],” Smithson says. “But you generally can’t prepare for a sale and then pivot to a spinoff — companies usually don’t then free up the resources to do an effective job of that stand-up exercise.”

Finally, he adds, a divestment probably shouldn’t overlap with another big organizational change: “If you’re asking your finance and HR people to implement a new SAP module, don’t simultaneously ask the same people to handle a complex divestiture.”

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