Divestment

What is Divestment?

Divestment or divestiture refers to a company selling off an asset considered to be mainly non-core in terms of the business's asset structure.

While it may bring liquidity, it also serves as a part of the overall corporate strategy.

Disinvestment is the opposite of investment. It is a part of the common advisory mandate of investment banks. It is the reverse of acquisition and could happen because of a particular division not achieving the targets or not operating at its highest efficiency.

Divestiture can include selling real estate, business, properties, or facilities.

It includes a company selling some of its assets to improve operational and overall efficiency. For example, large conglomerates divest because of operational optimization or political and social pressures.

This action might occur to optimize or increase efficacy, except for selling off profit-making divisions due to societal or political pressure.

In addition, companies might be selling off their assets to increase revenue, eliminate nonprofitable divisions, or react to business regulators.

Regardless of the reason, disinvestment helps the company's overall liquidity, which will allow it to focus more on its core activities.

Reasons for Divestment

It might not make sense for a company to initially decide to sell one of its assets or business divisions. Still, there are a few reasons why divestment might benefit the company. 

• Monopoly: In many countries, governments lay out mandates to avoid monopoly in an industry, abide by the rules, and maintain healthy competition companies divest.
• For example, in the 1980s, an American telecommunications company, AT&T, was forced to divest to allow other competitors to enter the market.
• Better Investment Opportunities: A company may lay off a business division generating less ROI to focus on or bring together other divisions that will provide better investment opportunities to the business.
• Socio-Political Reasons: A company might divest from regions experiencing political and social turmoil. Divesting brings liquidity and investment opportunities to that region and, as a result, might help establish a democratic government that works in the best interest of the citizens. 
• More Focus: Companies observe that some non-core activities hamper their focus on their expertise, which affects the business in the short and long run. Management decided to lay off the company's subsidiaries or assets to focus on their core activities.
• Liquidity: In times of financial inadequacy, management decides to divest its non-core assets. Instead of investing in new divisions or subsidiaries, the business seeks to lay off the non-performing divisions to bring in liquidity and avoid probable insolvency or future shortcomings.

Advantages And Disadvantages of Divestment

The benefits of divestment may include-

• An increase in the rate of returns. Different units or divisions of a business may report lesser or increased returns rates than the average or overall profits of the business as a whole, owing to different risks and factors.
• It helps in re-focussing the core activities, which generally lie in the area of expertise of a company.
• It is an opportunity to unload the burden of debts.
• Ultimately it brings more profitability to the shareholders of the company.

Despite the advantages, divestment has its limitations.

• If the strategy is improperly communicated or communicated poorly, investors might presume the company to be in adverse financial condition. Because of this, they may withdraw funds out of fear of losing a chunk of their investments.
• Clients and vendors can lose trust in the organization and may shift their trust and supply towards the competitors.
• It is a very cost-intensive process where a company has to pay off the professionals a very heavy amount and for the various other transactional and transitional costs.

Types of Divestments

The various kinds of divestitures are as follows.

Spin-off

A spin-off is the creation of a new and separate corporation which is created when a parent corporation distributes its shares in a subsidiary of the parent corporation.

Selling off or reducing shares to make a company more independent. For example, an entity creates a spin-off expecting that it will make it worth more as a separate entity.

A spin-off is executed assuming that a spin-off or a separate entity independent of the parent company will be more profitable.

Carve-out

A carve-out can be defined as a partial divestiture of a business unit of a parent company, where it is decided to sell the business unit's minority interest to an external investor.

It is a form of partial divestment in which a company relinquishes control of a business by giving up its entire equity. Losing control of part of its business might help an entity focus more on its core activities.

Direct Sale Of Assets

The transaction that leads to the selling up of entire subsidiaries of a business, properties, divisions, or facilities. This type of disinvestment involves using cash and may lead to tax consequences if the assets are sold again.

One of the primary reasons why a direct sale of assets is executed is because of the increased cash flow, reduced liabilities, and improved financial flexibility.

Mergers, Acquisitions, and Disinvestment

may change the structure of at least one company by purchasing or selling the entity or its assets.

Acquisition leads to gaining possession of another company that ceases to exist as a legal entity. The purchasing corporation assumes all the rights, obligations, and privileges of the target company. 

Acquisitions are the combination of any two companies where one of them is completely absorbed by the other. 

After the acquisition, the merged company ceases to exist as an independent body and becomes a part of the acquiring organization.

Divestitures are the flip side of corporate growth involving mergers and acquisitions. They refer to the partial or complete selling of an entity's assets or subsidiaries to reduce its size.

A court may require a divestiture in a merger to avoid monopoly or any violation of the anti-trust.

Divestment Process

The disinvestment process takes place by the professionals working in the corporate development department of an entity.

Divestiture involves a few steps:

1. Monitoring Of The Portfolio: If a business is active in its divestiture activity, it constantly reviews the divisions and decides whether they are relevant to the company's long-term strategy.
2. Identifying The Buyer: After a decision has been made to take out a division for disinvestment, a possible buyer must be identified. The price of the division must be estimated to be more than or equal to the opportunity cost of operating the business.
3. Performing The Divestiture: Performing and identifying various aspects of the business, such as valuation, legal ownership, retention of the present employees, and change of management.
4. Managing the transition: After the disinvestment, the company may look forward to the strategy and costs related to the business. After selling a division, a company must appropriate the amount liquidated and decide whether to use the money to write up the company's debt, grow with the business, or start a new division.

Divestment Cost

Some divestment costs may be related to the transaction and transition costs associated with the divestment activities. This includes hiring professionals and using tools to facilitate the divestiture process.

There is another cost related to divestments as of the time of them; a company may sell a division of the business because it might want to use its resources optimally.

Due to this process of events, the shareholders of a business might get a false signal that a

A company might need liquidity urgently because it is in trouble. As a result, shareholders might start selling their shares, further supporting the rumors.

Open communications with the shareholders regarding any corporation decisions are required to avoid the shareholders getting negative signals about the company's prospects or current position.

There is information asymmetry at times of divestiture, and the external investors of a business might get misapprehended about the company going through a transition.

Challenges Faced During Divestment

Compared to M&A (Mergers And Acquisitions), divestiture is more labor-intensive.

Process along with some time constraints.

Carrying out the process before the transaction closes, it requires decision-making, planning, and execution. Hence, the organization faces various challenges when laying off its assets or business subsidiaries.

• Operational Challenges: The company's finance department must ensure accurate accountkeeping, as its primary function is to measure the effects of the company's net profit or net earnings.
• Carving Out Statements: One main task at the time of divestiture is to remove the financial statements of the division or subsidiary's parent organization. These statements mention the divested organization and the costs of laying off.
• Calculation Of The Accounts: One last task before the divestiture is to calculate certain metrics, such as the division's total debt or the asset assigned to the buying organization. Calculating an appropriate capital structure also takes the place of the laid-off entity.

Corporate Divestment Transactions

For decades, firms such as Goldman Sachs, Citi Group, etc., have been catering to the needs of Russian firms. However, in 2022, the turmoil caused by the Russian-Ukraine war led to the exit of these firms from the Kremlin.

The government of India decided to sell the loss-making Air India to streamline its costs and operations. This will help cut the burden on taxpayers who pay for Air India's daily losses.

In the 1970s and 1980s, businesses and governments worldwide protested against the apartheid white-led government in South Africa. As a result, many Multinational Corporations (MNCs), such as IBM (International Business Machine), Xerox, Kodak, and many more, partially or fully divested their operations from South Africa.

MNCs like PepsiCo, Texaco, and Hewlett Packard divested from Myanmar (Burma) to protest against the military-led government during the 1990s.

In South Africa and Myanmar, these MNCs were encouraged to return and reinvest only after ensuring the election of democratic governments in both countries.

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