There are many reasons why executives shy away from divestment of non-core businesses. They're reluctant to shed revenue, they fear the market's reaction to a smaller company, and they don't want the challenge of stranded costs. They reason that the business could improve in time, or they have trouble accepting the fact that it could perform better in another's hands.
But it's OK to divest. When strategically selected to clean up a company's portfolio and designed to command an optimal price, divestitures can generate significant shareholder value. They can also create a catalysing event for improving the remaining business. When done well, they reduce complexity and provide fuel for the company to pump back into its core.
As part of our ongoing work with divestitures, Bain & Company studied more than 2,100 public companies and found that those engaging in focused divestment outperformed inactive companies by about 15% over a 10-year period, as measured by total shareholder return.
The results are even better for companies that combine focused divestments with a repeatable M&A model. They outperform inactive companies by nearly 40% over a 10-year period and generate more than twice the sales and profit growth.
Among the 137 largest divestitures in the study, companies that divested to focus on their core saw their market cap rise by 7.9% within three months of the announcement. This compares with 1.4% for companies that divest with the primary stated aim of raising cash to pay back debt.
From our experience working with companies across industries, we've identified several fundamental processes that enable successful divesting.
Proactively manage your portfolio. Start with the basics of understanding how all of your portfolio businesses contribute to your core and regularly assess them for fit. What is each business's competitive position and ability to win? Do you have the right resources and capabilities to take it to full potential? If not, are there other companies where it would be a better fit? Only by systematically assessing your portfolio can you identify the business units that would deliver more value in another owner's hands. In the pharmaceutical industry, for example, Bain recently found that companies that combine category leadership with portfolio focus deliver annual total shareholder returns that are more than twice those of companies with diversified portfolios that maintain a tail of smaller positions.
Thoroughly plan and prepare to optimise value. Don't race to sell the asset. Create a blueprint for making it attractive before selling -- even better, begin implementing some of those initiatives before the sale. We have found that six to 12 months is the right length of time to establish the blueprint and demonstrate progress. This allows you to improve the value of the business while you still own it and also demonstrates to a potential buyer what is possible. Both of these can help you achieve a higher price. An important consideration: include strong talent in the business in the pre-divestiture period. Good executives can help spur the growth and margin improvement that adds a lot of value.
A major US aerospace company believed that it would not find a buyer for one of its non-core business units; it was pursuing a sale process, though leadership internally believed that its only option was to spin off the business. In the process of preparing an equity story and separation programme for the business unit, the company identified ways in which the business could thrive outside of the parent. The aerospace company saw far more potential than it had anticipated, in both revenue growth and cost opportunities, and it embarked on a broad-ranging cost initiative. This process helped give confidence to a buyer, leading to a transaction in which the buyer later announced a synergy programme based heavily on that cost initiative.
While determining how to increase the value of the divested business, also define how to right-size the remaining company. Estimate the level of anticipated dis-synergies and develop a plan to offset them. Minimise stranded costs by adapting the infrastructure and the back office, as well as adjusting the IT architecture to match the smaller scale and shape of the post-divestiture business.
Focus your selling process on buyer value creation. Many sellers leave money on the table by short-cutting the divestiture process. Once they decide to divest they may call an investment banker, put an offering memorandum together and move as fast as they can. Based on our experience, divesting companies with the strongest track records take a more thoughtful approach. They devote the required resources to perform reverse due diligence to help decide who could create more value and how it could be created -- critical knowledge that helps a seller negotiate the best deal.
As part of the selling process, communicate clearly how a buyer could execute on the prescribed initiatives in those first 100 days and beyond. Anticipating a buyer's demands and establishing the principles for any temporary service agreements (TSAs) that you'll need makes you a stronger negotiator. Use the carve-out moment to make the remaining company future-ready. The deal's been made; it's now critical to carve out the old business, adhering to your priorities with a low-risk process that neither imposes risk on the business nor distracts the team. It's also an opportunity to wipe the slate clean and prepare for the future with a more focused business.
We find that the best companies establish a separation management office to plan and execute the carve-out while controlling one-off costs and managing TSA commitments. They develop a well-thought-out internal and external communications plan, optimising the remaining company's operating model and infrastructure for the future portfolio. They ensure robust TSA governance and then remove the associated costs.
Indeed, as more companies are discovering, divestitures are an important tool in a senior leadership team's arsenal. They are complex, however, and many companies' muscles are not as well developed for divestitures as they are for acquisitions. As a result, divestitures need careful attention both before and after the sale to deliver outsized value. Companies that regularly prune their portfolio, take an active hand in preparing assets for sale, manage the separation and use the sale funds to acquire core assets in a repeatable M&A programme make divesting a win-win for buyers and sellers.
Jim Wininger is a partner in Bain's Atlanta office and a leader of Bain's M&A practice. Derek Keswakaroon is a partner in Bangkok.