What it means
Companies accumulate businesses over time through acquisitions, diversification and internal projects. Not all of them fit.
A unit may need capital the parent would rather spend elsewhere, operate in a market the parent no longer understands, or drag down the group's growth rate and valuation. Selling it lets the parent focus, and often the unit does better under an owner for whom it is central rather than peripheral.
There are several routes. A trade sale transfers the unit to another company, usually for cash.
A sale to a private equity buyer does the same but with a financial owner. A spin-off distributes shares in the unit to the parent's existing shareholders, creating a separate listed company without a sale.
A carve-out sells a minority stake through an initial public offering while the parent keeps control. Liquidation closes the unit and sells its assets piecemeal, usually when no buyer wants the whole.
Divestitures are harder than they look. The unit being sold often shares systems, staff, contracts, brands and premises with the rest of the group, and untangling those takes months of work and usually a transitional services agreement under which the parent keeps providing support for a period after the sale.
Carve-out financial statements have to be prepared showing the unit as if it had been standalone, which requires allocating shared costs and debt. Buyers pay less for units that are poorly separated, so preparation directly affects price.
For the parent's accounts, a divestiture can produce a gain or loss on disposal, the difference between the proceeds and the unit's carrying value. Units held for sale are presented separately in the balance sheet, and their results may be shown as discontinued operations so that readers can see the continuing business clearly.
In practice
Real-world examples.
Example
A conglomerate spins off its healthcare division as a separately listed company so that investors can value the fast-growing unit on its own merits.
Example
A bank is required by competition regulators to sell 200 branches as a condition of acquiring a rival.
Example
A software company sells a legacy product line to a smaller specialist that will keep supporting the customers, freeing the seller's engineers for its main platform.
Think of it
“A divestiture is selling off part of your business-getting rid of what no longer fits.
Formula
Calculation
Gain or Loss on Disposal = Net Proceeds minus Carrying Value of net assets sold minus Disposal costs
Worked example. A consumer goods group sells its pet food division.
- Sale price: $180 million, with $4 million of advisory and legal fees
- Net assets of the division on the group balance sheet: $120 million (including $30 million of goodwill from when it was acquired)
- Net proceeds = $180 million minus $4 million = $176 million
- Gain on disposal = $176 million minus $120 million = $56 million
The group also loses the division's annual operating profit of $22 million. If it uses the $176 million to repay debt costing 6%, it saves $10.6 million of interest a year, so group profit falls by about $11.4 million but earnings per share may still rise if the group's remaining businesses are valued on a higher multiple than pet food was.
Value test: before the sale the market valued the group at 9 times operating profit. The buyer paid $180 million for $22 million of profit, or 8.2 times, but the parent's advisers estimated that the division was worth only about 6 times inside the group because it depressed the group's growth rate. On that view the divestiture created around $45 million of value for shareholders.Case study
Seen in the real world.
An industrial group owned a profitable but slow-growing packaging business that it had acquired a decade earlier. The group's share price traded at a discount because analysts applied the low packaging multiple to the whole company. Management decided to divest.
Preparation took nine months: separating shared IT systems, assigning 60 shared employees, negotiating a two-year transitional services agreement and producing three years of carve-out accounts. The process attracted four bidders and the unit sold to a packaging specialist for $410 million, 8.5 times its operating profit against the 6 times implied by the group's valuation. The group used half the proceeds to repay debt and half for a share buyback.
Within a year the group's shares re-rated by about 15% as the market applied the higher multiple of its remaining engineering businesses. The packaging unit, meanwhile, grew faster under an owner that invested in it.
Watch out
Common mistakes.
- Starting a sale process before the unit is separable. Buyers discount heavily for entanglement, and deals collapse over transitional issues.
- Divesting solely to raise cash in a hurry. Forced sellers get poor prices; plan divestitures from strength.
- Ignoring stranded costs. Group overheads that were allocated to the unit do not disappear when it is sold and must be cut or absorbed.
Questions
People also ask.
What is the difference between a divestiture and a spin-off?
A spin-off is one type of divestiture in which shares in the unit are given to existing shareholders rather than sold to a buyer.
How is a divestiture shown in the accounts?
The unit is classified as held for sale, its results may be reported as discontinued operations, and the gain or loss on disposal is shown separately.
Why would a company sell a profitable business?
Because the business may be worth more to someone else, because the capital is needed elsewhere, or because the unit is holding back the valuation of the group as a whole.
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