What it means
A divestiture can take several forms. The company can sell the unit to another business, sell it to its managers, or float it on the stock market.
It can also distribute shares of the unit to its own shareholders in what is called a spin-off. Reasons vary.
A business may want to focus on its core activities, pay down debt, fund growth elsewhere or respond to a regulator who requires a sale as a condition of a merger. Sometimes a unit simply earns lower returns than the rest of the group, and selling it frees capital for better uses.
The accounting treatment is important. The company removes the assets and liabilities of the unit from its balance sheet, including any goodwill linked to it, and compares the net proceeds with the carrying amount.
The difference is a gain or loss on disposal, and the unit's results may be shown separately as discontinued operations. Divestitures involve careful planning beyond the price.
The buyer will examine the unit's financial statements, and the seller must separate shared systems, staff and contracts. Companies often agree to provide transitional services to the buyer for a period, charging a fee for them, and these arrangements need to be priced and documented.
Tax, pensions and warranties are frequent sticking points. The seller may give guarantees about the accuracy of the accounts and may agree to pay for certain liabilities that arise later.
Part of the price is sometimes held back in escrow, a neutral account, until those risks pass. Investors usually watch what happens to the proceeds.
Cash used to repay debt or fund a better opportunity is generally welcomed, while cash left idle or spent on a weak acquisition draws criticism. Boards that explain the plan for the proceeds at the time of the announcement tend to get a calmer reaction.
In practice
Real-world examples
Example 1
A conglomerate sells its packaging division for $120,000,000 and uses the cash to repay debt. Its interest bill falls, and its remaining businesses are easier for investors to understand.
Example 2
A regulator requires two merging pharmacy chains to sell 40 stores in overlapping towns. The merged company agrees a sale to a smaller competitor within the deadline. The competitor pays $60,000,000, and the regulator approves the deal.
Example 3
A software group sells a slow-growing product line to its management team, funded partly by a private equity investor. The group keeps a minority stake and a licence to use some of the technology. The group records a gain on the part sold and values the retained stake at fair value.
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 divestiture = Net proceeds - Carrying amount of net assets sold
Net proceeds = Sale price - Transaction costs
Suppose a group sells a division for $50,000,000 and pays $2,000,000 in advisory and legal costs, so net proceeds are 50,000,000 - 2,000,000 = $48,000,000. The division's net assets in the group accounts total $38,000,000, including $5,000,000 of goodwill. Gain = 48,000,000 - 38,000,000 = $10,000,000, before any tax on the sale.Case study
Seen in the real world
Stonebridge Industries is an illustrative, fictional group with three divisions: construction products, specialty chemicals and a small logistics arm. The logistics arm earned a return on capital of 4%, well below the group's cost of capital of 9%, and absorbed management time.
The board agreed to sell the logistics arm for $35,000,000. After $1,000,000 of costs, the net proceeds of $34,000,000 compared with net assets of $30,000,000, producing a gain of $4,000,000.
The illustrative group used the cash to repay a loan carrying a high interest rate and to invest in its chemicals plant. Over the next two years, group return on capital increased, and the board concluded that the divestiture had improved focus as well as the balance sheet. Management also reported that the group's monthly reporting pack became shorter and easier to follow.
Watch out
Common mistakes
- Focusing on the headline sale price and overlooking transaction costs, tax, retained liabilities and stranded overheads that remain after the sale.
- Forgetting to include goodwill allocated to the unit when calculating the gain or loss.
- Underestimating the effort of separating shared systems and people, which can delay completion and add cost.
Questions
People also ask
What is the difference between a divestiture and a spin-off?
In a divestiture the unit is normally sold for cash, while in a spin-off the unit becomes a separate company and its shares go to existing shareholders.
Why do stranded costs matter?
Central costs that supported the unit do not disappear when it is sold, so the remaining business can see its margin fall until those costs are cut. Good planning identifies these costs before the sale and sets a target to remove them.
Does a divestiture always mean the business is struggling?
No, because healthy companies often sell units that no longer fit their strategy to focus capital on stronger areas. A well-run sale can create value for both the seller and the buyer.
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