Doing divestitures that deliver value

Successful companies actively manage their portfolios of businesses, identifying those with the greatest growth prospects and divesting others that no longer fit their overall strategy. But divestitures are easier in theory than practice, and many companies don’t achieve the anticipated value from the transaction.

Nonetheless, divestitures—if done right—can help companies transform faster and emerge stronger. Our analysis of US divestitures from 1998 to 2017 found that many sellers experienced higher growth in earnings before interest, taxes, depreciation and amortization (EBITDA) in the years following the divestiture. Such results varied over the years, but the share of divestitures associated with increased EBITDA growth has consistently risen, reaching 60% in 2017 as companies shed non-core and underperforming assets that dragged down valuation and used proceeds from those sales to fuel growth.

Divestitures create value for companies in times of economic uncertainty as well, our analysis found. Those that divested in previous recessions were able to focus on their core businesses and boost cash flow following the sales, especially companies that were under earnings or cash flow pressure. In one instance, those with less than 10% EBITDA growth, including those with negative growth, two years before the divestiture saw relative returns of 8% in the year after the sale.

Our research shows that, overall, divestitures that saw higher returns, share three key factors.

Transaction size

The bigger the transaction, the more likely the seller will benefit. For sellers who saw accelerated EBITDA post-divestiture, the median transaction price was nearly double the price for sellers that didn’t see faster EBITDA growth. We found that a seller parting with a larger piece of its company stands to generate greater proceeds to reinvest in core businesses, bring more scale to corporate development opportunities, and free up time, capital and other resources to invest in areas where the business is better positioned to grow.

Cross-sector transactions

Companies that sell assets to acquirers in other industries tend to perform better. After a cross-sector divestiture, 58% of sellers saw higher EBITDA growth, our analysis found, compared with only 42% of those that sold within the same industry. Companies in many industries in recent years have increasingly considered cross-sector acquisitions. The strategic rationale for these deals includes limited growth opportunities within their own industries and the need for new technology or other assets. That has expanded the pool of buyers for divestitures. Sellers should be mindful of this larger universe so they can be in a stronger position to secure higher premiums and negotiate better terms.

Buyer location

US companies can realize growth after a divestiture regardless of the acquirer’s nation of origin. Cross-border deals can present various regulatory, logistical and other challenges, but our analysis found that roughly the same percentage of companies that divested to non-US buyers saw increased EBITDA afterward as those that divested to US buyers. In both cases, more than 60% saw growth. This means companies have options beyond domestic buyers and can still generate positive outcomes.

How to capture value and transform your company through a divestiture

While many companies look to acquisitions as a path for transformation, divestitures can be instrumental in an organization’s evolution or reinvention. If you proactively consider a divestiture — as opposed to reacting in a time of distress — you’ll have a better chance of seeing positive returns, as you’ll be better able to sell on your own terms. And those returns can help accelerate change through investments in critical areas, including new technology and workforce training.

But preparation is crucial. To minimize risk of losing value in a divestiture and realize the full potential for transformation, understand and address these important areas before committing to a transaction.

Be proactive and agile in your divestitures strategy

Companies should proactively review their portfolio of businesses to better understand their capabilities and interdependencies. To capture the greatest value, you need to clearly define the perimeter or assets for sale and make sure they’re packaged correctly for the market. But while you may have an initial view of what you want to sell, remain flexible in case a buyer doesn’t want certain assets that you want to divest or is interested in assets you didn’t originally contemplate selling.

Position your assets. Divestitures often, but not always, involve underperforming businesses. You can improve an asset’s position by presenting various scenarios under which you believe the asset might have performed or could perform better. Different conditions — such as economic cycles, industry shifts or customer behaviors — could produce different results. This should be done early in the process to take advantage of your intimate knowledge of the business.

Think through multiple scenarios. To attract an optimal buyer, you need to plan how you will address buyers’ questions under different scenarios. Anticipating what buyers will want to know will help move the divestiture forward while also enhancing the value of the deal. Take, for instance, divestitures that cross industry lines. Buyers from the same industry as the seller likely will have different needs than those from a different sector. Same goes for private equity buyers, who may have different operational needs than a corporate buyer. All this requires preparing for multiple scenarios if you want to attract more buyers and lock in a sale.

Separate key functions early. A divestiture’s value can hinge on the time it takes to close the deal, especially during the separation phase when all parties need to address how back-office functions—from finance to human resources to IT—will separate from the seller. If the process drags on, it’s likely to diminish the deal’s value. Companies can expedite the separation phase by starting early, even before a buyer shows interest. By segmenting key areas of the business in a way that doesn’t impact operations if a sale doesn’t happen, you will be well positioned to reduce the time between deal signing and separation of assets.

Consider where value can be gained

Difficult economic circumstances require a refocus on generating appropriate returns, and divesting companies must have the discipline to be active sellers. This means conducting a thorough review of the asset in play and being vigilant about its true value. A business unit that is performing well clearly should command the appropriate price. But one that isn’t generating the expected returns shouldn’t be shortchanged out of hand and also deserves rigorous diligence.

Don’t leave diligence to buyers. In a divestiture, potential buyers will conduct their own due diligence to identify areas of concern and contingencies that should be accounted for in the purchase price. Be proactive and anticipate these areas of concern. By conducting sell-side diligence, you should be able to identify issues beforehand, putting you in a position to address these areas or formulate a negotiation strategy to help extract the most value from the deal.

Monetize tax assets and optimize tax structure. In most cases, involving the tax team in a planned sale’s early stages will enable sellers to create additional value through the development of an execution strategy that results in enhanced after-tax sale proceeds. In addition to identifying and resolving possible tax risks that could lower a buyer’s assessment of deal value, sell-side due diligence can help identify, quantify and substantiate the quality of tax assets (e.g., “step-ups,” tax losses and credits). Such tax assets can drive a seller’s ability to create additional deal value by conveying such assets to the buyer or by using them to enhance the amount of after-tax cash flows realized in the sale.

In addition, divestitures require careful and onerous structuring to unwind commingled business assets/entities and package the assets to be sold, often across multiple countries. Developing an optimal tax structure that minimizes tax leakage with the lead time needed to execute is imperative to capturing deal value within compressed timelines. 

Assess the financial implications and requirements. It's critical to assess what financial information will be needed as you embark on the divestiture of your business. Developing the right GAAP carve-out financial statements is vital as the deal process unfolds. From defining the appropriate documentation to putting together support staff, it takes strong operational and industry expertise to guide a smooth transaction. Even in situations where audited GAAP carve-out financial statements may not be required due to regulatory requirements or contractual purchase requirements, oftentimes sellers will prepare them for financing purposes or as an anchor to deal financial information, which provides sellers and buyers with confidence and increased comfort with the deal information provided.

Explore where and how operations can be optimized

While choosing the right asset to sell is a clear first step, most companies lose value as they begin to take action. This involves balancing the management of retained and divested businesses, especially as it relates to talent. Sellers must take steps to proactively manage expected lingering costs or disruptions when transferring assets to the buyer. These costs can include expenses related to separating the business, including redirecting IT systems as well as stranded costs. Sellers tend to underestimate these costs. If not managed properly, they can unintentionally bog down operations of the seller’s remaining business and undercut the value of the deal.

Set up your remaining company for growth. Using proceeds from the divestiture, sellers have an opportunity to accelerate change and drive growth across the rest of the company. This starts with reevaluating operations, such as supply management, customer service, warehousing and other areas. Identify what’s changed for good and how the business should respond. This could involve managing cost containment in a different way that doesn’t harm the business or revisiting strategic priorities to identify areas that will drive growth going forward. Leadership will need to think differently, as costs that were once fixed, such as office space, may have become variable. Sellers have an opportunity to reconfigure their workforce and adjust their priorities to compete in different ways going forward.

Negotiate a transitional service agreement (TSA). TSAs help both buyers and sellers manage separation costs and disruptions during the transition period. For sellers, the challenge with these contracts will be negotiating the best service terms possible since TSAs can become costly. You will need to agree with the buyer on an exit plan that includes a centralized way to update executives on progress – a process that could also present opportunities to exit the TSA early. Moreover, treating the TSA’s end date with as much rigor as the divestiture’s close date will be critical to retain the deal’s expected value.

Make the most of your people. To enable a smooth transition, be sure to pay attention to talent and put the best people in place for the program and for new roles while you focus on managing employee costs. A PwC survey found that 60% of executives said their companies lost key personnel during the TSA period. Employees may look to leave the company if they know their only purpose is to support a TSA or if they know they will eventually work for a different company. You will need to develop a plan to retain talent, which should include incentivizing employees to produce the highest possible returns.

Bottom line

Leveraging a transaction for transformation isn’t easy, and sellers who fail to adequately prepare before a divestiture face even longer odds of realizing value. Success depends on being a prepared seller — not only for a particular deal but for strategic divestitures as a whole.

  • With strategy, position your assets, think through multiple scenarios and begin to assess which key functions need to be separated early.
  • With execution, don’t leave diligence to buyers, assess financial implications and quantify tax attributes to simplify negotiations and establish value up front.
  • With operations, set up your remaining company for growth, negotiate a transitional service agreement and make the most of your people.

Positive returns are possible for companies that look across their portfolios of businesses and carefully assess how and where a divestiture can deliver value. By acting instead of reacting, a divesting company can chart a clearer course for transformation.

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Michael  Niland

Michael Niland

US Divestitures Services Leader, PwC US

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