An increasing market trend involves corporations performing a portfolio review to decide which parts of their business are wholly aligned with the overall corporate strategy. Often, following the review, corporations decide to divest or spin off the business units which are not critical to delivering on its strategic plan. The first expectation may be companies are divesting weak business segments, but some corporations have divested profitable businesses in order to simplify and re-align management’s focus on growing its core businesses. In other scenarios, companies have used these actions as a defense against a challenging environment or active investor base.
Pushed Towards Divesting
Darden Restaurants, the owner of Olive Garden and other dining chains, has been in a multi-year struggle with activist investors. Darden initially responded to activists by divesting its Red Lobster brand in 2014, which was met with waves of criticism and was partially responsible for Darden’s entire board to be replaced.
Recently, Darden spun off a sizeable portion of its real estate into a real estate investment trust. The new board believed owning the real estate assets offered no strategic value for Darden, but it can now use the funds raised to invest in the growth of its principal dining businesses.
More often than not if an organization decides to spin out or divest a part of its business it is a specific operating segment or business unit. The Darden Restaurants example is unique, because the organization solely spun out valuable assets. However, the end goal is the same; Darden removes parts of its business not driving the core strategic growth of the company.
Currently, the two leading strategies are divesting segments deemed to be low-growth or capital intensive, and divesting segments not aligned with a pre-defined core sector, such as industrial or healthcare.
Divesting to Focus on Growth Strategies
When an organization decides to invest in only its high-growth segments, it may choose to divest underperforming business units or ones with limited growth potential. As Ernst and Young noted in its 2014 Global Corporate Divestment Study, the cause for the divestment is not always the same and depends on the industry. Consumer-focused companies may find brands or product lines slowing due to a change in trends or consumer tastes. In the technology space, new innovation, like the new trends of big data and cloud computing, may cause a rapid shift in the entire industry.
One key example is consumer products leader Nestlé, who announced plans two years ago to move away from some of its underperforming business units. It was recently in the news for its divestiture of its Spanish frozen foods brand, La Cocinera. This move followed the sale of its PowerBar nutrition business and its divestiture of most of its Jenny Craig brand. Instead of investing additional capital into these businesses Nestlé has chosen to invest in its leading brands including Nescafe coffee, KitKat chocolate, and Purina PetCare all of which have grown well since announcing its divesting plans.
IBM altered its strategy to move away from businesses units with minimal growth expectations even if they were producing steady revenue streams. IBM recently completed its divestiture of its semiconductor technology business to GLOBALFOUNDRIES. IBM actually has to pay GLOBALFOUNDRIES over $1 billion to operate the business unit. This move followed IBM’s sale of its x86 server business to Lenovo, which closed in late 2014.
The technology giant has chosen to trim these large, but slow growing businesses in order to increase its investments in big data analytics and cloud computing. IBM’s recent performance has been stagnant, but its focus on high growth areas is providing it with a foundation to move back towards growing the business.
General Electric’s strategy is different from previous examples. GE is choosing to divest non-industrial related segments to generate funds for reinvesting in its core business or for returning cash to shareholders. Management recently announced it intends to generate 90 percent of profits from the industrials sector by 2018, compared to 55 percent in 2013. In June, GE agreed to sell its European finance business for $2.2 billion and earlier in the year it sold its private-equity lending business for $12 billion.
Future of Divestitures
Divesting has always occurred, for like when General Electric under Jack Welch became famous for selling any business where they were not a market leader. However, the attitude towards divestitures has changed. They are no longer seen as an option for culling weak business units, but are now nearly viewed as a necessity in order to kick start growth in the core business.
In Ernst and Young’s 2015 study, Steve Krouskos, Ernst and Young Deputy Vice Chair of Transaction Advisory Services, is quoted saying, “Even as the M&A markets experience their first real revival in nearly a decade, divestments remain at the center of a company’s growth strategy. Why is this? Because divestments are vital to portfolio optimization — they are at the heart of funding future business growth. Letting go is how a company grows.”
Ultimately, the rate of divestitures is not expected to slow down in the upcoming future. Ernst and Young said over half of the executives it surveyed are expecting the next twelve months to witness an increase in the number of strategic sellers.