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[Music] what causes Executives to delay or avoid divestitures even when it is evident
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that these transactions will help their companies and in some cases save them from decline or even Extinction
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most fundamentally divestitures suffer from Bad public relations they tend to be viewed as a last resort to use when
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something is going wrong like an acquisition that isn't working out or a business whose performance is
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deteriorating perceived Financial constraints can impede divestitures as well generations of Executives have been
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advised to milk not divest their cash cows after all how does one justify eliminating a predictable source of cash
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especially a source of cash for which potential buyers might not pay an acceptable price
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can also deter divestitures what does it mean to get rid of the Legacy business around which a company was built
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especially when that company's name reflects those original operations or when that divestiture will cost many
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long-time employees their jobs [Music] welcome to the ripple effect the podcast that takes you on a journey through the
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minds of work and faculty I'm your host Dan Loney and in each episode we'll be
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diving deep into the inspiration behind the groundbreaking research that Wharton
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professors have conducted and exploring how their findings resonate with the world today we'll be covering a diverse
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range of topics bringing you the latest insights and knowledge that you can apply to your life into work so get
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ready to dive into new ideas with the ripple effect while agreed to be joined by Emily
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Feldman Wharton management Professor Emily great to talk to you again how have you been hey Dan so good nice to be
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here great to great to be with you great and so obviously an important book that
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you have written uh talking about divestitures I should say the title is divest Insurance creating value through
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strategy structure and implementation give us a little bit of the back story on what it was that drove you to want to
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do a book on this uh on this segment yeah thanks so it's a great question and
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you know this is a topic that has taken a lot of importance in my in my research
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uh over the past you know 15 years that I've been at Wharton now so I actually
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started studying divestitures when I was a graduate student back in uh in my PhD
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program and you know just kind of recognized that these were understudied in the academic realm uh and so this
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kind of spiraled into just a bigger research agenda that I you know continued pursuing throughout grad
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school and then when I got to Wharton as well um and you know as I kept working on it
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the more I worked on it the more that I realized that you know among practitioners among
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um you know consultants and bankers and you know sort of the World At Large right these were sort of under
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recognized as well and so I I decided that you know the time had come to try to really you know produce a
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practitioner-oriented book that could speak to these uh these issues and you know talk about you know what some of
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the misconceptions around these transactions might be as well as you know some of the realities of of what
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they do and and how they work and how they can really help companies uh in their strategic objectives so that's
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really what motivated me to work on this book so obviously for a lot of the people that are kind of in the banking
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sector this is a very important topic for them but for the public at large what is it that in doing this book you
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want to try and bring to light do you think yeah for sure I think it's a very
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simple but important message right so you know the world focuses on mergers and Acquisitions right you read a
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headline about mergers and Acquisitions it's flashy it's sexy right synergies
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growth opportunity right all these great happy um you know things that are associated
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with these these expansionary transactions and it's quite the opposite when you read about divestitures if you
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even do read about these transactions it's much more you know oh the company
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is having problems or business is failing or a merger didn't work out or something went wrong and so you know I
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think the message of these are not just sort of failures or strategies or transactions to do when something has
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gone wrong but rather that they provide real strategic opportunities for companies to focus and realign
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operations to reconfigure resources and to achieve you know operational and uh you know stock market performance
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improvements is really the message for for kind of the public at large and I think that's a very important message
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given the misconception that I started out with right and so the the the term divestiture give us your best case
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explanation for the public at large as to what a divestiture truly is yeah for sure and that's that's a really
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important question right so a divestiture you know plain and simple is a transaction that a company can use to
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remove one of its business units a subsidiary a division that it might have us as part of its operations right so
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basically we're talking about getting rid of something that's part of a company's existing operations
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um and so there's there's various different ways and I'm sure we'll get
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into this later but there's various different ways that companies can uh accomplish divestitures or do
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divestitures right so you could sell a business you could spin it off you could do other types of transactions but in
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broadest terms right a divestiture is the removal of one of those business units
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are there and there are a variety of as you said different elements different types out there but are there ones that
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seem to be more popular more attractive than others yeah definitely yeah yeah so
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uh popular yes attractive is a trickier question but I'll try to answer each of
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those right so by far the most common uh way that companies will divest is to sell something right so I have a
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business unit that I don't want anymore or that I'm trying to get rid of so I
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sell it to another company or I sell it to private Equity or something like that
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right so sales actually account for about 95 percent of all divestiture activities So Far and Away the most
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common um spin-offs are the second most common right so in a spin-off what happens is
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that a company issues shares in the business unit that it is divesting to its existing shareholder base right so
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if you're a shareholder of the parent company you automatically will get shares in the spin-off company in the
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business that's being divested so it's not the same thing as a sale but rather
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what's happening is that the spun off business becomes a its own publicly traded company that's separate and
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distinct from the parent company that it used to be a part of so spin-offs account for about two to three percent
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of all of all divestiture activities so much less common than uh than than sales
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but but still the second most common and then there's a whole other range of much
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much less common divestitra structures like reverse Wars trusts or joint ventures Equity carve outs right and the
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like that can be used to accomplish different things and this ties to your comment about kind of attractiveness of
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these different types of divestiture structures so what's really interesting
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and and I think one of the biggest insights that I got just in the course of researching and writing my book was
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you know actually each of these transaction types can really accomplish very specific Financial objectives in
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terms of generating cash in terms of managing tax burdens in terms of uh you know getting an acquirer potentially to
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pay for synergies and so on and so forth so it's not to say that one is always
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more attractive or less attractive than another or but rather to say that these transaction types or these structures
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need to be used depending on what it is that the company is trying to accomplish
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through that transaction so if attractiveness may not be the proper word would it be easier to say
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that when you're talking about each of these there are probably pros and cons
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that go along with with each each different type yes very much that's a great way to put it
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speaking specifically like lets you spin-offs as the example when you're talking about spin-offs what are some of
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the pros and cons that you end up seeing yeah for sure so the biggest one far and
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away is that these can be tax-free transactions under certain circumstances right so they're a great way actually
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for companies to try to manage the tax burden from uh from divestitures and the easiest way to see that is to contrast
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them to sales right so if you sell a business to another company you're getting cash right for some kind of
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consideration but usually cash and so that's going to be a taxable transaction
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but because in a spin-off there's no cash that's being generated You're
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simply issuing shares in that business unit no cash is really changing hands and so these are these can be tax-free
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transactions depending on whether you've met certain kinds of conditions right so
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that's a huge advantage of a spin-off relative to a sale for example one of the biggest disadvantages of uh
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spin-offs of course is the potential for conflicts between the company that's
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doing the divestiture the parent company and the business that's being spun off
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the spin-off company and the reason is that in most cases the parent company will direct the process of going through
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that spin-off and so a lot of times the spin-off company doesn't have much of
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any involvement in terms of how it's being set up right so whenever things go
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wrong or maybe not whenever but oftentimes when things go wrong after the spin-off that is used as a basis for
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saying oh well I didn't have a I didn't have a say in this right so that's where
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the conflicts really start to come up between these types of companies so that would be a big disadvantage of spin-offs
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relative for example to a sale where this would not necessarily be the case right and so yeah you can go through
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each of these transaction types and sort of explain like relative to one another
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you know what are the advantages what what are the disadvantages and my book kind of goes through and sort of lays
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out these uh these considerations but it's actually really fascinating um you know strategy in and of itself
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right to sort of say well we have to think very carefully about you know what are the objectives that the specific way
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that we're going to do the divestiture can accomplish and match accordingly right and and there's that decision
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process between the potential idea of selling an entity in comparison to maybe spinning it off and again it's going
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through that process the corporate structure going through that process to understand which might be the best path
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to take it yeah very much and I I really hope that one of the effects of my book
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is to help to maybe um mitigate a little bit of the the the storytelling that goes on around these
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transactions right so for example a lot of times what I'll hear when I'm talking
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to companies is oh I don't want to do a divestiture because if I divest this
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business I'm going to have a huge tax bill right and that might be true if you're selling it but have you thought
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about these other modes of divestiture spin-offs and perhaps others as a way of maybe not having a huge tax burden uh
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when you're doing the sevestiture right so I think that there's a lot more
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element of choice maybe than managers realize um when when it comes to undertaking
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these transactions so I hope my book starts to correct some of those uh some of those ideas but when you think about
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where what a company is at a particular moment and where they would like to go I
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think a lot of the discussion ends up around the value of the company but also the performance of the company as well
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correct correct yeah and I think that's another really important aspect so we've
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been talking about structure so far in terms of how companies can do divestitures but I think what you're
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kind of talking about is is sort of the strategy element which is you know why why would we even think about doing
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these transactions in the first place what are they going to help us accomplish and how might they help us to
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improve our performance right and performance in terms of operating performance or perhaps share price stock
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market performance and so you know the whole first part of my book actually goes through and you know talks about
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these different strategic objectives that divestitures can help companies achieve and why they might be valuable
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under these different circumstances Are there specific examples you've seen where that component of focusing on
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performance or or that corporate value has played out that we've seen in the
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news oh very much yeah I mean I think we're seeing it very uh very intensively
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right now so for example one of the big strategic reasons why companies uh should and often do think about
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divesting is to improve corporate Focus right so this is basically the focus so if I may of of chapter two of my book
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um and so what I talk about there is okay so you have a company that has a number of different business units and
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perhaps you are having difficulty you know allocating resources to one of those areas perhaps uh the the number of
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different businesses that you have is confusing to uh external constituents like Securities analysts or investors
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perhaps There's issues of resource allocation and so on and so forth right so there's lots of different reasons why
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Focus might be desirable and so what my research shows first of all is that when companies do these
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Focus improving divestitures that we do actually end up seeing these performance
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improvements that we've been talking about and so you know we're seeing a lot
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of this right now actually so if you look at GE it's a great example uh so GE
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of course after you know a huge wave of kind of slimming down uh basically did the you know the final the final blow
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there uh in terms of breaking apart Healthcare Aviation and I believe Environmental Services is the third
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business if I'm not mistaken so breaking those three apart and allowing each of
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them to kind of stand on their own to feed and have their own corporate Focus or Johnson Johnson is another great
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example or uh Kellogg's from last summer is a third grade example right so you
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know cereals has a very different uh growth trajectory and profit margins than uh snacks right snacks are better
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basically and plant-based foods are you know very uncertain right depending on where consumer tastes goes so it's sort
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of hard to say um and so you know how do you keep those businesses in the same and portfolio
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right the idea of sort of separating and allowing each of them to be independent
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is kind of a key motivation for for the for for those three kinds of transactions it also seems like we were
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also seeing more consideration on these potential divestitures because of the regulatory side and and I think that's
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an area where a lot of people will will look to focus especially if there's more
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and more transparency around the company that they can truly understand what the
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company is doing and why they're trying to do it very much yeah and so you know
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regulatory regimes have changed obviously very very significantly right so for example right now we're in an era
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of much more robust Anti-Trust enforcement uh and of course Anti-Trust and competition is a is a huge
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motivation for divestitures uh when companies do M A's or certain M A's a
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lot of times they'll be required to divest certain businesses as part of those transactions right to try to
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mitigate anti-competitive or potentially anti-competitive effects that might result uh from their M A transactions so
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I imagine that we'll see a lot more activity in terms of trying to mandate divestitures from a from a regulatory
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perspective along that Dimension another area is National Security so cypheus is
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another reason why companies will often be required to divest certain Assets in response to kind of managing National
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Security interests right so another area of huge importance right now in the regulatory environment so so absolutely
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and I think this point is an important one because it helps to distinguish between if you will kind of the pure
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strategy motivations like we're doing a divestiture to achieve a particular strategy versus being required to do a
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divestiture perhaps as part of something else that's going on maybe from a regulatory perspective so I think it's
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it's it's interesting to distinguish between those uh those two aspects but
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what do companies have to look at when they're considering a divestiture to make sure that the process goes smoothly
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for them they don't want to obviously you know hit a pothole along the way to
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use that terminology uh and cause a significant negative impact to their bottom line yeah it's a great question
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and so you know implementation with any kind of corporate transaction is tricky right so I think this is probably the
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biggest Pitfall that we see with mergers and Acquisitions uh and and equally so perhaps when it comes to divestitures
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right the devil is in the details of of kind of managing implementation so when it comes to divestitures you
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know there's a lot of detail in the book obviously about the different things
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that companies need to pay attention to but if I had to highlight three I think I would say the following the first
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would be to try to you know be very clear about managing shared resources and shared liabilities that need to be
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divided between uh the divesting company and the divested business right so you know it's easy for example if you have
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something that's very clearly applicable to the divested business it just goes
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with the divested business after the divestiture but unfortunately the reality in many companies is that it's
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not that simple right and so a lot of times there are shared resources there are shared people there are shared
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functions like human resources that are hard to kind of disentangle shared expenses and so that process of
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disentangling is is complicated right so I would say you know don't underestimate
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the process of disentangling shared resources and shared liabilities and expenses and kind of manage those uh
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those carefully when it comes to divestiture implement education so that's one one Pitfall to watch out for
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the second would be managing cost structures right so on average when companies divest right what you end up
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seeing is that their sales decline uh by about 25 right so the average divestiture reduces a company's sales
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um by about a quarter right so that's kind of the average size of those transactions but what's interesting is
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that so you would think that the cost structure of those companies should decline after these transactions but
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what's really interesting is that they don't and quite the opposite the cost
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structure of the divesting company after these transactions increases by about 20
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percent so that is problematic right because basically divestitures need to be used as an opportunity to sort of you
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know cut the extraneous things that are no longer there but if companies are increasing their cost structure that's
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the wrong direction right so uh the second lesson that I would offer the second Pitfall that I would offer is be
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sure to manage costs carefully when uh going through these transactions because a lot of times you will end up with a
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bigger cost structure than you need or want after these transactions if you're
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not careful about it and then the third thing I would say is use divestitures as
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an opportunity to kind of reconfigure right and I think this is often underutilized as well right so in the
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sense of saying look you know what do we want to do differently after this after
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this transaction what do we not want to invest in what do we want to invest in that can help grow our business Beyond
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its existing boundaries and you know use that transaction as a catalyst right or
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an opportunity to kind of reposition the organization to go in that different strategic direction right it's not just
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a one-off like oh we're getting rid of something but rather it's something more
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in terms of saying we can we can reshape we can do something different after these transactions so that's the third
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lesson I would offer how frequent do we see now and maybe have we seen in the past uh when the
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potential of a divestiture occurs that it's more engaged a company is looking
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at a specific like segment line within a company in comparison to the larger company as a whole
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yeah so uh that's a good question so I think that you know with divestitures
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I'm I'm talking more about kind of the segments as opposed to kind of the
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company as a whole but you're right that companies can of course sell the entire
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entity to another organization and and that does happen right so I think that you know we we see um we tend to see
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sort of the full-scale uh full-scale types of sales right in situations of perhaps distress or you know sort of
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opportunities that need to be taken by by a different owner right so private Equity is a great example or private
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Equity is is um you know often utilized in these kinds of situations um so so I think that's an interesting
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distinction between sort of the more kind of corporate divestitures that the book is focused on versus kind of these
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full-scale uh sales of companies and again what is it that you would like the reader to to really take away from
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from reading your book yeah definitely so I was talking before about that under utilization right so I I quoted those
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statistics about how infrequently divestitures are utilized in comparison to their expansionary counterpart
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mergers and Acquisitions so here's the the killer statistic for me right if there's one takeaway this is what it
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would be if you look at the performance implications of divestitures versus mergers and Acquisitions we actually see
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that the divestitures outperform the M A's by two to three times in terms of
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their shareholder value and that different difference persists for up to 36 months after the completion of these
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transactions so that's the pathology right we don't do these transactions
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even though they actually create more value for companies than the transactions that we are actually
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focusing on right headline like wait we're doing the wrong thing pretty much
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when it comes to maximizing shareholder value improving performance right so divestitures need to enter the
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conversation right divestitures need to be as much a part of that conversation as mergers and positions are because
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clearly they are a lever that companies can pull uh to create outside shareholder returns for their for their
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companies well Emily thanks very much for your time all the best with the book uh enjoy
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the rest of your summer thanks Dan great to talk to you you got it Emily Feldman
00:20:38
Wharton management Professor her book divestitures creating value through strategy structure and implementation
00:20:46
thank you for listening to the ripple effect we hope you found this episode informative and engaging don't forget to
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