In times of uncertainty, what are the right reasons to divest?

This article was first published to betterworkingworld.ey.com.

The EY Global Corporate Divestment Study reveals that being reactive to disruption isn’t always the best portfolio management strategy

Geopolitical uncertainty is on the rise, while technological disruption continues to transform entire business models. Some companies are now faced with competitors they never saw coming this time last year. Throw a low-growth environment into the mix and portfolio and divestment strategies become that much more critical to long-term business success.

The need to divest

The EY Global Corporate Divestment Study – which analyzes how to approach portfolio strategy, improve divestment and future-proof remaining business during massive market disruptions – finds that:

  1. Nearly half (43%) of companies polled planned to divest in the next two years.
  2. Macroeconomic volatility, driven by changes in like oil prices or exchange rates, is the biggest external market force driving companies’ most recent major divestments (62%).
  3. But executives say that risks/opportunities related to technological change (50%) and geopolitical uncertainty (39%) will weigh more heavily on divestment decisions in the year to come.

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Feeling pressured to move quickly, companies are selling off non-core or underperforming businesses to fund growth and realign their portfolios. This divestment looks set to continue.

Making informed choices

However, the study also found that under certain circumstances, divesting due to immediate political or economic concerns could be the wrong move:

  • Companies that divest because of geopolitical uncertainty are 31% less likely to achieve a sale price above expectations.
  • Those that divest because of macroeconomic volatility are 20% less likely to deliver a favorable valuation.

The report also unearthed a worrying knowledge gap. While more and more companies respond to external forces, most don’t fully understand the impact these forces could have on their plans for growth. In fact, 53% say understanding the business impact of new disruptive forces is among their key portfolio review challenges.

On the other hand, companies that divest because of risks and opportunities prompted by technological change are 21% more likely to have received a higher sale price than expected. That could be because they have taken time to observe how competitors’ innovations unfold before reacting. And in addition, the market may have responded more positively to a rational, strategic assessment of long-term likelihoods, rather than a reactive sale in response to short-term uncertainties.

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Four key questions to ask when considering a divestment

  1. Are you divesting based on strategic reasons or disruptive forces? In the face of both market disruption and impatient shareholders, the best approach is to review your portfolio more frequently and use analytics to make more effective, quick decisions. But companies also need to take the time to prepare a business for sale – or the likelihood of failure increases. The survey found that companies that prioritize value over speed are 63% more likely to achieve a sale price higher than they expected – and actually tend to complete deals sooner than those who prioritize speed.
  2. Do you know what will change your valuation tomorrow? Perhaps the most value-damaging action a company can take is holding on to an asset too long. Understanding your performance, opportunity and perception gaps through rigorous portfolio reviews is the best protection against value erosion. These reviews should be fortified through descriptive, predictive and prescriptive analytics.
  3. How should you take action in disrupted markets? – Thinking like a buyer is critical to divestment success. Sale preparation is vital, even for the best-performing unit. And especially in disrupted industries, being flexible about the scope and structure of the deal can be the ultimate key to success. The survey found that companies that understand the value of alternative structures to potential buyers are 95% more likely to get a sale price higher than they expected. Conversely, 48% say lack of flexibility in the structure of a sale is a significant source of value erosion.
  4. How can you improve the agility of your remaining business in the new digital economy? – Even after a successful divestment, disrupted markets provide significant opportunities and risks for enhancing the value of the remaining businesses. It is essential to optimize the remaining company’s operating model and invest in agile technology platforms to make it easier to transact. For instance, tax policy is constantly in flux around the world, with significant changes over the last decade in most markets following the 2008 financial crisis. Further reforms are likely, making it even more difficult to understand the tax profiles of businesses. 48% of companies say tax has become a bigger challenge to divestment execution over the last year.

Keeping focused on your long-term purpose

While external disruptions may trigger tactical change, the basis of key decisions – like what parts of the business to sell and what types of new assets to acquire – should always be the organization’s long-term strategy.

This means that organizations need to take a more holistic view of their capital decisions, regularly assess their portfolios to be able to respond appropriately, and assess current uncertainties against longer-term trends. Companies that divest because of internal measures, such as profitability, are 25% more likely to have a successful divestment than those that divest because of external forces.

While many leaders and managers feel under pressure to be seen to be doing something, making tactical decisions without the right knowledge or vision of how those decisions will drive longer term strategic goals could be as risky as doing nothing at all.

EY Legal Services Contacts:

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Richard Norbruis – Global Transaction Law Leader

 

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Rutger Lambriex – Global Corporate Law Leader