In the modern world, so many organizations are using several strategies to enhance their performance and improve their competitive advantages. Some of the mostly relied on strategies are divestitures or mergers & acquisitions. The two though somehow different have some similarities. Mergers and Acquisitions refers to two companies combining together to form a single entity or one parent company absorbing another company and completely eliminating the entity of the target company to incorporate its operations in the parent company.
Divestitures or rather divestment on the other hand is the opposite of investment and refers to the reduction/addition of the firm’s partial assets or complete sale of an existing business by a firm due to some ethical or business reasons. One of the reasons behind the above corporate strategies is to increase the firm’s chances of survival in a market environment characterized by many competitors and in particular perfect market industry. This is because every firm is trying hard to retain a significant market share and increase its shareholder’s equity. In the recent past mergers & acquisitions and divestitures are increasingly being used by the organizations to strengthen their operations and increase their marketing penetration as well as expansion of their business activities.
No single firm is willing to be left behind in formulation and implementation of strategies that will enable it beat its business rivals in provision of the expected services or goods. The following brief report tries to focus on divestitures and how various firms, its advantages, risks and other associated financial aspects, have used it.
The Concept of Divestitures
As pointed out earlier, the principal goal underlying divestitures is the improvement of business performance and gaining of more competitive advantages in the market. Divestitures take place in four different but interrelated forms. Firstly, there is complete sale of firm’s entire division or unit to another firm for cash or stock in the acquiring firm.
Spin-off divestitures involve the entity’s owners being granted new stock that represent different and separate ownership rights in the specific unit that was divested. Once divestment has been accomplished, the specific unit creates its own directors and becomes a separate company. The shareholders own shares from two different companies rather than one but no cash is transferred in the entire process.
In curve-out divestiture, the firm’s minority interest in a subsidiary company is disposed to new stockholders therefore, the parent company gains new equity financing and end up retaining the control. Finally, there is liquidation divesture in which the assets of a particular unit are sold off piecemeal instead of as an operating entity.
The divesture entails restructuring of the company’s operations to improve the overall performance of the firm. This means the divested firms aim at changing the corporate strategy as well as improving the performance.
Reasons for Divestitures
There are several reasons behind carrying out divestitures. A particular firm may opt to sell part of its businesses that are not part of its core operations in a move seen to make the firm concentrate on the activities that it can pursue better. This can be linked to specialization.
When an organization realizes that, its inefficiency is caused by incorporation of some activities that the particular firm cannot operate effectively, it sees no reason for the retention of those activities. An organization may be too indebted and is facing financial constraints such that it cannot repay the dues within the stipulated time period. In such a situation, the business entity may too opt to sell some of its businesses for the purpose of generating the required funds.
When it is realized that the liquidation of an entity is likely to bring out more returns than the overall assets combined, it is advisable to sell what is worth more to be liquidated than retaining the assets. Creation of financial stability is another reason that can motivate a firm to divest its businesses. This happens when some section of the firm is too volatile and unpredictable that it may pose some risks to the company.
The best thing to solve such a problem is to get rid of the section that is likely to be affected by unforeseen economic fluctuations. Failure of some firm’s sections to perform as expected may lead to divestitures in order to cushion out the organization from incurring unnecessary excessive costs.
Motivational Objectives for Divestitures
Any firm interested in executing divestitures does that as a result of specific motivational objectives. The desire to attain broadened global presence is one of the motivational goals making organizations to change their business activities and distribution channels. This happens when a firm wants to extend its distribution channels over a wide area or to operate in other foreign countries.
Due to the fear of competition from other firms in the country where the parent firm wants to operate, it may decide to collaborate with another target company in the foreign country to make its market penetration a little bit easier. Global presence can be also achieved when the acquiring firm buys some businesses from a global known operating firm that has maintained its good reputation and goodwill for a long period of time.
An existing firm may also divest its business activities through additional acquiring of subsidiary branches to achieve geographical expansion. Geographical expansion is important to a firm as it helps it increase its popularity over a wide area hence improving the marketability of its goods and services and wider penetration.
As witnessed out by many firms that underwent divestitures in the United States in the year 1998/1999, some firms were aiming at achieving economies of scale. Economies of scale occur when a firm spreads its fixed costs over a wide number of units produced by a firm. The unit per cost of production reduces and the firm is in a position to minimize its costs to a greater extend thus leading to higher profitability on the part of the company.
However, this is only possible when a given organization is in possession of some production equipments (fixed) that are not optimally utilized and there is room for improvement of the productive capacity of such assets. Marketing integration can induce a firm to undertake divestment. This might be either vertical or horizontal integration. Horizontal integration is similar to expansion and takes place when a firm sells or buys some businesses of another one that are in the same level of production. The idea here is to reduce the operating costs through economies of scale concept. The mostly adopted integration in divestment is that of vertical integration. In most cases, this involves relatively large firm buying businesses of relatively smaller firms and the two should be in the same line of businesses but in different production levels.
Requirements for Companies Anticipating to Execute Divestment
Any entity anticipating to execute divestiture need to meet certain financial requirements before venturing in divestiture. This includes both the parent and the target company. A company need to have a better understanding of each other’s financial performance and its ability to have a positive impact once the divestment has been successfully implemented.
This is in particular the recent performance of the firm in question. This is indeed if the overall goal of improved performance is to be achieved. The parent company is actively concerned in confirming the business activities it is likely to acquire will lead to improved financial performance of the newly created entity and will expand the shareholder’s equity.
Proper analysis of the business activity of the other firm is essential as it gives an assessment of the firms’ compatibility and the possibility of achieving the desired goals after the divestment. This is due to the fact that not all the divestures give out the desirable outcomes. A firm need to establish the nature of ownership of the other interested firm in terms of shareholder’s right to determine their current rights and how their ownership might be affected together with the capital structure of the firm once it has been acquired.A slight miscalculation might end up bringing unimpressive results to the company and subsequent incurring of huge losses. This is why it is fundamental for the Chief Executive Officer (CEO) to involve the firm’s key associates before making any recommendations and discuss on the type of divestiture to adopt. This corporate strategy needs to be given too much attention and deep thought before any decision is made.
Advantages to the Divesting Company
The divesting companies benefited much since the divestitures led to generation of the required cash to cater for the firm’s financial needs. Properly structured divestitures offers an opportunity to distribute the highly valuable assets and other operations to the firm’s shareholders without necessarily affecting taxable event for the divesting company and its stakeholders.
The companies were able to get rid of some parts of businesses that were rendering their inefficiencies and thus enabling them to move forward with their efficient operations. Once the divesting firms have divested the anticipated units, the employee performance could be significantly recognized since their efforts could only be diverted to those units in which the companies could perform better.
The improved employee performance can be attributed to the fact that when a unit is being divested, the parent company may opt to retain the key productive employees and sell the divested unit with less efficient and unproductive employees. Another advantage that accrued from the divestment on the part of the divesting company was that their existing good reputation that could be ruined by the continued poor performance was avoided by retaining only those units in which the companies could produce better.
Customer satisfaction and retention was also achieved and the divesting companies are able to deliver high quality products to their esteemed customers. Other advantages that were realized include preservation of shareholders’ value, maintenance of positive market reception and minimization of risks associated with inefficiencies.
Advantages to the Buying Firm
The advantages that accrue to the buying firm are more numerous than the ones accruing to the divesting firms. It should be noted that the buying firms are the ones that initiate the entire process. As it was observed on the results that were released after the divestures that the shareholders equity expanded and subsequent increase in the profitability of the firms.
It is quite evident that the firms’ competitive advantage has significantly increased and their performance improved relative to their competitors. Just like the divesting firms, the buying companies are having increased market share in the industry and subsequent expansion has led to the economies of scale. The operating costs have been reduced to a greater extend and increasing their future prospects.
The buying firms that pursued the divestures due to vertical integration motive succeeded in offering their products more efficiently. The overall advantages to the buying companies are more as compared to the advantages accruing to the divesting firms.