A growing number of companies are expected to sell parts of their business in the next year, but only about one in five of the divestments is likely to be fully successful, according to a new report.
EY conducted more than 800 interviews with executives worldwide. Nearly half of the respondents (45%) recently divested or prepared to divest a business that didn’t reach performance criteria, the EY study found. Funds raised from the divestment were most likely invested in a company’s core business (34%), in new products or expansion into new markets and locations (23%), and in an acquisition (17%).
Fifty-four per cent of executives expected an increase in the number of strategic sellers in the next 12 months.
Many companies planning a divestment think they need to complete deals quickly to adjust to changing customer demand, new regulations, or rising costs in certain markets. “Half of businesses are willing to sacrifice value if it means closing the deal faster,” Paul Hammes, EY global divesture advisory service leader, wrote.
As a result, only 19% of divestments meet three key success criteria: the deal improves the valuation multiple of the remaining company, generates a higher sales price than expected, and closes faster than expected. About one-third of divestments (34%) meet one of the three criteria, and another 34% meet two.
To have a better chance of becoming a high performer, companies considering a divestment should be aware of the four key drivers behind a successful deal:
Accurate data drives good portfolio decisions. Executives said industry benchmarks, capital investment requirements, and consistently prepared profit/cash flow forecasts by business units are crucial to improve portfolio reviews. Also, 58% of respondents said they don’t conduct strategic reviews frequently enough.
The most critical analytical tools to get the information needed for portfolio reviews include scenario plays that model possible portfolio changes and their consequences; regression models that show how business units would respond to changes in pricing, advertising, promotion, and innovation; and big data technology that analyses non-financial metrics such as social media sources to see how consumers receive products.
Sustainable performance builds value. Operational improvements that create sustainable performance merit higher valuations. To prepare a business for sale, operational improvements one to two years ahead of divestment may consist of optimising the product line, entering a joint venture to expand into a new market, or acquiring and integrating another company.
Initiatives that participants in the EY study found most important to create value before a business divestment were operational improvements to reduce costs and improve margins (40%), revenue enhancements (40%), and extracting working capital (29%).
Timely preparation improves execution. High-performing companies participating in the EY study were 50% more likely to have started preparation for the transaction on time than low-performing companies, but many companies don’t stick to the timeline to execute a sale. Forty-four per cent of respondents in the EY study said they would improve time management in the next divestment deal.
Other steps to improve the execution of a scheduled divestment include defining the perimeter of the business for sale and coordinating all business functions involved in the separation.
Be aware of the speed-versus-value challenge. Finalising a deal quickly requires different steps than maximising value does, but companies that focus single-mindedly on speed or value frequently omit necessary steps to achieve either one.
When companies focus solely on time, they often take shortcuts and release incomplete or inaccurate information. The resulting uncertainty can cause buyers to drop out or make a lower final offer. But companies that hold off on signing a deal to get a higher valuation could waste time and energy only to end up without a buyer.
Related CGMA Magazine content:
“Five Ways to a Better Divestiture”: Strategic divestitures, as opposed to recent cash-grab shedding of assets, are foremost on the minds of global executives, an EY report shows.
—Sabine Vollmer (svollmer@aicpa.org) is a CGMA Magazine senior editor.
