Sell Offs and Divestitures

Chapter VI
Situations for Divestitures

 Opportunistic: not intentional, only reactive

 Planned: recovers some capital
 Forced: recovers much less capital, since
divestiture is done after much erosion of
asset value
Factors involved in Divestment
Decisions
 Economic
 Psychological
 Operational
 Strategic
 Government
Economic Factors
 Inability to acquire/maintain market share: narrow
markets, intense competition
 Continual failure to meet financial goals/ targets
 Tax considerations
 Shrinking profit margins
 Better alternative use of capital
 Profits not in line with other divisions, divisions that
erode profits, cannot be restructured
Psychological Factors

 To eliminate psychological effect of a loser

 Bad apple theory
Operational Factors
 Lack of inter company synergy: not as earlier envisaged
 Labor Consideration: unrest, unavailability
 Competitive reasons: inability to face competition
 Management deficiencies: inability to put together an effective
management team
 Possibility of diversion of management efforts and time to more
productive areas
 Eliminate inefficiencies: spot the downtrend early, to avoid further
erosion in value, and to realize better proceeds
Strategic Factors
 Change in corporate goals/ direction
 Change in corporate image: better visibility
 Technological reasons: to move out of/ into more
high tech businesses/ move into growth oriented
areas
 Poor business/ strategic fit into core areas
 Market saturation: when investment required to
maintain market share> its cash generation
 Takeover defense: sale of a “crown jewel”
Governmental Factors
 To avoid antitrust litigations
 To confirm to environmental laws and practices
 Business may be forced to shut down/ be acquired
by the government in national interest
 Government’s own privatization program: in line with
its changed liberalization policies
Rationale for Gains of Sell-Offs
 Efficiency gains and refocus: reverse synergy
 Information effects: boosts share price when
transaction is perceived to enhance value of seller
company
 Wealth transfers: to shareholders
 Tax reasons: when unable to use carry forward
losses; or to take advantage of tax shield on
leverage due to restructuring
Types of Sell Offs
 Divestiture
 Spin off
 Split off
 Split up
 Equity carve out
 Divestiture:
 Sale of a portion of the firm to an

outside party
 Maybe a division, or a subsidiary or

an asset (tangible or intangible) sale

 Results in cash infusion for the

seller
 Spin Offs:
 Creation of a subsidiary company out of a division of parent

company and distribution of shares in this subsidiary to

shareholders of parent company
 On a prorata basis: so shareholding pattern in newly created

subsidiary company is initially same as that of parent company

 No cash infusion to parent company

 Additional shares given like dividend

 Results in direct benefit to shareholders of parent company

 New company gets listed and traded separately

 Tax issues

 “Pure play” advantage

 Disadvantages: may create selling pressure, no cash flow to

parent….
 Split Offs:
 New company is created to takeover operations of a

division/ unit
 Section of the shareholders of parent company may

be given shares in newly created subsidiary company

in exchange for their old shares
 Thus resulting in different shareholding patterns in

subsidiary and parent companies

 No cash infusion to parent company
 Split Up:
 Entire firm is broken down into two or more

companies
 Parent company thus ceases to exist

 Shares of new companies are distributed

amongst the existing shareholders of the firm

 Equity Carve-Outs:
 Partial offering of shares of a subsidiary, mostly through an IPO,

thus inducting outside shareholders, and requiring disclosures,

expenses
 Generates cash for parent

 Parent normally retains controlling interest, initially

 Subsidiary is listed and traded separately

 Benefits:

 Pure play investment opportunity, improved capital market access

 Strong growth prospects: potential to command a higher P/E multiple
 Creates independent borrowing capacity: additional financing sources
 Unique corporate culture of subsidiary
 Equity Carve-Outs (contd.):
 Process:
 Publicly announce the intention
 IPO process formalities
 Retention of IPO proceeds: sale by subsidiary (primary
offering), sale by parent (secondary offering): tax liability
accordingly
 After the IPO, parent may continue to perform some
corporate services for the carve out, on a contractual
basis
Divestiture Process
 Decision Process
 Financial Issues of Divestiture: if sale value> equity value of subsidiary’s
business
 Formulation of a restructuring plan: covering details of assets to be sold off,
retention of employees, facilities transfer etc.
 Approval of the plan by shareholders
 Registration of the shares and completion of the deal
 Assembling the divestiture team:
 Team of functional experts with a project manager
 Assemble the core team
 Formulate a definitive project plan with timetable, budget…
 Use of outside resources like investment bankers, law firms etc.
 Preparing the divestiture:
 Precise determination of what is to be sold with their impact
on business, tax, legal areas
 Interdependencies between parent and subsidiary and their
resolution after the divestiture
 Resolution of management and human resources: critical
elements and their compensation structures
 Gathering data and information about the business to be
sold off
 May prepare a formal information memorandum
 Contents of the offering memorandum:
 Executive summary: captures key points of the transaction
 Lists the buying procedure: rules, dates of bids submission, method of
payment, contact persons….
 Background note on the company
 Market for the business: size, competitors, customers, distribution
channels….
 Products/ services: quality, price, technical specifications…
 Facilities and fixed assets: complete details of ownership, location, condition,
contractual obligations….
 Systems and operations
 Organization management and personnel: list of key executives and their
remuneration benefits
 Key financial information: of at least last five years
 Valuing the business: using various techniques
 Selling process:
 Identification of potential buyers: direct competitors, companies in
similar lines of business, customers, suppliers, investment
companies, VC/PE firms
 Selecting the selling process:
 Competitive Bidding: get the best price and deal structure, however
gives deal public visibility
 Sequential selling: establish a priority list of buyers, and go down
sequentially; however no market frame of reference available, and
priority list needs to be constructed carefully
 Single/ One Buyer: leaves seller with little negotiating leverage, must
identify other buyers and try to convert it to competitive bidding
 Going Public: comply with regulatory formalities, procedure is lengthy
and expensive
 Business reviews: are done as clarifying discussions, after
receipt of initial bids: primary objective is to provide sufficient
information to evince buyer interest and get the best price/
valuation
 Negotiating and closing the transaction
 Preparing for negotiations: by the negotiating team
 Conducting the negotiations: get the term sheet: conveys agreement
in principle
 Due diligence examinations: verifying all the claims, books and
physical facilities of the selling business
 Purchase agreement: prepare the final, definitive purchase
agreement/ shareholders’ agreement in an equity sale
 Closing the deal: sign agreements/ closing documents, exchange the
proceeds of the transaction