Divestment – Why and How?

It involves the sale of those units or parts of a business that no longer contribute to or fit the firm’s distinctive competence. The firm simply gets out of certain businesses and sells off units or divisions for various reasons.

Divestment may take one of these forms:  Outright sale to another company, Leveraged Buy-out and Spin off. A leveraged buy-out occurs when a company’s shareholders are brought out by the company’s management and other private investors using borrowed funds. In the last case, the parent company creates a new company and then distributes its shares to shareholders of the parent.

Reasons for divestment

–Spinning off unviable units may help a firm focus on its core business more closely and regain the lost ground quickly.

–The firm can sell those assets whose values have declined as a result of neglect.

–Firms can use the cash generated through spin offs in emerging or future technologies that better leverage or revitalize their core competencies.

–Sometimes the firm may spin off units in fields where it has no dominance. If the firm wants to be in the top slot, it must naturally get out of all those ventures where it is only a marginal player.

–Assets bought at inflated prices might drain out cash flows, especially if they are funded through debt capital. Spinning of such assets would help a firm liquidate debts, improve the cash flows position and recharge its operations in areas where it has strength.

–If the business becomes unviable due to stiff competition or change in government policy it is better to get out quickly.

Some Indian examples:

The Associated Cement Companies Ltd decided to spin off its holding in various companies with a view to focus more on its core business and use the realizations to fund its modernization programs in all its 12 plants in 9 states.

The Raymond Group sold two of its units. The unlocked funds are being used to add strength to its core businesses – garments, ready-mades and engineering files apart from modernization, automation, brand building in ready markets.

Birla group: In 1995 Aditya Birla Group had 38 companies with interests in aluminium, carbon black, crude oil, caustic soda, pulp, chemicals and edible oil businesses. Since the group was no longer in a monopolistic regime, it had to face stiff competition from various quarters. To survive, Birla regrouped the businesses into aluminium, apparel, financial services, cement and telecom. Portfolios were realigned to give representation to new age businesses such as insurance, asset, management, telecom, software etc.

Companies in India have followed divestment for various other reasons: ITC divested ITC Classic Financial Services when the latter began bleeding heavily; Parle sold its branding including Thums up to Coca Cola visualizing stiff competition from MNC giants, Godrej Soaps spun off its consumer products division and transferred all its brands to the new unit; Glaxo divested its food divisions to Heinz after taking a decision to stick to its core pharmaceutical businesses.

As the above examples clearly indicate, firms are often compelled to spin off unattractive, unrelated and unviable ventures because of competitive pressures. In many instances the spin offs enable both the remaining core businesses and the newly independent spin off or sold unit to compete better in the market place.

A turnaround is designed to reverse a negative trend in the organization back to normal health and profitability. The basic purpose of a turnaround is to transform the corporation into a leaner and more efficient firm. It usually involves getting rid of unprofitable products, trimming the workforce pruning distribution outlets, and finding other useful ways of making the organization more efficient. If the turnaround is successful the organizations may then focus on growth strategy.

Firms often lose their grip over markets due to various internal and external factors. If they have to survive and flourish in a competitive environment, they have to identify the danger signals quite early and undertake rectification steps immediately. Negative trends that have to be anticipated:

–Continuous cash flow problems
–Declining profits; lower profit margins.
–Dwindling market share.
–High employee turnover
–Low morale of employees
— Underutilization of capacity
–Raw material supply problems.
–Rising input prices.
–Strikes and lockouts
–Increased competition, uncompetitive products or services

The action plans for achieving a turnaround aim at yielding immediate results focussing attention on certain key areas like quality improvement, cost reduction, new product development, rejuvenated marketing effort etc. Such short term action plans usually tackle the following issues.

–Change the leader
–Focus attention on specific customer and specific products.
–Extend the product’s life through product improvements.
–Replace existing products with new ones
–Focus on power brands that are valued, visible and bring in most of the revenues of the firm, in short, rationalizing the products line.
–Liquidating assets for generating cash.
–Better internal coordination
–Emphasis on selling advertising etc.