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