What is Divestiture?
A divestiture occurs when a company disposes some or all its assets through a sale, bankruptcy, closure, or exchange. It’s the opposite of an investment.
There are several reasons why a company may initiate a divestiture. Companies may sell underperforming assets, such as when there’s little demand for a particular product or service or the cost is too high. In this scenario, the asset will be discontinued.
A bankrupt company initiates a divestiture to sell some or all of its assets. Sometimes a company sells assets because it needs the money. Other times, a divestiture happens when a company has too many locations and needs to close some of its stores. A divestiture can also be initiated to comply with court orders or to increase resale value.
How do divestitures happen?
There are a few different ways a divestiture can happen. A spin-off demerger is when a company takes an existing division and turns it into its own company. In a spin-off demerger, the parent company remains intact. In a split-up demerger, a company morphs into multiple independent companies. The parent company does not remain intact in a split-up demerger.
Equity carve-outs occur when a company uses an initial public offering (IPO) to sell shares of a subsidiary it already owns. It keeps control of the subsidiary, but now public shareholders have equity. A partial sell-off happens when a company sells a subsidiary to a different company. This brings in cash and eliminates the responsibility of managing the subsidiary.
What is an example of a divestiture?
A large transportation corporation called Intelligent Travel has two main segments. It has separate subsidiaries for automobiles and air travel. Most of its revenue comes from automobiles, and the government recently announced strict air transportation regulations.
Rather than go through the trouble of altering its air travel subsidiary, it decides to sell it to another corporation. Intelligent Travel can now use the revenue from its air travel subsidiary sale to pour into its automobile business. Because of the regulations and the smaller amount of revenue generated, it makes sense to initiate the divestiture of its air travel division.
How to decide if a divestiture is worth it
When deciding whether to get rid of a business asset, it helps to look at long-term goals. If a company has a profitable subsidiary with a big upside, it should hesitate to sell even if it needs cash now. If the subsidiary or asset has a minor long-term payoff, it may be worth getting rid of.
A product’s life cycle is another factor businesses consider before selling. If an asset is still in an introduction or growth phase, it may be worth hanging on to. If it has hit its maturity or is on the decline, selling could be the right move. Of all the assets on a company’s balance sheet, current assets are the most likely to be sold. Companies should also consider factors like profitability ratios, gross profit margin analysis, and break-even analysis when determining whether to divest.
When a company decides to get rid of existing assets, it is called a divestiture. Divestitures can happen because an asset underperforms, a company goes bankrupt, or it needs to close a location.
Some of the types of divestitures are spin-off demergers, split-up demergers, partial sell-offs, and equity carve-outs. Factors like life cycle, long-term goals, asset type, and profitability are considered before initiating a divestiture.