Knowing when to divest a business is arguably one of the most difficult elements of running a multi-unit company.
Perhaps one of your divisions isn’t doing that well. But maybe it’s just going through a rough patch? Perhaps one segment is lower margin than the rest of the company. But why not just hold on and try to turn the business around?
While it can be painful to spin off a segment of a company, in certain cases it’s critical to reaching full operating potential. Here are the top four reasons industry leading companies have actively chosen to sell off assets rather than maintaining the status quo.
I. Absence of Alignment with the Core Business
Probably the most common reason for a divestiture is a lack of cohesion with the fundamental company strategy.
For example on January 12th, pharmaceutical titan Merck announced that it was divesting Sirna Therapeutics. Sirna is Merck’s RNA interference (RNAi) business, and was sold to Alnylam Pharmaceuticals for $175 million upfront with an additional $115 million in possible contingent payments.
Why did they decide to divest? It was only eight years ago that Merck acquired Sirna for $1.1 billion. However while the divestiture resulted in a large writeoff from the original price, Merck Chairman and CEO Ken Frazier was willing to take the hit on this transaction.
He explained to investors that the sale of the drug delivery subsidiary — though at a valuation cut to its purchase price — was integral to Merck’s strategy moving forward. “We assess on an ongoing basis,” he articulates, “whether particular assets are core to our strategy[,] whether they provide comp[etitive] advantage and whether they would generate greater value as part of Merck or outside Merck.”
Moreover the move to jettison the RNAi business “is consistent with our strategy to reduce emphasis on platform technologies,” continues head of Merck’s business development team, Iain D. Dukes. He concludes that the divestiture aligns heavily with the company’s primary goal to “prioritize our R&D efforts to focus on product candidates capable of providing unambiguous promotable advantages to patients and payers.”
II. Sustained Margin Underperformance
Prolonged lackluster profitability is one of the most fundamentally sound reasons for a divestiture. Its structural differences from momentary dips in margin performance make it a much more reliable motive for an asset sale than many other quantitative or qualitative factors.
For example just this Monday, insurance giant CNA Financial announced the divestiture of Continental Assurance. Continental is CNA’s life and group insurance business, and will be sold to a subsidiary of Wilton Re Holdings for $615 million.
Why did they decide to divest? Lower interest rates have been capping life insurance returns for a while. “The life business returns have been pretty uneven” explains CNA Chief Financial Officer Craig Mense, “and I would say relatively low”.
In fact, CNA joins Hartford Financial and Allstate in selling off each of their in-house life insurance assets. Structurally, these companies are struggling to make a profit on these lower-return products and are each increasing their reliance on property-and-casualty sales.
Concludes Macquarie analyst Amit Kumar, “[Property and casualty] companies want to go back to their core insurance underwriting and let someone who is really good at life insurance to focus on it”.
III. Better Opportunities
Executing a divestiture to free up management and financial resources for better investment opportunities is one of the most compelling reasons for an asset sale. While operating inertia always encourages company executives to hold onto non-core units rather than severing the cord, when it comes at the expense of pursuing better opportunities, the cost of maintaining the status quo simply becomes too high.
On January 17th, specialty pharma company Actavis announced that it was divesting its Western European operations. The company’s generic pharmaceuticals commercial infrastructure in France, Italy, Spain, Portugal, Belgium, Germany, and the Netherlands was sold to Aurobindo Pharma.
Why did they decide to divest? “This transaction,” summarizes Actavis President Sigurdur Oli Olafsson, “will permit Actavis to focus management time and resources to support accelerated investment in driving faster growth of other markets, including Central and Eastern Europe and Southeast Asia”.
IV. Capital Needs
Unfortunately one of the most common catalysts for a divestiture is a pressing need for capital. This can be either to boost shareholder returns, pay off debt, stabilize leverage ratios, or a number of other reasons. Unlike the preceding points, divestitures resulting from capital needs often have less to do with the value of the subsegment than overall health of the parent company, but is regrettably often the underlying motive for a division sale.
In October 2013, global manufacturer of specialty chemicals Chemtura announced that it was divesting its Consumer Products business. The Consumer Products unit makes pool and spa chemicals (e.g., chlorine) and was sold to KIK Custom Products for $300 million.
Why did they decide to divest? The agreement to sell the Consumer Products business is aimed at delivering substantial near-term value to shareholders.
Explains Chemtura’s Chairman, President and CEO Craig A. Rogerson, “We expect to return a substantial portion of the proceeds from the sale of the Consumer Products business to shareholders.” Moreover they intended to return the majority of the remaining divestiture funds to “pay down debt such that we preserve the same leverage ratios as we had prior to the sale”.