What is Disinvestment?

Disinvestment is the action of an organization or government selling or liquidating an asset or subsidiary. Absent the sale of an asset, disinvestment also refers to capital expenditure reductions, which can facilitate the re-allocation of resources to more productive areas within an organization or government-funded project. Disinvestment can be carried out for a variety of reasons, some of which are outlined below. Whether a disinvestment action results in divestiture or the reduction of funding, the primary objective is to maximize the return on investment (ROI) on expenditures related to capital goods, labor and infrastructure.

Understanding Disinvestment

Disinvestments, in most cases, are primarily motivated by the optimization of resources to deliver maximum returns. To achieve this objective, disinvestment may take the form of selling, spinning off or reducing capital expenditures. Disinvestments may also be undertaken for political or legal reasons.

Commoditization and Segmentation

Within the target market for commoditized goods, a company may identify product segments delivering higher profitability than others, while expenditures, resources and infrastructure required for manufacturing remain the same for both products.

For example, a company may determine that its industrial tool division is growing faster and generating higher profit margins than its consumer tool division. If the difference in profitability of the two divisions is large enough, the company may consider selling the consumer division. After the disinvestment, the company could allocate both the sales proceeds and recurring capital expenditures to the industrial division to maximize its ROI.

Disinvestment of Ill-Fitting Assets

A company may opt for the disinvestment of certain assets of a company it has acquired, particularly if those assets do not fit with its overall strategy. For example, a company focused on domestic operations may sell the international division of a company it has purchased, due to the complexities and costs of integration, as well as operating it on an ongoing basis. As a result of the disinvestment, the acquiring company can reduce the total cost of the purchase and determine the optimal use of the proceeds, which may include reducing debt, keeping the cash on the balance sheet, or making capital investments.

Political and Legal Disinvestments

Organizations may decide on the disinvestment of holdings that no longer fit with their social, environmental or philosophical positions. For example, the Rockefeller Family Foundation, which derived its wealth from oil, divested its energy holdings in 2016 due to false statements from oil companies regarding global warming.

Companies considered to be monopolies may be legally required to disinvest holdings to ensure fair competition. For example, after being found to be a monopoly after eight years in court, AT&T divested its seven regional operating companies in 1984. After disinvestment, AT&T retained its long distance services, while the operating companies, referred to as the Baby Bells, provided regional services.

Key Takeaways

  • Disinvestment is when governments or organizations sell or liquidate assets or subsidiaries. It can take the form of divestment or a reduction in funding.
  • Disinvestment is carried out for a variety of reasons, from strategic to political and environmental. For example, several institutional investors have begun divesting their holdings in fossil fuels under pressure from customers and nonprofit organizations.

Example of Disinvestment

Disinvestment in fossil fuels is the most prominent and recent example of political and environment-related disinvestment. In 2011, students on college campuses began demanding that their endowment foundations, which are some of the richest institutional investors in the world. begin divesting their stakes in fossil fuel companies because they were major carbon polluters.

The movement spans 37 countries and has resulted in divestiture of $6.2 trillion worth of assets, according to a September 2018 report from Arabella Advisors. One thousand institutional investors, including insurance companies, sovereign wealth funds, and pension funds, have committed to divest assets related to fossil fuels. The report attributes the surge in fossil fuel-related divestments to moral pressure that gave way to financial and fiduciary imperatives as the movement grew and stocks for major oil companies fell.

Weyerhauser Co. (WY) is an example of strategic disinvestment. The Washington-based company was a manufacturer of paper and paper products until 2004. Since that year, it has divested operations by selling its pulp manufacturing business and moving into timber and real estate.