What Is a Divestiture?

A divestiture is the partial or full disposal of a business unit through sale, exchange, closure, or bankruptcy. A divestiture most commonly results from a management decision to cease operating a business unit because it is not part of a core competency.

A divestiture may also occur if a business unit is deemed to be redundant after a merger or acquisition, if the disposal of a unit increases the resale value of the firm, or if a court requires the sale of a business unit to improve market competition.

Understanding Divestitures

In its simplest form, a divestiture is the disposition or sale of an asset by a company. Divestitures are essentially a way for a company to manage its portfolio of assets. As companies grow, they may find they are trying to focus on too many lines of business, and they must close some operational units to focus on more profitable lines. Many conglomerates face this problem.

Companies may also sell off business lines if they are under financial duress. For example, an automobile manufacturer that sees a significant and prolonged drop in competitiveness may sell off its financing division to pay for the development of a new line of vehicles.

Divested business units may be spun off into their own companies rather than closed in bankruptcy or a similar outcome. Companies may be required to divest some of their assets as part of the terms of a merger before the deal goes through. Governments may divest some of their interests in order to give the private sector a chance to profit.

By divesting some of its assets, a company may be able to cut down on its costs, repay its outstanding debt, reinvest and focus on its core business(es), and streamline its operations. This, in turn, can enhance shareholder value. This is especially important when there is volatility in the markets or if the company experiences unstable conditions.

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Divestiture

Divesting Assets

There are many different reasons why a company may decide to sell off or divest itself of its assets. Here are some of the most prevalent reasons why:

Bankruptcy: Companies that are going through the process of bankruptcy will need to sell of parts of the business.

Cutting Back on Locations: A company may find it has too many locations. When consumers just aren't coming through the doors, the company may be forced to close or sell down some of their locations. This is especially true in the retail sector.

Selling Losing Assets: If demand for a product or service is lower than expected, a company may need to sell it off. Continuing to produce and sell an underperforming asset can cut into the company's bottom line, when it can concentrate on those that are performing.

[Important: Government regulation may require corporations to divest some of their assets, especially to avoid a monopoly.]

Key Takeaways

  • Divestitures happen when a company disposes of all or some of its assets by selling, exchanging or closing them down, or though bankruptcy.
  • As companies grow, they may decide that they focus on too many business lines, so divestiture is the way to remain profitable.
  • Divestiture allows companies to cut back on costs, repay their debts, focus on their core businesses, and enhance shareholder value.

Examples of Divestitures

Divestitures can come about in many different forms. The most common form is the sale of a business unit to improve financial performance. For example, Thomson Reuters, a multinational mass media and information company based in Canada, sold its intellectual property and sciences (IP&S) division in July 2016. The company initiated the divestiture because it wanted to reduce the amount of leverage on its balance sheet.

The division was purchased by Onex and Baring Private Equity for $3.55 billion in cash. The IP&S division booked sales of $1.01 billion in 2015, and 80% of those sales are recurring, making it an attractive investment for the private equity firm. The divestiture represented one-quarter of Thomas Reuters' business in terms of divisions, but is not expected to alter the company's overall valuation.

Divestitures can also come about due to necessity. One of the most famous cases of court-ordered divestiture involves the breakup of the Bell System in 1982. The U.S. government determined that Bell controlled too large a portion of the nation's telephone service and brought anti-trust charges against the company in 1974. The divestiture created several new telephone companies, including AT&T and the so-called Baby Bells, as well as new equipment manufacturers.