Corporate divestiture gains as value-creator. (Strategic Planning).

With acquisitions often failing to fuel desired growth, corporation reframing their priorities are looking to divest non-core business units. New challenges are emerging, for buyers and sellers alike. A recent KPMG survey sheds new light.

Divestitures may once have been looked upon as a symbol of failure, but no more. Increasingly, companies are selling non-core businesses to focus on core competencies, divesting business units that no longer fit strategic goals and selling under-performing assets to generate cash. In fact, divestitures are becoming a preferred way to create and preserve shareholder value: 73 percent of senior leaders at Fortune 1000 companies queried in a recent KPMG survey predicted that the annual number of corporate divestitures in the U.S. would rise in the next five years.

But as divestitures carve a greater niche in the market landscape, companies are learning that, contrary to prevailing wisdom, divesting presents challenges not only to the buyer but to the seller, as well. Shedding a business is as complicated and resource-critical to the seller as buying one is to the purchaser. No matter which side of the deal you're on, both parties strive for the same Holy Grail: maximum shareholder return. In the study, 84 percent of participants said companies divest to increase shareholder value (See Figure 1).

But sellers frequently fail to fully comprehend the strategic aims they hope to attain from the deal, leading them to fall short in their responsibility to shareholders. The research indicates that successful divestitures are a product of well-conceived and thorough planning and preparation. Leaders who follow a rigorous and systematic process can make divestiture a first-choice strategy rather than a last-resort reaction to events.

While mergers and acquisitions tend to have a higher profile, divestitures are deemed just as important to corporate strategy, say the survey participants. Fully 88 percent of the senior executives agreed that divestitures can be part of a progressive corporate strategy.

Companies can pursue divestitures to reverse earlier efforts to diversify through acquisition. Eliminating an under-performing asset permits management to concentrate on--and free up capital for--its core competencies and businesses.

How Leaders Divest

Some 78 percent of the survey participants cited the straight sale as the most popular and effective divestiture strategy. A distant second, at 33 percent, was the spin-off or "de-merger." Fewer participants favored alliances (18 percent), equity separations or "carve-outs" (10 percent) and tracking stocks (8 percent).

After a company has chosen its divestiture strategy, it needs to establish priorities for the process of divesting. The primary tactical issues cited include:

* Maximizing the purchase price, 82 percent; * Maintaining the support of the board and senior management, 75 percent; * Managing tax consequences, 65 percent; * Minimizing disturbances to other operations and personnel, 63 percent.

When survey participants were asked to what degree various activities in the divestiture process presented an opportunity for financial or strategic advantage, four steps were ranked highest: negotiation, due diligence, identifying potential buyers and valuation. In ranking the risks of the divestiture process, the same steps--excluding "identifying potential buyers"--were rated highest. These results indicate that companies see a divestiture as a puzzle with many pieces, all of which must fit together seamlessly for the deal to succeed

Barriers to Effective Divestiture

While divesting offers a promising opportunity to enhance a company's bottom line and deliver higher value for the shareholder, the process of closing a sale is steeped in risk for both purchaser and seller. That's why a successful divestiture requires that the company define its goals, measure its progress against those goals and be flexible enough to adjust to changing conditions throughout the process.

Indeed, clearing potential hurdles while preparing for the divestiture can boost the odds of a favorable deal and help sidestep the risk of disputes. Some challenges facing sellers include:

Strategic assessment: Corporate heads take pains to understand the strategic underpinnings for the deal in advance. In addition, they must be fully cognizant of the deal's value for prospective buyers.

Preparation: Potential delays and renegotiation are in store for the seller who neglects preparation for the sale, including pre-sale due diligence. Sellers should ready themselves for the issues that will surface during buyer due diligence.

Value preservation: Corporate assets need to be protected; otherwise, there is a risk of customer abandonment and other operational problems before the sale. In addition, sellers need to maintain workforce consistency and communicate their activities and plans clearly.

Completion: Several pitfalls can derail completion of the transaction, including undefined terms, incorrect language and harmful omissions in the written agreement.

Transition and Separation: If the divested business is closely integrated into the parent, a separation can be a formidable and expensive pre-close effort for the seller.

Post-Transaction Review: Without a formal review of the lessons learned during the process, the parent company may not understand whether it achieved its aims and how it should handle future transactions.

Measurement: Without appropriate measurement, management may not know whether the deal aligns with organizational intent or if goals need to be adjusted due to shifting conditions during the process.

The Divestiture Decision

Survey responses also indicate that the human element of the divestiture process cannot be overlooked. The transaction team is charged with meeting the expectations of all constituents--employees, customers, stockholders, regulators, vendors and the media--and should prepare a plan clearly delineating communication benchmarks throughout the sale.

The selling entity, too, is faced with concerns from these constituent groups. For example, employees may worry about their employment status or changing role within or outside the new organization. At the same time, the seller may be concerned about retaining key employees and reaping their continued productivity.

Corporate leaders must weigh an array of factors before they can make the decision to divest. Chief among these is identifying business aims and weighing the transaction's basic issues related to risk, legal, accounting, tax and regulatory considerations.

Among the questions leaders need to answer during the decision-making stage are:

* What is the current and future condition of the overall organization and the business it may divest?

* What are the aims and benefits of a divestiture, and why is the company considering it?

* Will the transaction team have continuing support from management and the board throughout?

* How integrated within the organization is the business to be sold?

* What are the key risks--including commercial, operational, legal, tax, accounting, financial reporting and regulatory issues?

* If the company lacks the resources or skills to identify the legal, tax, financial reporting and regulatory implications of the divestiture, should it engage outside advisers?

The Divestiture Process

The seller cannot reach its business goals for the deal unless a formal transaction plan--a board- and management-supported blueprint that defines clear roles and responsibilities--is in place. The plan should be reviewed throughout the transaction to measure progress against defined goals.

The process plan emerging from the survey responses encompasses six stages, which match the categories referred to earlier as barriers to effective divestiture:

Strategic Assessment: Establish business case; clarify aims; identify risks and opportunities.

Preparation: Appoint team; consider tax and accounting implications; perform due diligence; complete valuation; define business for sale; contact potential buyers.

Value Preservation: Identify buyer; develop employee retention plans; maintain communication with all constituents; establish transition leadership; develop transition plan.

Completion: Negotiate agreement and ancillary contracts; execute contracts; fulfill conditions to closing (regulatory, accounting, tax, legal).

Transition and Separation: Carveout entity and decouple systems; transfer benefit plans to buyer; plan post-divestiture activities.

Post-Transaction Review: Communicate strategic and financial goals; plan for use of divestiture proceeds.

Measurement: Take specific steps to measure against goals at each of the six preceding stages; help ensure that the transaction remains aligned with the organization's goals and is responsive to changing business conditions.

By making divestitures an integral part of formal portfolio planning, leaders can reap an array of benefits. Without this approach, a company may lapse into crisis mode, prompting decision-makers to downsize or eliminate operations, regardless of the overall aims. A well-ordered approach to the process can help ensure that when the divestiture is completed, the steps taken will result in enhanced shareholder value, improved profitability, emphasized core competencies and, ultimately, strengthened competitive performance.

Figure 1

Strategic Divestiture Objectives

                Increasing shareholder value  84%
                     Improving profitability  73%
               Emphasizing core competencies  71%
           Improving competitive performance  57%
               Refining organizational focus  51%
                                Raising cash  37%
                               Managing risk  29%
              Regaining analysts' confidence  24%
Diffusing regulatory or government pressures  16%
         Motivating management and employees   8%
         Easing internal competitive threats   2%

Source: KPMG, 2002

Note: Table made from bar graph

Shaun T. Kelly is partner in charge of Transaction Services for KPMG LLP, based in Chicago ([e-mail]). KPMG (www.uskpmg.com) is the U.S. member firm of KPMG international.