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Sell Offs and Divestitures
Chapter VI
Situations for Divestitures
Opportunistic: not intentional, only reactive Planned: recovers some capital Forced: recovers much less capital, since
divestiture is done after much erosion of asset value
Factors involved in Divestment Decisions Economic Psychological Operational Strategic Government
Economic Factors
Inability to acquire/maintain market share: narrow markets, intense competition
Continual failure to meet financial goals/ targets Tax considerations Shrinking profit margins Better alternative use of capital Profits not in line with other divisions, divisions that
erode profits, cannot be restructured
Psychological Factors
To eliminate psychological effect of a loser Bad apple theory
Operational Factors
Lack of inter company synergy: not as earlier envisaged Labor Consideration: unrest, unavailability Competitive reasons: inability to face competition Management deficiencies: inability to put together an effective
management team Possibility of diversion of management efforts and time to more
productive areas Eliminate inefficiencies: spot the downtrend early, to avoid further
erosion in value, and to realize better proceeds
Strategic Factors
Change in corporate goals/ direction Change in corporate image: better visibility Technological reasons: to move out of/ into more
high tech businesses/ move into growth oriented areas
Poor business/ strategic fit into core areas Market saturation: when investment required to
maintain market share> its cash generation Takeover defense: sale of a “crown jewel”
Governmental Factors
To avoid antitrust litigations To confirm to environmental laws and practices Business may be forced to shut down/ be acquired
by the government in national interest Government’s own privatization program: in line with
its changed liberalization policies
Rationale for Gains of Sell-Offs Efficiency gains and refocus: reverse synergy Information effects: boosts share price when
transaction is perceived to enhance value of seller company
Wealth transfers: to shareholders Tax reasons: when unable to use carry forward
losses; or to take advantage of tax shield on leverage due to restructuring
Types of Sell Offs
Divestiture Spin off Split off Split up Equity carve out
Divestiture: Sale of a portion of the firm to an
outside party Maybe a division, or a subsidiary or
an asset (tangible or intangible) sale Results in cash infusion for the
seller
Spin Offs: Creation of a subsidiary company out of a division of parent
company and distribution of shares in this subsidiary to shareholders of parent company
On a prorata basis: so shareholding pattern in newly created subsidiary company is initially same as that of parent company
No cash infusion to parent company Additional shares given like dividend Results in direct benefit to shareholders of parent company New company gets listed and traded separately Tax issues “Pure play” advantage Disadvantages: may create selling pressure, no cash flow to
parent….
Split Offs: New company is created to takeover operations of a
division/ unit Section of the shareholders of parent company may
be given shares in newly created subsidiary company in exchange for their old shares
Thus resulting in different shareholding patterns in subsidiary and parent companies
No cash infusion to parent company
Split Up: Entire firm is broken down into two or more
companies Parent company thus ceases to exist Shares of new companies are distributed
amongst the existing shareholders of the firm
Equity Carve-Outs: Partial offering of shares of a subsidiary, mostly through an IPO,
thus inducting outside shareholders, and requiring disclosures, expenses
Generates cash for parent Parent normally retains controlling interest, initially Subsidiary is listed and traded separately Benefits:
Pure play investment opportunity, improved capital market access Strong growth prospects: potential to command a higher P/E multiple Creates independent borrowing capacity: additional financing sources Unique corporate culture of subsidiary
Equity Carve-Outs (contd.): Process:
Publicly announce the intention IPO process formalities Retention of IPO proceeds: sale by subsidiary (primary
offering), sale by parent (secondary offering): tax liability accordingly
After the IPO, parent may continue to perform some corporate services for the carve out, on a contractual basis
Divestiture Process
Decision Process Financial Issues of Divestiture: if sale value> equity value of subsidiary’s
business Formulation of a restructuring plan: covering details of assets to be sold off,
retention of employees, facilities transfer etc. Approval of the plan by shareholders Registration of the shares and completion of the deal
Assembling the divestiture team: Team of functional experts with a project manager Assemble the core team Formulate a definitive project plan with timetable, budget… Use of outside resources like investment bankers, law firms etc.
Preparing the divestiture: Precise determination of what is to be sold with their impact
on business, tax, legal areas Interdependencies between parent and subsidiary and their
resolution after the divestiture Resolution of management and human resources: critical
elements and their compensation structures Gathering data and information about the business to be
sold off May prepare a formal information memorandum
Contents of the offering memorandum: Executive summary: captures key points of the transaction Lists the buying procedure: rules, dates of bids submission, method of
payment, contact persons…. Background note on the company Market for the business: size, competitors, customers, distribution
channels…. Products/ services: quality, price, technical specifications… Facilities and fixed assets: complete details of ownership, location, condition,
contractual obligations…. Systems and operations Organization management and personnel: list of key executives and their
remuneration benefits Key financial information: of at least last five years Valuing the business: using various techniques
Selling process: Identification of potential buyers: direct competitors, companies in
similar lines of business, customers, suppliers, investment companies, VC/PE firms
Selecting the selling process: Competitive Bidding: get the best price and deal structure, however
gives deal public visibility Sequential selling: establish a priority list of buyers, and go down
sequentially; however no market frame of reference available, and priority list needs to be constructed carefully
Single/ One Buyer: leaves seller with little negotiating leverage, must identify other buyers and try to convert it to competitive bidding
Going Public: comply with regulatory formalities, procedure is lengthy and expensive
Business reviews: are done as clarifying discussions, after receipt of initial bids: primary objective is to provide sufficient information to evince buyer interest and get the best price/ valuation
Negotiating and closing the transaction Preparing for negotiations: by the negotiating team Conducting the negotiations: get the term sheet: conveys agreement
in principle Due diligence examinations: verifying all the claims, books and
physical facilities of the selling business Purchase agreement: prepare the final, definitive purchase
agreement/ shareholders’ agreement in an equity sale Closing the deal: sign agreements/ closing documents, exchange the
proceeds of the transaction