Dissertation

For Seminar paper:

Mergers and Acquisitions

Titled:
“Analysis of Effectiveness of Divestiture as a Strategic Tool”

Submitted by:
Atisha Jain (13A027)

Under the guidance of:

Dr. Deesha Khaire
Assistant Professor (Law),
Gujarat National Law University.

1
 Table of contents
Chapter Title Page
No. No.

Acknowledgements 4

1 Introduction to the topic 5

1.1 Aims And Objectives 5

1.2 Statement of Problem 6

1.3 Significance of the Study 6

1.4 Hypothesis 7

1.5 Research Questions 7

1.6 Research Methodology 7

1.7 Limitations Of The Study 8

1.8 Chapterization 8

1.9 Literature Review 10

2 Drivers Of Divestiture 13

2.1 Small Market Share 13

2.2 Availability Of Better Alternatives 14

2.3 Need For Increased Investment. 14

2.4 Capital Requirement 15

2.5 Lack Of Strategic Fit 15

2.6 Legal Pressures To Divest 16

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2.7 Sustained Margin Underperformance 17

2.8 Focusing On Core Business. 17

2.9 Social Or Political Reasons 18

2.10 Market Transparency And Unlocking The Hidden Value 18

2.11 Poison Pills 19

3 Choosing Optimal Mode Of Divestiture 20

3.1 Spin Off 20

3.2 Split Off 24

3.3 Equity Carve Out 26

3.4 Sell Off 28

3.5 Choice Of Divestiture Method: 30

4 Strategizing Divestiture 32

4.1 Strategic Assessment 33

4.2 Divestiture Planning 35

4.3 Divestiture Preparation: 38

4.4 Divestiture Execution 40

4.5 Retrospective Analysis 42

5 Issues And Challenges Faced By The 44

Professionals

6 Conclusion And Recommendations 47

7 Bibliography 51

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 ACKNOWLEDGEMENTS

First of all, I would like to thank my faculty supervisor for this seminar paper, Dr. Deesha
Khaire for her graceful guidance and constant encouragement to research and write well.

I will take this opportunity to thank my colleagues working under the same supervision for
helping me find resources relevant to my research topic. I am very grateful to the GNLU
Library staff for their help and support.

I also thank the Almighty, my parents, my sister and my friends. They have contributed
immensely in ways unknown.

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 CHAPTER 1
INTRODUCTION

With the advent of globalization, markets and business conditions have become volatile which
necessitates the businesses to adopt dynamic strategies to sustain and grow. Amongst the
different forms of corporate restructuring, divestiture had always been assumed to be a last
resort to carve out entities of strenuous situation. This ideology has been undergoing a change
in the recent past where active divestitures are opted for rather than restricting to the reactive
ones undertaken under pressure on the parent entities. Divestiture has been widely used as a
strategic tool by business entities. There are different forms of divestiture that can be adopted
in different situations to ensure optimum returns to shareholders. The entire process of
divesting a unit or asset is intricate and require aid of different professionals at every step with
innumerable issues and challenges faced by entities involved in the transaction.

The research tries to study and analyse the various dimensions of divestitures along with
evaluating the challenges faced by the professionals and suggest appropriate solution. Research
is also aimed at contributing to the limited pool of literature available on divestiture and its
implications. The study shall focus on devising mechanisms to ensure the effectiveness of
divestitures as a strategic tool.

1.1 AIMS AND OBJECTIVES

The research is conducted with an aim to understand the concept of divestiture with a view
to analyze the trends, concerns and issues involved in divestitures. It is an attempt to scrutinize
the implications of business divestitures on both the acquiring entity and divesting entity. The
object of the research is to analyze the impact of divestiture on corporate sector in the short
and long run. The research shall also delve into the accounting as well as the taxation aspects
of divesting of entities. The study focuses on the causes of divestiture along with the possible
reasons for the failure of the same.

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1.2 STATEMENT OF PROBLEM
Although divestitures are increasingly being used as an avenue for corporate restructuring, but
still the entire process of undertaking a divestiture could be arduous and grueling. The
divesting firms face problems look up for the most viable option for divestiture. The firms
not only have to hunt for acquiring entities but also settle for the most profitable deal.

Reactive divestitures are very common; such divestitures are a response to some sort of
business pressure like poor performance or to meet excessive capital requirements.
Theoretically, the divesting firm would be able to pursue new revenue opportunities due to
their newfound independence but, the divestiture might not lead to any value addition to the
firm. The greatest challenge is to present a precise estimation of the returns to the transactions
from the transactions. Due to the reactive nature of divestitures, the divested entities are often
construed to be non-profitable asset and valued lower than the actual value of the asset. Also,
the transactional costs of undertaking divestitures could be very high. The post-integration
issues faced by the acquiring entities are also a major concern.

Thus, during this research, the author shall evaluate varied kinds of divestiture along with their
suitability. The research would focus on finding appropriate course to ensure the process is
hassle free and both the entities involved in the transaction are able to add value their
businesses.

1.3 SIGNIFICANCE OF THE STUDY

The corporate sector has been undergoing a lot of changes major one being increasing use of
divestitures as business strategy or a tactic. The idea of this paper is to study the divestitures
as a process of corporate restructuring alongside it being used as a strategic tool. The research
is undertaken to determine the influence of divestitures on the two entities involved in the
transaction as well as the industry.

The paper will contain a detailed discussion on divestitures and its kind with the suitability of
each to certain types of transactions. The study also focuses the possible reasons for
undertaking divestiture from the perspective of both the entities involved in the transaction.
The research shall scrutinise the effectiveness of divestiture as a means of corporate
restructuring vis-à-vis to acquisitions. The author through this research will also analyse the

6
taxation and accountancy aspects of divestitures. The research shall also focus on the valuation
aspects of the transaction of divestiture.

The study will also consider the issues involved in the process of divesting for divesting as
well as acquiring firm. The research will be concluded with the observations and suggestions
which are required to be implemented for making the process of divestiture effective for the
industry as well as the two entities involved in the transactions.

1.4 HYPOTHESIS

1. Divestitures benefits not only the divesting firm but also the acquiring firm as it allows
optimum valuation of the divested asset or entity leading to overall augmentation of
the industry.

1.5 RESEARCH QUESTIONS

1. Would Divestiture prove to be an effective strategic tool for the business entities
involved in the transactions allowing increased returns for shareholders?
2. Is divestiture a better avenue for corporate restructuring than acquisitions as far as
taxation aspects are concerned?
3. What will be the impact of the divestiture on the industry as well as individual
performance of the entities involved in the transaction?
4. What are the major issues posed to both the acquiring and divesting firms concerning
the valuation of the divested asset or entity?

1.6 RESEARCH METHODOLOGY

The methodology that will be followed by the author will be the doctrinal research method.
The research methods employed are historical, descriptive, and analytical and case law related.
The only primary sources used for research would be the bare legislations, case-laws, reports
etc. As most of the information can be extracted from the available literature, the researcher
has chosen to read and derive the concepts from books, online journals, judgments and the
news articles. The author shall also subject the information to rigorous scrutiny in appropriate
instances to present a critical analysis of the primary and secondary sources. The author will
also employ the aid of videos and some documentaries available on internet which are related
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to the subject matter of the research as well as the opinion of learned scholars and experts in
the field. The author will try to analyse the different aspects of the subject matter.

1.7 LIMITATIONS OF THE STUDY

To study the concept of law, the researcher has limited the present research to the data
collected that is based on the works of the researchers, the related laws and the scholar articles,
along with blogs and the news on the official websites of news channels that are available. In
addition to that the research herein is confined to Indian perspective of the subject matter, for
the sake of convenience and for detail study. Due to paucity of time and resources, no
empirical research shall be undertaken to analyse the issue at hand.

1.8 CHAPTERISATION

1. Introduction :

The author in this chapter shall discuss the concept of divestitures along with its significance
for the corporate industry as a whole. It shall focus on giving a general overview of the concept
which would act as an aid to understand the complexities of the entire process. The author
shall discuss in detail the structure of the research.

2. Drivers of divestiture:

In a globalized world where firms are involved in diversifying business it is essential to

understand the reasons for undertaking an exercise of shrinking business. The firms may
voluntarily undertake divestiture to improve performance and providing better shareholder
returns commonly termed as proactive divestitures. But divestiture may as well be reactive
whereby the entire exercise is undertaken due to some pressure on the parent unit. The chapter
shall encompass a detailed discussion on the possible reasons for divestitures.

3. Choosing optimal mode of Divestiture:

The chapter will introduce the possible options available to the divesting firms. It would also
discuss the suitability of each available option to different scenario by analysing the advantages

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and limitations of undertaking each of them. These forms have subtle difference and hence
are often confused; thus, this chapter shall focus on differentiating the different kinds with the
help of illustrations.

4. Strategizing Divestitures:

The chapter shall discuss the entire process from the perspective of the divesting unit and the
acquiring unit. A sound divestiture process draws on a number of professionals involved at
different stages, this chapter shall discuss in detail the role of such professionals in bringing
the deal to a close. The chapter shall also delve into the complexities of the entire process the
resolution to which shall be worked out at the conclusion of research.

5. Taxation benefits and exemptions accruing post divestiture:

The most important aspect of the financial transactions is tax liability which could make or
break the deal. Thus, this chapter shall delve into how the divested asset or entity shall be
valued along with the tax liability that shall follow.

6. Issues and challenges:

Inspite of gaining popularity in the recent past, divestitures can be cumbersome and
convoluted, the chapter shall discuss the major challenges faced by the managers across in
successfully consummating the deal. The chapter shall not only focus on the pre-transaction
issues but also highlight the post deal hurdles faced by the divested and the acquiring entity.
The chapter shall further focus on the implications of the challenges on the entities involved
in transaction along with industry at large.

7. Conclusion and suggestions:

The researcher would conclude the paper by reaching to the answers of the questions raised
in the aforementioned chapters and also evaluate whether the hypothesis of the author is
proved or disproved. The author shall also try to put forth suggestion to the concerns raised
during the course of research.

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1.9 LITERATURE REVIEW

1. Eckbo B. Espen and Thorburn Karin, ‘Corporate Restructuring’ (2013).

Foundations and Trends in Finance
The article discusses the various kinds of breakup transactions in corporate restructuring like
divestitures, spin-offs, equity carve-outs, tracking stocks, leveraged recapitalizations, and
leveraged buyouts (LBOs), etc. For each transaction type the techniques are surveyed to
comprehend the various aspects of deal including the financing, transaction volume, valuation
and their correlation with potential sources of restructuring gains and value addition for
shareholders. This article serves as an aid to understand the financial aspects of transactions
for the research.

2. Martin De Holan P., & Toulan O., ‘The antecedents and consequences of
emerging market divestitures’, (2006), Instituto de Empresa Business School
Working Paper No. WP06-05
Divesting assets owned in emerging markets has substantive consequences for the
multinational corporation. The working paper examines two dimensions surrounding the
decision to divest a business in an emerging market: institutional effects impacting the timing
of the divestiture, and the effects of the ownership structure on the stability of the venture.
Also, the paper explores the consequences of divestment on the sale price of the assets with
the help of a proprietary database of all acquisitions in Argentina (> US$1 million) for the
period 1990-2002 to test the hypotheses. Evidences supports the existence of institutional and
ownership effects on the propensity to divest, which in turn affect the divestiture price. The
paper proposed a new dimension in the form consequence of ownership structure on the
decision to divest to the author.

3. Schlingemann Frederik P., Walkling Ralph A. and Stulz René M., ‘Asset
Liquidity and Segment Divestitures’ (2000), Dice Center Working Paper No.
2000-12

A firm can stop reporting a segment because it divests it as a whole, sells it off piecemeal,
discontinues its operations without asset sales, or restructures it (perhaps only to the extent
of changing its reporting) so that it is incorporated into another segment. The article show
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that asset liquidity can help resolve this puzzle and that it helps in understanding which
segment a firm divests. This microstructure literature has investigated liquidity in financial
markets extensively with the help of market depth, and volume among measures of liquidity.
The research is focused on the variable that helps explain why some sample firms divest a
segment while others do not. The article gives a basic understanding on the reasons for
which a divestiture transaction can be undertaken by a firm.

4. Berchtold Demian, Loderer Claudio F. and Waelchli Urs, ‘Core Abilities and
Divestitures’ (2016)
It has been observed that the firms increasingly focus on their core competences overtime.
This evolution impairs their ability to manage noncore assets, which they therefore divest. This
research test this prediction and try to find consistent evidence. Moreover the article examines
the causal relationship between mature firms and divestitures as response to exogenous
technology shocks. The article perceives divestitures as consequences which are induced by
structural and process rigidities that firms accumulate over time to better exploit their core
competences. The author during the course of this research shall critically evaluate this article.

5. Powers Eric A., ‘Spinoffs, Selloffs and Equity Carve-outs: An Analysis of

Divestiture Method Choice’ (2001)
The article analyzes a large variety of samples for different divestiture kinds of divestiture
transactions in order to quantify the determinants of the chosen divestiture method. The
article examines the univariate and multivariate logistic regression results show that the
parent’s need for external capital, coupled with the quality of the division being divested, are
the primary factors determining whether a spinoff, selloff or carve-out is chosen. Weaker
evidence is found indicating that the parent’s pre-divestiture level of focus and the degree of
alignment of parent managerial incentives with shareholder interests influence the divestiture
method choice. This article introduces the fundamentals of the various possible options to
undertake the divestiture transactions. The article further contributes for understanding the
various factor for the selection of the most suitable option in different circumstances.

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Books
1. Joy Joseph, Divestitures and Spin-Offs: Lessons Learned in the Trenches of the
World’s largest M&A Deals

Corporations encounter their toughest business problems during a divestiture as they are
complex and nuanced. At the same time, optimal execution of divestitures can also create high
value for the seller as well as the buyer. This book presents the leading practices on
Divestitures and covers end to end transaction life cycle from pre-deal scenario through
execution including post deal transformation using valuable real-life examples and references,
which are pertinent for implementing a divestiture efficaciously. The book acted as a reference
guide as to the entire procedure to be followed for conducting the divestiture effectively.

2. Sewing Jan-Hendrik, Corporate Divestiture Management Organizational

Techniques For Proactive Divestiture Decision-Making

Corporate divestitures can be a strategic tool for value creation when approached proactively.
Despite their high managerial relevance, however, divestiture decisions are often made on a
relatively unstructured and irrational basis, lacking routines and professional management. Jan-
Hendrik Sewing through this book, makes a significant contribution to opening the black box
of current divestiture decision-making. He uses detailed case studies, including numerous
interviews with corporate executives and experts from management consulting, private equity,
and investment banking. The author develops a conceptual framework to identify remedies to
behavioral pathologies and their origins. The study highlights multiple techniques for pursuing
divestitures proactively and formulates best-practice recommendations. The book steered a
direction as to the structure and cater to the dimensions of the research.

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 CHAPTER 2
DRIVERS OF DIVESTITURE

Shocks to the corporate economic environment may give rise to severe organizational
inefficiencies which may compel the organization to transform its structure. One form of
transformation is Divestiture where an asset or part of an entity is divested. The chapter shall
delve into the details of possible inefficiencies which result in divestiture. There are large
number of reasons due which an entity may decide to undertake dispose of an asset or part of
entity by opting for one of the forms of divestiture:

2.1 SMALL MARKET SHARE

It is well established fact that one of the main determinants of business profitability is market
share. Under most circumstances, enterprises that have achieved a high share of the markets
in which they serve, are considerably more profitable than their smaller-share rivals.1 The
rationale for this is the economies of scale which allow greater operational efficiency to the
business. The business giants have achieved economies of scale in procurement,
manufacturing, marketing, and other cost components giving it an advantage of more efficient
methods of operation within a particular type of technology.2 Also, the greater size of the firm
afford better bargaining power. A firm which has greater market share is less affected by the
market turbulence and can sustain greater business shocks.3 In case a market share accruing
from a business activity is very small or is shrinking the business would like to dispose away
the part to ensure better returns on resources. A firm with very small market share might not
be able to meet the costs. The firms are likely to divest in case the market share is too small
or them to achieve operational efficiencies4 and be competitive in the market.5 The business
run for profits and to provide higher returns to investors. Market share and returns are related

1 Robert D. Buzzell, Bradley T. Gale,Ralph G.M. Sultan, ‘Market Share—a Key to Profitability’ (January, 1975)
HBR <https://hbr.org/1975/01/market-share-a-key-to-profitability> Accessed on April 15, 2018
2 Ibid.
3 Berry Heather. “Why Do Firms Divest?”, (vol. 21(2), 2010) Organization Science, JSTOR 380

<www.jstor.org/stable/27765973> Accessed on April 15, 2018

4 Ibid.
5 Pierre Vernimmen, Pascal Quiry, ‘Corporate Finance: Theory and Practice’, (2 nd Edition, John Wiley & Sons

2009) 298

13
and go hand in hand and thus when the market share is diminishing or pocket sized, the firm
would prefer to divest the business.

The firms may decide to divest if the market share of the activity is too small for them to be
competitive or when the market is too small to provide the expected rates of return.

2.2 AVAILABILITY OF BETTER ALTERNATIVES.

The Firms tend to divest for better investment opportunities. It is obvious that the resources
are limited with any organization. The organization works to achieve maximum or greatest
return with the limited resources that they have. If an investment has become redundant or
the business has come to a standstill pertaining to a particular segment where there is no scope
for growth and the market has better opportunities to offer in other segments. The business
is likely to divert its limited resources from a marginally profitable line of business to one
where the same resources can be used to achieve a greater rate of return. 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.6 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.7

The firms may call shot to divest an operating unit or an asset to pursue better investment
alternatives in order to ensure optimum returns to its shareholders.

2.3 NEED FOR INCREASED INVESTMENT.

The cost involved in sustaining a business differs from industry to industry. There are large
number of heavy industries which require greater gestation period. The returns to the industry
might accrue in small installments with large gaps. There are situations where the entity does
not give returns as expected or in the expected period of time. The cost of maintain the

6 Eduardo Alvarez, Steven Waller, and Ahmad Filsoo, ‘The Secret to a Successful Divestiture’, (2013) Autumn
72 Strategy+ business < https://www.strategy-business.com/article/00208?gko=6f753> Accessed April
15, 2018
7‘Strategic Management Inputs’, (Cengage Learning, October 20, 2011)
<https://www.cengage.com/custom/static_content/troy_university/data/Strategic_Management_978111182
5874.pdf> Accessed April 15, 2018

14
business is on rise. The firm might reach a level of saturation with regard to availability of
resources or investments. At a point where maintaining the operation is going to require large
investments in equipment, advertising, research and development, and so forth to remain
viable, the firm rather than investing the monetary and management resources, may elect to
divest that portion of the business.

The firms tend to divest when the operating costs with respect to an operating unit go beyond
the capacities of the firm to manage so as to maintain overall sustenance.

2.4 CAPITAL REQUIREMENT

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.8 Unlike the preceding points, divestitures resulting from capital
needs often have less to do with the value of the sub segment than overall health of the parent
company, but is regrettably often the underlying motive for a division sale. 9 In times of
financial difficulties, companies opt to sell off non-core assets in order to obtain funds that
are important in keeping their primary business afloat. Instead of putting money in a poorly
performing subsidiary or unit, businesses choose to sell assets or close subsidiary operations
to save money and prevent insolvency or liquidation of the mother company. The Divesting
Company may intend to pay of its debt from the proceeds from the sale of the asset or business
line to maintain healthy leverage ratios. The motive in such type of transaction is maintenance
of overall financial health of the company and offering better returns to the shareholders.

The high capital requirement for the core business may force the entity to divest the non-core
asset to keep enduring the primary business operations.

2.5 LACK OF STRATEGIC FIT

A common reason for divesting is that the acquired business is not consistent with the image
and strategies of the firm.10 This occurs as a consequence of acquiring businesses in diversified

8 Jens Kengelbach, Alexander Roos, Georg Keienburg, ‘Don’t Miss The Exit: Creating Shareholder Value
Through Divestitures’ (Institute of Mergers, Acquisitions and Alliances , November 25, 2016) <https://imaa-
institute.org/dont-miss-the-exit-creating-shareholder-value-through-divestitures/> Accessed April 15, 2018
9 Supra note 4
10 Supra note 8

15
arenas of operation which might not in the end conform to organizational goals. It may also
be consequent to decisions to restructure and refocus the existing business. Often a business
amalgamates or merges with another but the amalgamated entity is unable to integrate well
with the acquirer. Over-diversification of a business entity may in turn result in poor
performance and operating inefficiencies causing financial constraints being enforced upon it
due to the negative synergies. These problems may simultaneously serve as motivating factors
for focusing divestitures to alleviate these troubles through foreign asset sales.11 When the
diversified business fails to manage and run together, the firm may opt to divest a part of it.
There might be inconsistency between a part of the business either with the goals or the
objectives of the firm, in such a scenario divestiture becomes inevitable.

Probably the most common reason for a divestiture of a diversified business is a lack of
cohesion amongst the different diversified units with the fundamental company strategy.

2.6 LEGAL PRESSURES TO DIVEST

There are times when companies are compelled to divest where the legislation imposes certain
restriction on entities, like the Competition Act or the Anti-Trust laws. In order to maintain
fair trade and prevent monopolistic practices, anti-trust commissions in various countries
mandate divestment.12 The goal of a structural merger remedy is to maintain or restore
competition in the markets affected by the merger while allowing the parties to proceed with
those parts of the merger that do not raise competitive concerns.13 Usually, this approach
results in a Commission order to divest key assets or capabilities to a buyer that will become a
new competitor in the market and that can maintain the competitive status quo. Competition
authorities are responsible for ensuring that competition in the market can be effectively
maintained or restored.

11 Ike Mathur, Kimberly C Gleason and Manohar Singh, ‘Foreign Asset Divestitures by U.S. Firms: An Analysis
of Motives and Valuation Consequences’ (SSRN,January 24, 2006) <https://ssrn.com/abstract=891871>
Accessed on April 15, 2018
12 Ibid.
13 Dan Ducore ‘Divestitures may include assets outside the market’,(Bureau of Competition, April 24, 2015)

<https://www.ftc.gov/news-events/blogs/competition-matters/2015/04/divestitures-may-include-
assets-outside-market> Accessed April 15, 2018

16
The competition authorities legally enforce the divestiture on anti-competitive firm, thus the
firm may be forced to divest under legal pressure.

2.7 SUSTAINED MARGIN UNDERPERFORMANCE

Prolonged lackluster profitability is one of the most fundamentally sound reasons for a
divestiture.14 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.15 The business in case of continued underperformance have two option to sell of the
underperforming asset or completely shut down the underperforming unit. Disposing away a
non-core unit to another entity which is well equipped to manage the unit is a strategic
decision. This would not only rescue the entity from …but also create value addition by
bringing in liquidity to focus on core areas. The divestiture may be related to overall
performance of the firm and not just one unit. It has been observed that the managers shall
hang on to the poor performing divesting unit only up till a point where they can report
adequate levels of firms performance, implying thereby that if the performance of other unit
is not good enough to cover up for the losses incurred due to poor performance of the
underperforming unit, it shall be divested.16 Further it is only when the firms overall
performance is less than the industry peers than the divestiture shall take place on these
grounds.17

2.8 FOCUSING ON CORE BUSINESS.

The corporate refocusing on core business from diversified firm by way of voluntary
divestment has become a commonplace strategy.18 The firms diversify with an intent to
venture into underutilized assets but at times the organizational costs that come along with

14 Supra note 11
15 Hinfelaar, Maria, ‘Key success factors in international retailing: a qualitative study into the performance, success
factors and pitfalls’ (Journal of Biotechnology, 2004)
<https://www.researchgate.net/publication/254436863_Key_success_factors_in_international_retailing_a_qu
alitative_study_into_the_performance_success_factors_and_pitfalls_in_the_case_of_four_international_retaile
rs_taking_a_longitudinal_perspective> Accessed on April 15, 2018
16 Myeong-Hyeon Cho and Mark A. Cohen, ‘The Economic Causes and Consequences of Corporate

Divestiture’ Managerial and Decision Economics, (vol. 18,1997) JSTOR, 367 <www.jstor.org/stable/3108098>
Accessed on April 15, 2018
17 Ibid.
18 Haynes, M., S. Thomson and M. Wright, ‘The determinants of corporate divestment: evidence from a panel of

UK firms', (2003) Vol. 52 Journal of Economic Behavior and Organization

17
such diversification is ignored.19 The size and diversity of the firm increases the informational
problems and firms become difficult to manage. Although the increasing size necessitates
decentralization of decision- making but decentralized structures are not without their own
difficulties like the availability of managerial resources, informational asymmetries causing
organizational inefficiencies causing the firm to divest the units of the entity so that the firm
can refocus on the core business line.20 Diverting resources to non-core businesses can hurt
the main operations of a company. Nowadays, one of the common reasons corporations spin
off, sell or close non-related units is to have all their resources focused on building up the
main business and maximize profitability.21

2.9 SOCIAL OR POLITICAL REASONS

There are certain cases when a company divests primarily due to political or social reasons.
This usually happens in case of multinational conglomerates wherein they face issues to carry
on business in certain territories due to political or social disturbances and thus they withdraw
from such territories by divesting their operating units to another entity centered locally. When
there is public clamor for businesses to cease their operations or sell off investments in areas
where there are socio-political tensions or questionable governments, then a conglomerate
may be forced to get rid of certain business units.22

2.10 MARKET TRANSPARENCY AND UNLOCKING THE HIDDEN

VALUE:

Valuation of a firm could be a complicated process for an Investor where they are unable to
precisely arrive at the market value of particular business units of a large conglomerates.23
Thus, the business in order to provide transparency as to operations and valuations decide to
divest the operational units of the entity.24 This shall allow the investor to arrive at the actual

19 Evan Rawley, ‘Diversification, Coordination Costs and Organizational Rigidity’ (Wharton, May 28, 2009)
<https://faculty.wharton.upenn.edu/wp-content/uploads/2012/04/Diversification-Coordination-and-Org-
Rigidity-28MAY09.pdf> Accessed April 12, 2018
20 Supra note 16
21 Joseph L. Bower and Lynn S. Paine, ‘The Error At The Heart Of Corporate Leadership’ HBR (May, 2017)

<https://hbr.org/2017/05/managing-for-the-long-term> Accessed April 12, 2018

22 Supra note 7.
23 Supra note 16
24Michael Mankins, David Harding and Rolf-Magnus Weddigen, ‘How the best Divest’, HBR (October, 2008)

<https://hbr.org/2008/10/how-the-best-divest> Accessed April 15, 2018

18
value of the unit. The divestiture therefore, acts as an aid to determine the hidden value of
different assets.25 There is high probability that a business undervalues or overvalues its assets
which can only be discovered once it is left to the market force to determine its actual worth.

Thus, in cases where a high diversified business intends to pump in capital through variety of
investors, it may voluntarily decide to divest the business so as to unlock the actual value of
the entity and do away with the prevailing informational asymmetries.

2.11 POISON PILLS

Divestitures might act as a strategic defense against the hostile takeover. The company which
is the target might decide to sell of most lucrative assets in the market to defend itself. This
kind of defense mechanism is termed as poison pills whereby the targeted company decides
to sell of its assets in order to become less attractive investment in the market.26

25 Supra note 7
26 D.L.Sunder, ‘The Controversial 'Poison Pill' Takeover Defense: How valid are the Arguments in Support of
it?’, (NMIMS, January, 2014) <http://www.nmims.edu/NMIMSmanagementreview/pdf/Oct-Nov-13-Jan-
14/Controversial-Poison-Pill-Takeover-Defense.pdf> Accessed April 15, 2018

19
 CHAPTER III

CHOOSING OPTIMAL MODE OF DIVESTITURE

A divestiture is a private transaction involving the sale of a part or portion of the firm's assets
to another firm which may be typically a company or a buyout fund. There could be different
kinds of assets that may be sold in such a transaction like division, segment, subsidiary, or
product line. The consideration for such sale mostly is cash, but sometimes also securities or
a combination of both. The proceeds from the sale are reinvested in the remaining business
or distributed to the shareholders of the divesting firm. While eliminating a fraction of its
assets, the selling firm continues to exist in essentially the same form as before in most cases.
There can be variant forms in which such transaction can be consummated which is decided
on the basis of the facts and circumstances of each case. Different scenarios call for a different
kind of break-up suiting the needs of a particular firm. This chapter shall focus on the possible
forms of break-up transactions along with their advantages so as to give a better understanding
of what kind should be adopted different circumstances to achieve desired outcome.

3.1 SPINOFFS

A corporate spin-off is an operational strategy used by a company to create a new business

subsidiary from its parent company. 27 A spin-off occurs when a parent corporation separates
part of its business into a second publicly-traded entity and distributes shares of the new entity
to its current shareholders.
In a spinoff, a public company distributes its equity ownership in a subsidiary to its
shareholders. The distribution is a pro-rata dividend and parent shareholders receive subsidiary
stock in proportion to their ownership in the parent firm.28 The spinoff involves a complete
separation of the two firms. After the spinoff, the subsidiary becomes a publicly traded
company with same shareholding as that of the parent initially. The new entity takes assets,

27 Alexandros P. Prezas and Karen Simonyan, ‘Corporate Divestitures: Spin-Offs vs. Sell-Offs’, European
Financial Management Association (December, 2012)
<http://www.efmaefm.org/0efmameetings/efma%20annual%20meetings/2013-
Reading/papers/EFMA2013_0059_fullpaper.pdf> Accessed April 15, 2018
28 Ibid.

20
employees or existing product lines and technologies from the parent in exchange for a pre-
determined amount of cash.29 The spin entity may take on debt to provide a distribution to
the parent in exchange for those assets or loss of cash flow30. There is no dilution of equity or
transfer of ownership that takes place in such transaction. Also, since the spinoff involves a
public listing of shares, it has higher transaction costs and takes longer time than others.

A spin-off may be a method for the parent to reduce agency costs and create tax shields or to
enter a new industry while retaining a close relationship with the spun-off company.31 It is a
way of reorganizing a company’s administrative structure in order to improve its profitability.
In cases where the diversified units of the company lack the strategic fit with the organizational
goals, then it can sell a less productive division to form a new independent company. In other
words, a company creates a new business entity out of its existing divisions, subsidiaries, or
the subunits. This is done as the new individual company is presumed to function well alone than
as a part of the parent company.
Unlike split off, in spin off the parent company does not exchange its shares for the shares of
the subsidiary instead it’s a pro rata division.

3.1.1 BUSINESS PURPOSE OF SPIN OFF:

Spin offs increase the combined market value of the parent company and the subsidiary, thus
opted by large number of companies. Under the right circumstances, a spin-off can release
latent shareholder value by removing obstacles to both valuation and growth. 32

 Pursuing independent growth

The primary goal of any spinoff is to create a vibrant standalone brand and business, free and
independent of its parent company. When executed correctly, both the newly created spinoff

29 Małgorzata Porada-Rochoń, ‘Divestitures As The Tool Of Enterprise Restructuring – The Example Of Japan’
(2008) 3 Scientific Journal <http://www.wzieu.pl/files/sm/SM3/19%20Porada%20Rocho%F1.pdf> Accessed
April 15, 2018
30 Roger Rüdisüli, ‘Value Creation of Spin-offs and Carve-outs’, (University of Basel, May 10,2005)
<https://edoc.unibas.ch/276/1/DissB_7179.pdf> Accessed April 15, 2018
31 C. Moschieri, J. Mair, ‘Research for corporate unbundling. A synthesis', IESE Business School (WP No 592,

2005) 3.
32 Francis J. Aquila, ‘Key Issues When Considering a Spin-off’ (In The Boardroom, June 2015)

<https://www.sullcrom.com/files/upload/June15_InTheBoardroom.pdf> Accessed April 15, 2018

21
and the prior owner are given the flexibility and autonomy to pursue their own growth
strategies.33

For the spinoff company, operating independently allows investments to be more targeted to
specific areas of the business that have been identified as having strong growth potential.34

The newly formed entity is able to develop and pursue its own tailored, growth strategy, which
can be effected more quickly than when the business unit was embedded in a diversified
company, with interests spread across multiple divisions or sectors.35

 Exercising newfound agility

All stakeholders can reap the benefits of a properly managed spinoff. With a smaller footprint,
incremental growth is easier to achieve and sustain for the spinoff business, despite the smaller
market capitalization. Employees also benefit, as they can break away from past conventions
and seek their own paths to success as part of a smaller, and in most cases, more
entrepreneurial culture.36 Finally, customers of the spinoff brand should experience an increase
in quality of service from dedicated account representatives, as well as a product and services
portfolio that more closely reflects their needs. A more robust R&D product pipeline, specific
to the spinoff’s market, means the new entity is able to allocate the majority of its resources
to developing innovations directly motivated by the industry they live in.37

 Attracting new opportunities

The new independent entity formed after the spin-off represents a great opportunity to invest
from investor’s perspective as it is focused on its core areas with experienced leadership. The

33 Cornelius Boland, ‘Corporate spinoff: how all roads can lead to growth’, (Interband)
<http://interbrand.com/views/corporate-spinoff-all-roads-lead-to-growth/> Accessed April 15, 2018.
34 Kristin Samuelson, ‘The strategy behind spinoffs: Recent spinoffs have heads spinning: Why split a company

in two?’, (Chicago Tribune, October 23, 2011) <http://articles.chicagotribune.com/2011-10-23/business/ct-

biz-1023-outside-opinion-spinoffs-20111023_1_spinoff-abbott-laboratories-damien-conover> Accessed April
15, 2018.
35 Ibid.
36 Berbegal-Mirabent, J.; Ribeiro-Soriano, D.E; Sánchez García, J. L ‘Can a magic recipe foster university spin-

off creation?’, Journal of Business Research 68 (2015) 2272.

37 Supra note 29.

22
above feature allow a vibrant standalone brand to the divested unit which would definitely
have a higher market value than earlier with better market expectations. This developed brand
could turn the spinoff into an attractive target for acquisition ensuring an avenue for growth
to its investors.

By shedding the weight of a bigger diversified company, a market-ready spinoff can also
become a fast target for investors (both public and private) looking to make bolt-on
acquisitions, with the goal of entering new markets.38

But in order to prove the potential worth of the new brand, several steps must first be taken
to ensure all stakeholders that there will no loss of service:39
1. The organization’s value proposition—both internally and externally—must be clear
and galvanizing for audiences to understand and rally around;
2. The newly spun-off business must quickly reassure customers that nothing will change
in terms of product quality, service, and future innovation;
3. Finally, the newly formed business must prove through both its leadership team and its
quarterly financials that it can consistently exceed targets, expand margins, and decrease
operating costs.

 A brand that gets you to your goal

The independent standing along with the developed and a mature brand is something that
with attract better investments in market and will get the stakeholders and the organization to
its goals.

The primary goal of all spinoffs is the same: to become a vibrant entity that consumers,
investors, employees, and other companies want to attach themselves to. A market-ready
brand will bolster you through this major business transformation, and set you on the path
towards growth.40

38 Supra note 26
39 Supra note 30.
40 Supra note 33

23
  Elimination of negative synergies
The separation of an unrelated business segment may further reduce any negative synergies
that exist between the subsidiary and the rest of the firm. Spinoffs help eliminate value-
reducing cross-subsidization in diversified firms. In such transaction, the subsidiary's
investment decisions become much more sensitive to the firm's investment opportunities after
the spinoff. These changes take place primarily for subsidiaries whose operations are unrelated
to the parent's core business and in spinoffs generating higher announcement returns.

3.2 SPLIT OFF

Split off is define in the Black’s law Dictionary in the following way: “ when a corporation set
up and funds a new corporation and gives shares of this new corporation to the old
corporation’s shareholders in the exchange of some of their shares in the old company, this
process is called split off”41

Although the definition is not comprehensive as more often in practice split of transaction
involves an already existing subsidiary rather than a new corporation. Thus, Split off is a type
of corporate Divesture wherein the parent company offers its shareholders the shares of the
subsidiary on surrendering the shares in the parent company. This is the point of
differentiation between spin off and split off, where in the former the shares are divided on
pro rata and in later there is an offer of shares in subsidiary in lieu of shares of parent company.
Typically, split of is a buy-back of shares of parent company in consideration of shares in the
subsidiary. This leads to concentration of ownership which stands unaffected in spinoff.
Though the parent company may have to increase the nominal value of share to compensate
for the loss of subsidiary to the remaining shareholders.

A split off is similar to a spinoff in that the subsidiary becomes an independent company with
a separate stock listing. The split off, however, involves an exchange offer, where shareholders
are offered to exchange parent company stock for subsidiary stock. Thus, the splitoff
effectively resembles a stock repurchase, where the parent company buys back its own shares
using subsidiary stock as consideration. As a result of the exchange offer, the ownership

41 ‘Black’s Law Dictionary’ (9th ed. 2009)

24
structure in the parent and the subsidiary are different post-split off. The split-off is a less
common tactic and is usually used by companies evaluating a divestiture and that also desire
to reduce the number their shares outstanding. Split-offs have been employed to retire the
overhang of a large block of parent stock held by an individual shareholder, or to adjust a
shareholder’s (or class of shareholders’) investment level in a subsidiary.42

3.2.1 BUSINESS PURPOSE OF SPLIT OFF

There are certain peculiar purposes for which split off can be employed:
 Conflict:
When an entity encounters internal conflict between different groups of shareholders, then
split off can be opted to resolve such disputes. The shareholders may be given an option of
accepting or refusing the exchange offer. They can make a choice with respect to the entity
they want to retain their investments. There have been large number of examples whereby a
large entity has divested so as to resolve the internal disputes amongst the shareholders having
conflicting interests, popular one being the divestiture of EDS from General Motors.

 Minority buyout:
The split offs can be used as a method to buyout large minority by offering them stake in the
subsidiary. This can be done by dropping down a large quantum of liquid assets to the
subsidiary of the said company and tendering shares to the minority, often referred to ad cash
rich split off.

 Maintaining Focus on the core operations:

The split of can be used as a means to focus on the core operations by divesting the non-core
unit. The separation of an unrelated business segment may further reduce any negative
synergies that exist between the subsidiary and the rest of the firm. This increases operational
efficiencies and create value for the parent company. A split-off often results in an increased
focus of the parent company’s business, and also the split-off company is usually much

42Michael E. Raynor ‘Tracking Stocks and the Acquisition of Real Options,’ (2000) ) vol. 13 (2) Journal of
Applied Corporate Finance

25
focused in one line of business. A simplified business is often valued at a higher rate than a
complex conglomerate.43

 Dilution of earnings:
A large number of shareholders increase the probability of conflict as their interests will be
widely dispersed. The earnings will be diluted as well, thus it might interest the company to
cause concentration of ownership. Thus, split off may prove to be a viable option whereby it
may retire some of its share. The existing pool of shareholders will have a choice to take the
shares of subsidiary in lieu of share of parent. This was the object with which Viacom opted
for a split off with Blockbuster over spin off.

3.3 EQUITY CARVE-OUT

In an Initial Public Offering (IPO), a firm issues shares of a subsidiary to the public in
exchange for cash. IPOs are frequently undertaken with the goal of "unlocking trapped value"
while also raising proceeds for the parent.44 Attractive businesses of sufficient size are
frequently sold in the public markets at a premium to precedent transactions and trading
multiples. IPOs are often the method of choice for divesting growth businesses during “hot”
markets, when embedded tax gains are relatively insignificant, and there is a strong desire to
raise proceeds. The parent company often retains a controlling interest, creating a public
minority interest in the subsidiary.45

3.3.1 BUSINESS PURPOSE OF EQUITY CARVE OUT

Purpose for undertaking Equity carve out:

 Corporate focus
One of the reasons for an equity carve-out is increased corporate focus for the parent and
subsidiary after the carve-out. Before the carve-out they both are operating in the same
company and focus on increasing value for the company in total, this could lead to lose of

43 Supra note 33
44 Supra note 30
45 Eckbo B. Espen and Thorburn Karin, ‘Corporate Restructuring’ (2013). Foundations and Trends in Finance,

Forthcoming, <https://ssrn.com/abstract=2272970> accessed 26 February, 2018.

26
sight of core operations of some business segments within the company.46 Without the strong
focus on core operations, business segments may see their performance deteriorate and may
even lose their competitive edge over rivals.47

 Separate financing of growth opportunities

Another characteristic of equity carve-outs is the ability for subsidiaries to fund projects with
external financing.48 Without the carve-out these subsidiary projects would have be foregone,
as there exists information asymmetry between managers and investors regarding the value of
the existing asset and the project, a conflict of interest between new and old stockholders, and
managers acting in the interest of old stockholders. Separate financing for the project will
mitigate the negative information asymmetry as the focus shall be the net present value of the
entity. Companies with subsidiaries that have growth opportunities but which cannot be fully
exploited due to negative information effects can carve-out the subsidiary which would be
possible with separate financing. The subsidiary shall be able to create value and grow
independent of the parent company.

 Managers incentives
It is important that the employees are rewarded on the basis of their performance to boost
their confidence and motivate them to work better. In a pre- carved out firms, Incentives were
to be based the value of the entire firm and not directly linked to the performance of the
specific unit. Thus, they were less effective for division managers. But when the subsidiary is
standalone operating in the market then the performance of the subsidiary can easily be linked
to the stock price. It acts as a more direct incentive and boosts employee morale. This wasn’t
possible earlier as parent and subsidiary were traded together. Moreover, listing equity publicly
enables management to provide high-powered incentives in the subsidiary through stock and stock
option plans, which make up a significant part of total compensation to carve-out executives.49

46 P, Justin, ‘Positioning for Growth: Carve-Outs & Spin-Offs,’ (SSRN, April 1, 2004)
< https://ssrn.com/abstract=546622> Accessed April 15, 2018
47 Ibid.
48 Supra note 29
49 Patricia Aslinger, Sheila Bonini, and Michael Potsalos ‘Doing The Spin Out’ Mckinsey quarterly (November

2001) 98

27
 3.4 SELL OFF

A divestiture is referred to as a sell of transaction if an asset or business unit is sold in

consideration of money. There is a complete severance of operations of parent and the
divested unit which is then absorbed by the acquiring entity. Sell offs are usually low value
assets with poor operating performance, high leverage, high diversification and operate in
industries different from their parent’s other industries.50

The sell-off transaction operates like a simple sale where the company sells its assets or part
of the entity for money. There is a simple exchange where in consideration of its assets or part
of entity it receives compensation from the third party to which a sale is made and the funds
so generated are invested in the business or may be distributed among shareholders.

As sell off is a sale transaction it is dealt as a capital gain for the purposes of taxation and no
special benefits accrue to the business.

3.4.1 BUSINESS PURPOSE OF SELL OFF

A sell off transaction may be undertaken for the following purposes:

 Urgent capital requirement:

A sell off transaction facilitates quick liquidity to business to meet its urgent fund
requirement.51 In times of financial difficulties, companies opt to sell off non-core assets in
order to obtain funds that are important in keeping their primary business afloat. Thus, instead
of keeping investments blocked in a poor performing subsidiary or unit, the entity may opt to
shut the operations and sell of the operations. Such sell off is preferred in the hour or dearth
need of funds where the company is at risk insolvency or liquidation. The Parent Company
may intend to pay of its debt from the proceeds from the sale of the asset or business line to
the third party in order to maintain its leverage ratios and henceforth the overall financial
performance of the company.

50 Sewing Jan-Hendrik, ‘Corporate Divestiture Management Organizational Techniques For Proactive

Divestiture Decision Making’, (1st edn, Springer US 2010)
51 Supra note 4

28
  Persistent Poor performance of subsidiary

The business may intend to sell off its subsidiary, if it has failed to give desired returns on
investment. A continuous underperformance by a unit not only affects the overall
performance of the firm but also its reputation and thus instead of investing further in the unit
company may withdraw from it completely. The company may use the funds so generated for
investing in better alternative avenues available in the market.

 Lower transaction cost

The cost of undertaking a sell off is minimum as there is a need to find a private buyer. In
other cases the subsidiary companies have to go for an IPO which may turn out to be relatively
expensive affair. The company needs to look for the best bid for the targeted asset or unit to
be disposed of and negotiate the deal. Sometimes it may shortlist a number of buyers and then
undertake the deal which may be cumbersome but would still prove to be economical vis-à-
vis to other options.

29
 3.5 CHOICE OF DIVESTITURE METHOD:

There are a large number of factors that the entity may consider before opting for a particular
kind of transaction which are as follows:

Financial need:
Since equity carve out and sell of generate cash, these methods are an obvious choice in case
the company is in need of liquidity to pay back debts or for investing in another venture or
for meeting the funds for operating the remaining business. In case there is an urgent need of
funds than sell off shall be the most suitable of all the options as there is a direct sale to a
particular investor. In case of others there is a need for IPO to be effected for the subsidiary
which might prolong the process. Thus, both the urgency as well as the financial need are to
be looked into before making a sound choice of the method.

Control:
In situations where the parent wishes to retain control over subsidiaries, carve out shall be
preferred over others. In other forms the parent loses complete control over the subsidiary
but it is only in carve out that there is a dilution of control. The cases where the parent is
looking for complete control over its operations carve out may seem problematic as the new
investors although in minority may have different interests than the parent. The dispersed
public interest created due to carve out should be catered by the parent in order to sustain the
subsidiary operations which might be an arduous process. Hence, the firm should be clear
about the ownership rights it wishes to offer to the new investors. It case it is unwilling to
change the ownership pattern in the core business line than spin off or sell off are most suitable
or in cases where it feels the need to concentrate ownership in hands of few it shall opt slit
off. And where it wishes to retain some control over the subsidiary then carve outs are the
best available option.

Focus:

If the object of undertaking the divestiture is focusing on the core areas then carve out are
futile as the control over subsidiary is retained. The focus on core activities require separation

30
of the non- core operating unit from the parent. Thus, sell off, split off or spin off can appear
to be a viable option. Though a further choice depends on other aspects.

Taxation:
Another important consideration is taxation aspect of the transaction. The taxability varies
from transaction to transaction which leads to accrual of different level of the net receipts
through the transaction. The taxation aspects shall be discussed in details in further chapters,
but it shall be noted that in terms of taxes to be paid sell off and split off are most lucrative as
they are tax free.

Prospective price:
The price of the subsidiary which is to be sold or divested shall also be a factor to be
considered. Under different market conditions the prices offered shall vary with each method.
The price of subsidiary shall be lower than the value management attaches t it in cases where
the market conditions are bad or where the market size is too small.52 In cases where the
company has great repute in the market then the company may opt for an equity carve out. In
case the market conditions are bad spin off may seem to be viable.

52Veronika
Kovacs, ‘Corporate split off: comparison of US and German Models’ (Central European University,
March 2008) <http://www.etd.ceu.hu/2008/kovacs_veronika.pdf> Accessed April 15, 2018

31
 CHAPTER IV

STRATEGIZING DIVESTITURES

Divestitures are complex transactions that consume large amount of both time and resources.
The process is a long arduous one which is can be effectively strategized with the help of a
pool of professionals. The chapter shall delve into the details of the process of divestiture and
intricacies involved.

FIGURE 1: PROCESS OF UNDERTAKING DIVESTITURE

32
 4.1 THE STRATEGIC ASSESSMENT:

The strategic assessment tasks is the first step in the divestiture process whereby the
preliminary analysis into the business portfolio and candidates for divestiture is done. After
this the decision is put forward for validation by the shareholders and finally ab optimal
transaction is structured.

Analyze Identify Validate Structure

business divestiture divestiture the
portfolio candidates decision transaction

Figure 2: Strategic assessment tasks

4.1.1 ANALYZE BUSINESS PORTFOLIO:

The first and foremost task is to evaluate all the units of the business in terms of their
profitability, return on investment, compatibility with long term goals of the organization.
After the analysis a document called company overview ranging from 8-30 pages is created for
sending it to the prospective buyers. The document is thus prepared by careful examination
of companies as well as prospective buyers’ expectation. The document is only shared after
the buyer signs Non-Disclosure Agreement to protect the confidential business information
provided in the business overview.

4.1.2 IDENTIFY DIVESTITURE CANDIDATES:

The next step is to shortlist all the possible potential buyers whom the request for proposal
(RFP) should be sent. The buyers can range from corporates for profits or nonprofit entities.
Any business which may have interest in the acquisition may be included accessing market at
national or international level or for that matter even local businesses.

While considering all the prospective buyer though a wide range is preferred but the seller
might want to limit its search to similar organizations for better strategic fit. For example, an
MNC withdrawing from a country due to any reason may like to sell the business to some

33
national profit making entity rather than a small business operating at local levels or even
nonprofit organizations. This step may require advisory services from experts in the field
having a wide network so a larger potential buyer pool can be shortlisted for ensuring a better
deal.

There is no limit to on the size of the potential buyer pool which varies depending on the
preference of the seller’s company. Also the variety in the pool is again a decision to be ttaken
by the seller company which at times may prefer buyers from different industries or from same
industry. The identification of additional prospective buyers to contact is ongoing until there
is a Letter of Intent in place.53

In attempting to determine the compatibility of the various elements of their business

portfolios, individuals conducting the analysis should ask the following questions:

• Are the markets served by the individual businesses stagnating or contracting?

• Are there macro-level forces such as changes in demographics, technologies, or
regulations that will cause businesses to stagnate or contract in the future?
• Are there competitive dynamics that will reshape the market to the organization’s
disadvantage?
• Are any businesses in isolated market positions that have no synergistic relationship with
the broader portfolio?54

The business compatibility of the prospective buyer with the organization’s strategic objectives
and long-term growth goals will be determined on the basis of the answers to these questions.
Then only a final shortlist of candidate be prepared from the potential pool of buyers.

4.1.3VALIDATE DIVESTITURE DECISION

53 Jeff Weirens, ‘Divestiture Planning and Execution’, (Deloitte, October 3, 2017)

<https://www2.deloitte.com/us/en/pages/operations/solutions/about-our-divestiture-planning-and-
execution-services.html> Accessed April 15, 2018.
54 ‘Divestiture: Applying Five Step Process’, (CPA Canada, October 1, 2017) <
https://www.cpacanada.ca/en/business-and-accounting-resources/finance/corporate-finance-
transactions/publications/divestitures-introduction/divestitures-guidance> Accessed April 15, 2018.

34
The organization’s management shall support the divestiture decision as it is necessary
compliance. Poor performance may indicate, but does not necessarily equate with, strategic
incompatibility. There can be large number of factor which may have impacted the decision
to divest which shall be put across to the shareholders of the company by the board members.
Their validation on the entire course of action is a necessary step. There may be time where
the shareholders believe that the divestiture may harm their as well companies interest and
decide against the entire decision, thus their approval has to be taken at the earliest.

4.1.4 STRUCTURE THE TRANSACTION

Once a preliminary divestment decision has been made by management, the next step is to
determine the form and structure of the transaction that is most likely to optimize after-tax
proceeds of the prospective divestment.55 The various options available include a sell off,
equity carve out, spin off and split off. The decision to opt for anyone of these can depend on
a number of factors which have been discussed in previous chapter. The decision can be
undertaken after weighing all the pros and cons of every transaction and then arriving at the
most apt transaction with due consideration to the organization needs.

4.2 DIVESTITURE PLANNING

Once there is preliminary agreement that a divestiture is desirable, the planning step in the
process should be initiated.

Obtain Create Develop

Create retention Assemble Develop
corporate organization communication
plan divestiture team divestiture plan
approval plan plan

Figure 3: divestiture planning tasks

55Christian Thywissen and Ulrich Pidun, ‘Divesting on Time: How Decision-Making Processes Influence
Divestiture Outcomes’ (SSRN, May 2, 2017). <https://ssrn.com/abstract=2961827> Accessed April 15, 2018

35
 4.2.1 OBTAIN CORPORATE APPROVAL

The divestiture transaction once structured need an approval to move forward. A document
which presents well-considered recommendation of the KMPs and the board is created so
that the transaction may incorporate such changes for better outcomes. Its major components
would be the strategic rationale underlying the recommendation, a background discussion of
the business and its markets, valuation estimates, a description of alternative transactional
approaches that were considered, and a description of the planned divestiture process
contemplated, as well as a timeline for planning, preparing, and executing the transaction. 56

4.2.2 CREATE ORGANIZATION PLAN

The divested entity has been parent companies part for a long period of time which may lead
to development of a functional dependency on the parent and shared operational
infrastructures. A major objective of untangling the two entities is to present the business unit
being divested as a stand-alone entity to the greatest extent possible so its sales potential can
be optimized by making it attractive to the broadest possible range of potential buyers.57 The
initial effort to rationalize the infrastructures is the establishment of an organizational plan
that includes:

• Determining business unit leadership. This would typically include the business unit’s
chief executive and senior management team;
• Performing an operational analysis. This process consists primarily of identifying all the
customer related operations and functions;
• Performing a preliminary infrastructure analysis. Although a detailed evaluation of shared
services will not be done until a dedicated team is assigned later in the process, the basic
functions necessary for the unit to approximate a stand-alone business should be
identified;

56 Ibid.
57 Supra note 53

36
• Assigning employees. Based on the operational and infrastructure analysis, a preliminary
determination of those individuals who will staff the unit and those who will be retained
by the parent organization should be made. 58

4.2.3 CREATE RETENTION PLAN

The management shall formulate a plan to retain all the key personnel as there is a higher
possibility of greater employee turnover in this period. Appropriate rewards be given to the
individuals in order to retain them until the business is sold.

4.2.4 ASSEMBLE DIVESTITURE TEAM

The success of a divestiture transaction depends on the team formulating and executing the
transaction. Thus, the importance of the creation of a team comprising of skilled and
experienced individual is critical for a successfully undertaking the divestiture exercise. The
team not only formulates the plan and ensures timely execution the process but also keeps it
on the track. The divestiture team is typically composed of a core team of senior executives;
external consultants and advisors; selected internal experts and managers; and is led by a clearly
empowered designee of the CEO of the parent organization.59

4.2.5 DEVELOP DIVESTITURE PLAN

Once the divestiture team is finalized with the members, then next obvious step is to develop
an appropriate plan. The divestiture plan shall be as detailed as possible placed under the
direction of the team leader.

This divestiture plan should provide for the following details:

• Identify all the key activities to be undertaken in the transaction;

58 Supra note 54
59 Ibid.

37
• provide complete outline of all material tasks, milestone accomplishments as well as the
deliverables for the entire divestiture transaction;
• Assignment of duties and developing deadlines for the assigned tasks;
• Identify key decision points associated with making and executing decisions;
• Identify any major risks associated with the transaction.60

4.2.6 DEVELOP COMMUNICATION PLAN

Although the announcement of the divestiture shall not happen before the execution step but
it is important to devise a communication plan once the team is assembled and the decision
to divest if finalized.

There are two constituencies towards which the communication plan is directed at:

1) External constituencies which shall include the customers, suppliers, shareholders,

lenders, and the investors; and
2) Internal constituencies which would include the management and employees of both
the organization being divested and the parent organization.

The communication plan shall convey the following points to all the above mentioned
stakeholders:

• The announcement of the transaction

• The rationale behind the decision;
• The advisors involved in the process
• The anticipated timelines for the execution of the process;

4.3 DIVESTITURE PREPARATION:

The preparatory step shall be focused on mobilization of resources as well as measures to

ensure the controlled separation of the businesses. The tasks that comprise the first of these,
preparing for the sale, are illustrated in Figure:

60 Supra note 53

38
 Figure :Divestiture Preparation

Engage Determine Develop

Prepare divestiture
external divestiture divesting
data room preparation
resources process materials

4.3.1 ENGAGE EXTERNAL RESOURCES

The successful completion of the transaction depends upon a large number of financial
advisors who act as an external resource to help timely execution of the transaction. The
financial advisor may include a business broker, investment banker, accounting firm or a team
of legal experts. The financial advisors majorly focus on designing and managing the
transaction with respect to the valuation of the business, the structure of the transaction, the
selling approach employed, and buyers to be targeted. The accounting firm may look into the
aspects pertaining to the financial information which is to be provided to buyers.

4.3.2 DETERMINE DIVESTITURE PROCESS

The core divestiture team members with the help of the financial advisor will have an
informed view of the potential market and from the market understanding determine the best
possible way to execute the formalized divestiture strategy.

4.3.3 DEVELOP DIVESTING MATERIALS

The next task to be performed in the process is to prepare the divesting materials. The
divesting materials comprise of the following three elements:
 a “teaser”: a formal document containing information on the business with the
financial profile attached to it.
 an offering document: a document containing a substantive description of the
business, its historical financial performance, and its strategic potential

39
  a management presentation: a presentation which reflects the offering document for
live presentations to selected potential buyers.

4.3.4 PREPARE DATA ROOM

The financial, legal, and operational information subject to review by potential buyers is
housed in a data room. The examination of this information provides an opportunity for
bidders to assess the veracity of data underlying the seller’s representations.61

4.4 DIVESTITURE EXECUTION:

The next step is for the team to initiate the sales effort, which consists of the following tasks:

Execution of Divestiture

Announce
Manage the Negotiate Close
intent to
divestiture transaction transaction
divest

4.4.1 ANNOUNCE INTENT TO SELL

The details of divestiture upto this point has been kept very confidential by maintaining a small
team performing most of the planning and preparatory activity in a confidential setting. But
before executing the transaction a public announcement is to be made which would cause
drastic changes in the market.

The stakeholders of the transactions would want to understand the impact of the transaction
on their interests. For example, shareholders would be interested to know the implication on
the value of their shares in the; potential buyers would like to know the business opportunity
to expand their market presence through the divestiture; customers and suppliers would be

61Supra note 53

40
interested in the implications of divestiture prospective undertakings with the business being
sold.

With all the rising concerns in the market with respect of divestiture presents a challenging
situation for the team managing the divestiture as to how convincingly they bring around their
proposal to reassure the stakeholders of the post divestiture scenario. Actual announcement-
day activities are divided between the external announcement to the public and internal
communications with employees.62 The external announcement by the corporation would be
done through a press release with elaborate details regarding the future course of actions and
the rationale behind the decision. The purpose of the public announcement is to minimize the
negative market sentiments and reassure the stakeholders of sustaining their interest.

The Employee announcements are equally important and cannot be taken lightly. It requires
a more detailed planning. The employees of the business being divested and the parent
company have to be informed of the transaction to be undertaken by the divestiture team in
an employee meeting. The focus shall be satisfaction of their concerns regarding their status
and position in the organization post divestiture and the implication of the divestiture on them.
It is good practice to distribute a package of information at the time of the announcement that
addresses employee concerns and make HR personnel available to answer questions right after
the announcement.63 Also there shall be mechanisms developed to hear and redress the
employee queries pertaining to the transaction through employee bulletin or maybe emails by
senior managers.

4.4.2 MANAGE THE DIVESTITURE:

In a typical sale off transaction there can be a highly structured and deliberate auction sale
unless the entire sell off is to be done confidentially. This will entail soliciting initial bids,
qualifying those bidders, inviting those who have been qualified to perform due diligence,
soliciting final bids, and selecting a “winner.” 64

62 Supra note 54
63 Supra note 53.
64 Ibid.

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 4.4.3 NEGOTIATE TRANSACTION:

After finally determining the purchaser the contracts and ancillary agreements are shortlisted.
The purchase agreement and transition services agreement (TSA) are the major agreements to
be negotiated which have the bearing on the future prospects of both the parties involved in
the transaction. Along with the two, the disclosure schedules which is document listing all the
disclosures to be made by the parent company and exceptions to its representations and
warranties shall also be negotiated by the two parties. It is only after all the contracts and
agreements are negotiated that the transaction be closed by the parties.

4.4.4 CLOSE TRANSACTION

Once the purchase agreement is signed and certain conditions are fulfilled, the process for
closing the transaction shall begin. This is the situation when one or more of the following
conditions must be met:
• At this point the buyer financing has to be finalized like if third party debt will finance the
transaction, a period of time will generally be needed to finalize these arrangements;
• Government approvals must be obtained, wherein the transactiona are above a certain
size or with certain characteristics;
• Third-party consent other than the government are needed before the transaction can
close like of the shareholders and investors.

4.5 RETROSPECTIVE ANALYSIS

Retrospective analysis of the entire transaction is an important step whereby the divestiture
team will evaluate the transaction post completion so as to understand the mistakes committed
in the process for future reference. This would help the organization to learn from past
experience to reap the benefits in future.

The retrospective analysis will involve a meeting of the divestiture team whereby the
transaction shall be reviewed to understand the limitations and loopholes in the deal closed.
The following aspects shall be discussed in the meeting where the inputs from the members
are welcomed:

42
• the aspects of the transaction successfully undertaken and reasons for the same.
• The part of the process which could have been done better
• The performance of external advisors so as to decide on their future engagements in the
company.
• Performance of the internal team in execution of the plan
• The effectiveness of communication plan and scope of improvement if there is a
possibility.
• The measures to improve the performance of internal team.
• The key takeaways from the transaction.

The discussions on the above key aspects would generate a feedback on the entire exercise
and provide for areas where improvement is required for future. This is the most important
aspect whereby the entire transaction is reviewed with the performance of the team members
as well as external resources. Although divestitures are convoluted and arduous process to be
undertaken but has great impact on the value of the company. Thus in order to optimize the
benefits accruing from these transactions the organizations must undertake the transaction
with the help of skilled and experienced team in disciplined and timely manner.

43
 CHAPTER 5
ISSUES AND CHALLENGES

A divestiture may appear to be a simple break-up of business to an amateur but there are a
number of challenges and issues faced by the companies while structuring a divestiture. The
entire process of divestiture is convoluted and arduous exercise which require careful analysis
of varying factors. Divestitures are rife with unique challenges and pitfalls, some of which are
as follows:

1. Separating Tightly Integrated Businesses-

The business may look diversified on the face of it but can be closely integrated in operation
especially due to the advancement in information systems which enables a diversified business
to be centrally managed. A popular illustration can be ERPs which have enabled cross unit
integration in different sectors of economy. There are a large number of services and
operations that may be common to the parent and the targeted unit to be diversified. Implying
thereby that the divested entity would continue to rely on the Parent Company even after the
post-transaction close. This can pose challenges for the buyer until the buyer plugs-in in the
place of the parent or the divested unit can stand alone. The difficulty of separating a tightly
integrated business increases the cost of separation. The cost of operation post transaction
may increase for the diversified unit unless the buyer makes other arrangements.

2. Providing Transitional Services —

Due to the above mentioned reasons the parent may be compelled to provide transitional
services to the divested unit even after the transaction close to keep it operational. Many a
times there may be cost effective and quick alternative options available than that of the
transition service agreements (TSAs) which are often assumed to be the default option. This
may prove to be economically inefficient in terms of performance as well as the cost as both
the seller nor the buyer are not in the business of the transition services to be provided. The
organizations do not evaluate the transition service agreements in terms of the costs incurred
and effectiveness of the arrangement which put both the parties in a disadvantageous position.

3. Increased Stranded Costs —

44
Divesting the non-core business units might leave the seller with a disproportionate cost
structure vis-à-vis to the new business size. The management shall carefully evaluate the loss
of scale and capacities whereby it can balance the two aspects so that the costs can be in
control. There are situations where the increase in cost is evident but the management fails to
keep a control on the cost. During the time of transition there is a high possibility of increasing
the costs but the organization may lack resources to execute, which may overburden the parent
company with unnecessary costs affecting its future profitability.

4. Confronting Varied Disruptions —

The divestitures may cause disruptions in the internal functioning of both the parent and the
divested unit. The employees may find it difficult to perform there functions in a new
separated entity. The activities which were common and performed by a common department
may find it difficult to cope with the changing ownership pattern. There are high risk of market
position and business continuity to be affected due to inability to tune to the new setting of
the business with respect to the internal functioning of both the parent and divested entity.

5. Managing Multiple Parties and Divergent Agendas —

A large number of parties are involved in a divestiture transaction having different agendas.
The non-aligned goals of parent company, divested unit and the buyer involved in a divestiture
may cause the failure of the entire transaction. The conflicting interest of parties may lead to
mishandling of the deal and increased costs of the transaction. The parent may focus on
maximizing its shareholder value and divesting unit may look for a standalone market image
or better profitability whereas the focus of the buyer will be on the expansion of its business.
The alignment of three, is important for the success of the divestiture.

6. Lack of information regarding the transaction-

The employees are often not well informed about the divestiture which may leave them
demotivated and uncertain. The business after the public announcement, ignores the
importance of keeping the employees informed, thus creating an aura of uncertainty thus
leading to greater employee turnover. The employee retention at this point is critical for
business continuity.

45
Also the other external stakeholders having a direct bearing on the business like the
shareholders and other investors are kept uninformed during the transition period after the
announcement which portends another set of problems.

46
 CHAPTER 6

CONCLUSION AND RECOMMENDATIONS

The development of technology and its increasing use for conduct of business has brought
uncertainty in the market. In order to survive the market, businesses must adapt to the
changing situations and amend their structure. The business shall continue to strive for
maximization of value of their business, even when the business is facing a downturn or
unfavorable change. In the continuing efforts to sustain market shocks and unlock greater
shareholder values the business are increasingly turning to divestitures.

The divestitures is disposal of business asset or subsidiary by a corporate entity. Divestitures

may be driven by varying factors. There can be reactive divestitures undertaken under external
market pressure faced by the entity which is forced to divest in order to sustain or the proactive
divestitures which are actively undertaken by executives without external pressure to maximize
shareholders’ value. Depending on the circumstances in each case and the outcome the entity
expects to achieve out of a divestiture, an appropriate mode can be chosen. Every mode of
divestiture, be it spin –off, slit-off, equity carve out or even sell off entails its own set of
benefits on the entity which has to be planned in advance. There are a number of taxation
benefits endowed upon on the divestiture depending on its kinds which determine the
transaction costs.

One of the most difficult elements of planning a divestiture is planning a suitable time for
divestiture to optimize returns. The value of entities involved in transaction heavily rely on the
market sentiments about the transaction which necessitates strategizing the divestiture
appropriately with the aid of a team of experts. There are certain steps to be followed in
discipline while undertaking the exercise so as to ensure the success of the transaction.
Maintaining the focus and staying on the track throughout while meeting all the deadlines is
critical for the process.

The divestitures may on outside look like a merger in reverse but it has more to it than that.
The process is complicated and arduous, which may prove to be very challenging for the
executives as involve stakeholders of multiple entities. Balancing each one’s interest while

47
maintaining positive market sentiments is difficult. While at the same time it can be painful to
divest a segment of a company, in certain cases it may be a difficult task to disintegrate a closely
bound business.

In order to overcome the challenge posed to the company executives and divestiture team and
effectively undertaking the divestiture the following is suggested:

1. Plan in advance:
The divestiture planning shall be done in advance and after consideration of all the
factors. Poorly prepared deals may prove to be costly affair. The parent shall try to devise
plans for post deal disintegration, whereby the dependency of the divested unit on parent
could be reduced. The closely integrated units shall carefully devise strategy to enable the
divested unit to have a standalone operations.

2. Create a Transition Team:

There shall be a transition team created for planning out activities during the period of
transition. The transition period is very critical and if planned in advance to separate the
two entities it may reduce costs. The cost benefit analysis of the transitional services to
be provided by the parent shall be carefully undertaken and various other alternatives also
be evaluated to figure out the most lucrative option in order to insure minimum costs to
the organization. The following points shall be kept in mind:
 The divested entity shall have its own resources and systems in place well in
advance so that it may operate on its own post divestiture.
 The various contracts and agreements of the divested unit shall be renegotiated.

3. Develop a communication strategy

Communication plays a very important role in developing positive or negative market
sentiments towards the transition. There shall be effective communication with internal
as well as external constituencies. Even after the public announcement the parent shall
keep the stakeholders well informed. The employees should be given adequate assurances
so as to retain them. Also proper mechanisms be developed for communicating with the
external constituencies so that the goodwill of the company is retained and positive
sentiments sustain in the market

48
3. Focus on Core Processes–
During the course of undertaking the divestiture the core processes shall not be ignored.
The profitability of the parent has a great impact on the divestiture deal. Better financial
position may fetch better buyers. Also it will help the parent to retain the customers as
well as the employees.

4. Avoiding stranded costs:

The organization may try to balance the increased cost due to shredding of asset and loss
of capabilities. The costs may increase due to reduction in the scale of operations. Thus,
the capacity building shall be the focus. Mechanisms to reduce the costs be devised well
in advance so that the post deal impact be minimized.

5. Separation planning
Separation planning involves decisions regarding the completion mechanisms and tax
planning. The standalone costs shall also be estimated in advance to gain an extra
advantage out of the deal.

6. Aligning different interests:

The parties to the transaction may have variant interest and thus before finalizing the deal
all the goals and expectations be communicated to others in advance so that the conflict
can be avoided. The divergent interest may lead to the process going off track and
increasing the transaction cost which should be avoided.

7. Remember it’s not over when divestiture is complete

Even after the completion of the deal, the two entities must not have completely
disintegrated in terms of operations and thus should be managed carefully. Members of
each company must continue to work together to minimize disturbances to both the
parent and divested companies in order to ensure that operations continue without
interruption.

In the end it is important to stay objective throughout and look at the long term portfolio.
The time is the essence of any kind of divestiture, thus proper planning is necessary with the
aid of advisors. The entire process is arduous and complicated involving large number of

49
activities undertaken simultaneously. Therefore, alignment of all the activities in one direction
is critical to the success of divestiture.

50
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