Most divestitures start with a strategic
decision that a company is no longer the best owner of one of its
businesses. It’s a natural move for executives who see value in actively
managing their portfolio of business units—recognizing that to grow,
they sometimes have to shrink first—to deploy capital into a business
with higher returns, for example, or to reshape the company’s strategy.
Indeed, past McKinsey research has shown that companies that more
frequently reallocate capital generate higher returns than their peers.
But once a company decides to sell, problems can arise. Managers devote
their attention to finding a buyer but seldom scope deals from a
potential buyer’s point of view, even as they struggle to figure out
exactly what should be included in the sale, apart from the productive
assets that are its centerpiece. They often think about the separation
process only secondarily, assuming they can separate a business and
worry about stranded costs later. And they neglect the reality of
internal competition for resources that can flare up between the
managers who are staying and those who are leaving. Management and the
board can get so caught up in the sale that the core business begins to
suffer from neglect. All in all, divestiture turns out to be no panacea:
sellers can take up to three years to recover from the experience
(exhibit). Indeed, some companies are so wary of these pitfalls that
they decide to muddle through with businesses of which they are not the
natural owners—another unsatisfactory result, as research suggests that
these sales can produce significant returns for both the parent company
and the divested or spun-off business.
In our experience, even highly complex divestitures can work well,
provided companies follow proven practices, especially in three areas:
scoping the deal in detail, addressing the so-called stranded costs left
behind when the revenue-generating assets are sold, and managing the
expectations and concerns of employees.
These are not discrete goals—in fact, they are mutually reinforcing.
Setting clear boundaries for the deal will enable managers to understand
the implications of any subsequent adjustments to the scope and
accordingly help them maximize value. Clear boundaries will also help
the seller understand the costs that are likely to be stranded; knowing
these early is essential, as they often require some time to wind down.
And the process of defining the deal’s potential boundaries lets
companies be more transparent with employees about the deal process, its
progress, and where they’re likely to end up. Getting started on these
activities quickly, in parallel with the search for a buyer, can unlock
enormous value for buyer and seller alike.
Taking the buyer’s point of view
Few companies adequately study the likely boundaries of a deal before
they start searching for buyers, preferring to start with a simple
high-level definition rather than dig into the details. Admittedly, it’s
a bit impractical to define exact deal boundaries before the identity
of the buyer and its preferences are known.
To get around that problem, smart sellers define a number of different
deal packages—of assets, people, and services—configured to attract
interest from a broad spectrum of buyers. These packages not only
broaden the field of potential buyers, often in ways that companies
cannot envision at the outset, but also help the company cope with the
tough questions that buyers inevitably have about what’s in scope, how
to separate, the transitional services they can count on, and the
financials of the business. Sellers that haven’t begun to define the
deal will be unable to provide good answers—delaying the sales process
and losing their competitive position, as well as leaving buyers to
factor more risk into their valuation models and lowering the value they
see in the deal.
When one European private-equity firm, for example, didn’t get all the
answers it sought about a company it was negotiating to acquire, it
raised the level of assumed risk in its valuation model, suppressing the
value of the deal and lowering the price it was willing to pay. To
prevent such problems, a US industrial company divesting a subsidiary
conducted a detailed analysis of its true sales, general, and
administrative costs and, by clearly defining which activities were
attributable to the business being sold, found them to be tens of
millions of dollars lower than current allocations. That exercise
provided detailed information for potential buyers, increased the profit
of the business being sold, and helped get a higher price for the deal.
Sellers can construct sale packages for a range of buyers. Each buyer is
unique and will have more or less need for infrastructure,
capabilities, and a geographic presence where the assets for sale are
located. To prepare for the wide range of needs, most sellers will want
to develop basic packages for at least three types of bidder: a
strategic buyer with a local presence, a strategic buyer from another
region, and a private-equity firm seeking a stand-alone entity. Bundles
for strategic buyers with no local infrastructure and for private-equity
buyers typically include more support services than those designed for
local strategic investors, which may only want the operational and
market-facing parts of the business.
These packages represent two ends of the spectrum; in between, there are
many possible configurations of support services to package with the
assets. And there may also be buyers interested in cherry-picking parts
of the core business instead of taking all of it—which, while probably
not ideal, should not be discounted out of hand. Sale packages include
pro forma financial statements tailored to represent the package being
offered to each buyer or class of buyer that highlight the true value of
the business, separation and transition plans, and details on proposed
management and talent assignments.
When a large industrial company was looking to divest one of its
business units in the late 2000s, its managers’ first instinct was to
sell to a large strategic buyer. But by conducting a form of due
diligence on its prospective buyers (often known as a “reverse due
diligence”)—including some private-equity firms—the company was able to
understand all the potential synergies each would gain by buying the
business. That enabled managers to design a specific value proposition
for each potential buyer. Eventually, they were able to attract—and sell
the business to—a much smaller player that hadn’t even come up in their
initial scan for potential buyers. Even better, the company got a price
20 percent higher than first expected. In fact, all the bids exceeded
expectations; the final list of bidders included a private-equity
consortium and a few other unanticipated interests.
Rooting out stranded costs
One of the most challenging aspects of a major divestiture is that even
sellers that control expenses well are inevitably left with some
corporate costs associated with the business but not sold with it.
Without the revenues to support them, these stranded costs are a direct
threat to the bottom line. Stranded costs essentially can be any type of
cost that does not automatically disappear with the transaction, from
costs related to shared services, such as marketing and investor
relations, to IT infrastructure. Some of these are fixed, such as the IT
system, and cannot be readily reduced regardless of the size of the
divestiture. Others are more variable and can contract, for example,
with a lower head count—but they can still take years to unwind unless
explicitly planned as part of the divestiture. As noted, sellers often
take up to three years to recover from a divestiture.
Sellers whose cost management is weak are all the more challenged by
stranded costs and are often surprised by how much overhead they have.
The divestiture typically reveals unsuspected layers of complexity or
outright duplication within centralized functions.
We see three strong practices to reduce overhead. First, as we have
discussed, defining the precise boundaries of potential deal packages
early in the deal brings to light the full extent of the subsidiary’s
sales, general, and administrative costs. The parent company can make a
better attribution of resources to the parent and the subsidiary. That
benefits both companies.
Second, successful sellers often use the momentum generated by the
divestiture as a catalyst to reduce stranded costs—and to improve the
performance of any bloated or inefficient corporate-center activities
revealed by the divestiture. (This mirrors a similar effect of
transformational acquisitions, in which buyers take advantage of the
circumstances of an acquisition as a catalyst to restructure costs more
broadly.
Companies can seize the impetus of the divestiture to reexamine their
entire cost base using benchmarking analysis to highlight potential
inefficiency or even zero-based budgeting to encourage a radical
rethinking of the corporate infrastructure.
Rooting out stranded costs takes a separation manager with the foresight
to rethink the parent company’s cost base and the authority to make it
happen—the third good practice.
One industrial organization had divested a few units over the years, but
it had not followed suit with its corporate functions, which were still
sized for their earlier duties. When it came time to shape another big
divestiture, representing about 10 percent of revenues, the company
conducted a thorough search for the stranded costs that lay within
individual support functions, as well as costs that cut across functions
such as real estate. All told, these added up to hundreds of millions
of dollars. That proved to be a catalyst for an even broader cost
restructuring.
Companies of this size often face a special problem in rooting out
stranded costs. For many large multinational companies organized by
matrix, the only pragmatic method is for senior management to lead a
cross-functional initiative to tackle cross-cutting opportunities such
as shared-service and outsourcing operations, as well as the change
programs required to support the cost transformations.
Managing employee expectations
The challenges of talent management in a divestiture start at the moment
companies begin defining the boundaries of different sale packages and
continue right through to the close of the deal. First and foremost,
managers struggle to figure out what to say to the people involved. Most
choose to say nothing at first, reflecting the genuine uncertainty
about what will happen. Sometimes company leaders will choose to keep
plans for the deal confidential up until signing— as one global CEO and
seasoned divestiture veteran told us, “I just deny everything until the
deal is signed. It’s easier that way.” This may be true, but it creates a
communication challenge. Many employees inevitably will know about the
deal because of the massive preparation work that is impossible to
conceal. But if management officially denies the reports, it becomes
very difficult to put in place communication plans and other measures to
minimize the concerns that always arise in such situations—all
employees want to know, “What happens to me?”
Some form of short announcement is essential. Once managers make an
announcement, they should clearly define and communicate the selection
process to keep employees motivated while they wait for news of their
fate. That can, of course, be challenging in situations where the deal
boundaries are unclear until late in the process. Ideally, the
communication plan should be part of a compelling story that shows not
only employees but also investors, analysts, and customers why the
divestiture will leave both buyer and seller better off.
Once the word is out, other challenges begin. In almost every
divestiture we’ve worked on, tension has arisen from the moment it
becomes clear who is staying and who is going. Given the role the
exiting managers will play in communicating the business’s value to
potential buyers, delay in informing them is undesirable. But once they
are informed, they immediately become another party at the negotiating
table, bargaining for the talent, assets, and contracts they feel
they’ll need to be successful and trying to avoid the ones they don’t
want.
Failing to manage the tension between the two groups can be damaging.
When a global industrial company divested a multibillion-dollar
division, for example, it began to receive a lot of applications for
transfers from the entity to be divested back into the parent company—so
many, indeed, that the company was at risk of visibly depleting the
divested company of talent and experienced leadership, potentially
affecting its value. To discourage the transfers, it aligned the
incentives of people in the departing unit to the characteristics of the
sale. It decided to reward managers based on earnings before interest,
taxes, depreciation, and amortization (EBITDA)—a critical negotiating
point with the private-equity firm that ultimately bought it. The
emphasis on EBITDA motivated exiting managers to minimize the overhead
they took with them; it also reduced transfer requests.
This approach did leave more overhead for parent-company managers to
deal with, just as they too were striving to reduce overhead costs. But
they made a conscious choice to accept this, believing that the right
way to deal with broader cost issues was, as we discussed above, as part
of a thorough change process in the wake of the divestiture.
Parent-company managers often lack the incentives that would compel them
to take care of the departing entity. If they do not feel responsible
for the unit’s success, they may stop investing in value-creating
projects, caring for employees and customers, or watching costs. In our
experience, it is important to define and implement a set of performance
measures and rewards aligned with value maximization, and to use these
with all key people involved in the divestiture process. The most
obvious rewards are monetary, but research shows that other incentives
(such as recognition and promotions) can be equally if not more
important determinants of performance.
Negotiations over talent are particularly sensitive. The first
inclination of parent-company managers is to keep the best performers
and send the rest with the divested business. That’s not practical, in
the end, because regardless of the type of buyer, the divestor has a
moral obligation—and in some places a legal one—to make sure the
business is a going concern. Furthermore, sellers who intend to divest
multiple businesses in the future do not want to be perceived by the
market as selling bad businesses stripped of key talent, as this will of
course affect their ability to make future deals. At the same time, the
parent company must retain critical resources, and quite often, the
exiting managers have the very skills they need. Thus, successful
divestors will address the issue of talent early in the process and
start building or acquiring the skills needed in both the parent
organization and the business to be sold.
Much of the value of a divestiture depends on the
effectiveness of the separation process. Defining the right deal,
managing talent uncertainty, and rooting out stranded costs can make the
difference between a deal that succeeds and one that destroys value.
And skill in divestiture is comparatively rare; doing it well can help
companies get a competitive edge.
Source: https://www.mckinseyquarterly.com/Profitably_parting_ways__Getting_more_value_from_divestitures_3061
