It’s a common misconception that companies divest assets because of underperforming businesses. According to Dealogic, only 10 percent of carve-out deals were for the purpose of shedding an underperformer, whereas in nearly 80 percent of the cases the divestiture’s purpose was to refocus on the company’s core assets and capabilities as a means of enhancing shareholder value.
Yet companies too often struggle to create incremental value through such divestiture activity. Our research shows that not only do most divestitures fall short of their value-creation goals, but many companies end up worse off.
The good news is that executives can actively influence the value creation outcome depending on how well they craft the divestiture strategy and manage its execution. In this article we explore the common challenges and identify how organizations can create value from a divestiture.
Kearney Value Creation Scorecard
Past divestitures—whether successes or failures—offer valuable lessons that can improve the outcome of future deals. To get a better understanding of these lessons, we examined more than 2,000 divestiture events from the past 20 years and evaluated these deals for both the divested entity (SpinCo) and remaining organization (RemainCo) against Kearney’s Value Creation Scorecard.
The Kearney Value Creation Scorecard is a means of assessing and visualizing the success of divestiture transactions in the 12 months after the transaction (see figure 1). The scorecard measures “value creation” across two dimensions: (1) market capitalization growth relative to the S&P 500, and (2) revenue growth versus the company’s competitive set. We then categorize each divestiture event as being a value creator, value parity, or value destroyer.
Our findings were revealing (see figure 2). Twelve months after the deal, only 30 percent of companies created value, while nearly 40 percent destroyed value. RemainCos fared much more poorly than SpinCos. For example, they are more than twice as likely to destroy rather than create value in the 12 months following a divestiture. While SpinCo organizations are three times more likely than RemainCos to create value, their success rate is still lower than 50 percent.
Missteps and opportunities
Based on our experience, most companies experience four common challenges when completing a divestiture. However, whether they became value destroyers or value creators depended on their priorities in the aftermath of the transactions. Here are four challenges that reveal the approaches that led to success as well as missteps to avoid.
Challenge #1: Missed transformation opportunity
“We placed too much effort on tactical playbook and short-term cost decisions… and almost no emphasis on growth or value creation… we missed an opportunity to truly transform the organization.”
—$60 billion personal computing RemainCo (value parity)
Regardless of their size and complexity, divestitures are strategic events. Divestitures offer a rare reset opportunity for both RemainCo and SpinCo organizations to implement their own transformation agenda. Both internal and external stakeholders and customers are often more receptive to change during this separation period, opening up the opportunity to remove longstanding business and operational constraints. Investor scrutiny also tends to soften as the financial community adopts a wait-and-see attitude directly following the transition.
Conducting a transformation effort in conjunction with a carve-out is not easy—but most value creators do just that. They take on both functional and companywide transformation initiatives focused on streamlining operations, building or strengthening capabilities, and improving their strategic or value positioning. Because of the strategic nature of these initiatives, it’s common for value creator organizations to assign divestiture management accountability to their most influential senior executives, typically a chief operating or chief strategy officer.
In contrast, we found that many value destroyers emphasize the tactical and administrative elements of a divestiture needed for day one readiness, while overlooking the broader transformation opportunity. In many cases, they also delegate divestiture management accountability to roles outside of the C-suite—and focus primarily on financial objectives.
Challenge #2: Core business disruption
“We made a mistake spinning off a key shipbuilding electronics shop that should have remained with the core business… morale and retention took a huge hit and we never fully recaptured the expertise.”
“It took way too long to untangle our IT infrastructure.”
–$8 billion shipbuilding spin-off (value destroyer)
Whenever a business separation is under way, the sheer number of resources required can divert executive attention from the day-to-day running of the business. Perhaps an important growth initiative falters due to neglect, a key customer is ignored, or employee morale begins to waver. These all distract focus from daily operations; prolonged separation time frames only worsen the situation. As such, value creators place high importance on an accelerated announce-to-close timeline of usually nine months or less. Meanwhile value destroyers are more likely to drag the process out for 12 months or longer.
Value creators also emphasize stabilizing their customer-facing and go-to-market functions such as sales, supply, customer service, marketing, R&D, and crucial IT infrastructure. They make longer-term resource decisions based on the goals and aspirations of the future organization. Value destroyers often place equal attention across all functions. They are also more likely to make short-sighted resource decisions that result in new targets for overhead reduction.
Finally, we saw a distinction in how value creators often planned toward an operational cutover period, in which the two organizations begin operating as separate entities up to three months prior to day one. This approach reduces business disruption risk by helping both RemainCo and SpinCo organizations identify and resolve cutover issues while they’re still technically the same company.
Challenge #3: Unsustainable costs
“We stuffed [SpinCo] with as much costs as possible and let them go with the assumption it will get fixed later.”
—$4 billion pharma spin-off (value destroyer)
“Our overheads were more than 500 bp higher than competitors. It took more than one year to reset, and severely limited our pipeline.”
—$5 billion smart home spin-off (value destroyer)
By design, a divestiture results in two businesses with reduced scale. However, without a focus on optimizing the results, each company ends up with a diminished competitive advantage. Ongoing success is therefore dependent on resetting the cost structure.
The seller’s deal priorities and divestiture rationale often leads to one or both Newco entities being saddled with unsustainable costs. The benefits from emerging as a smaller and more nimble organization can be outweighed or at least significantly impaired by stranded costs and “big company” overheads.
There may be good reasons to focus on the divestiture execution while addressing costs at a later date. These might include contractual commitments, stakeholder implications, or limiting business disruption. However, those who take this approach are more likely to be value destroyers. Value creators on the other hand undertake more rigorous cost take-out programs that are central to the separation process. Their approach is often more aggressive in nature, with emphasis on quick wins and same-year savings realization. The value creators are also more willing to pressure test and evaluate their Newco cost structure based on the future operating model and needs.
Challenge #4: Stakeholder uncertainty
“We [RemainCo] relied on SpinCo for risk/compliance customer information… we were not equipped to handle even simple customer questions.”
“Employees were shocked and surprised after being told just last week we’re not spinning off this business.”
—$9 billion payment processing spin-off (value destroyer)
Many stakeholder interests are at play in a divestiture and keeping communication lines open with them throughout is crucial. When management conveys unclear or conflicting information about the deal rationale and the plans for separation, it creates an environment of uncertainty, which can lead to short-sighted or confused decision-making. Employees may be worried they will be laid off and lose focus; some, typically the stronger ones, may leave in anticipation. Customers may delay signing contracts or begin searching for other suppliers, while competitors may proactively look for opportunities to take share. Investors—without a firm understanding of the deal—may question the strength and viability of the business.
Value creators manage fear, uncertainty, and doubt (FUD) among stakeholders by being consistent and transparent about deal rationale, and by proactively sharing separation plans both internally and externally. Furthermore, after announcing plans for divestiture, they often actively involve those who will be affected in evaluating and planning for the impact. Not only do they make talent retention a core focus, they take a proactive approach to customer communication. For example, within 48 hours of announcing the separation, all hands should be on deck executing a customer outreach initiative. The effort needs to include a closed-loop feedback system based on actively reaching out to customers, capturing and centralizing their inputs, and then taking action as needed.
Becoming a value creator
In summary, here’s our guidance on the key moves organizations need to make when planning for and executing a value-creating divestiture:
- Manage the divestiture as you would a broad-scale transformation. Use this window of opportunity when stakeholders are receptive to change to rethink your operating model and redesign business operations. Assign C-level oversight and accountability to the divestiture management office.
- Accelerate the separation timeline. Minimize disruption to your core business in part by constraining the announce-to-close timeline to nine months or less. Also pressure test and refine the new organizations by planning for an operational cutover three months prior to close. This involves significant upfront planning and a dedicated divestiture management office.
- Take a rigorous and outside-in cost management approach. Reset both the RemainCo and SpinCo cost structure with a streamlined and more agile and efficient future organization in mind. Relentlessly pursue and eliminate stranded costs. Don’t wait until after the separation to do this difficult work.
- Conduct proactive and closed-loop employee and customer stakeholder management. Communicate often and be highly transparent with employees regarding the purpose of the divestiture and its implications. Plan for and conduct top-to-top customer outreach within 48 hours of the separation announcement. Then maintain a closed-loop customer outreach and deal-monitoring process to quickly identify and resolve issues that will inevitably arise.
Divestitures can enable significant topline growth and shareholder value when the strategic rationale is strong and the implementation is successful. They present an opportunity to rethink and reset business and operating models, as well as streamline costs and focus on core capabilities. Companies that successfully navigate these four key divestiture challenges are most likely to come out stronger and more well-positioned than ever.