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Divestitures - the ace of a tool up a CFO's arm to survive and thrive in crises

The crisis of the pandemic has surely left companies across sectors with unprecedented challenges in the face of a tepid economic situation. In such a scenario, finance leaders are uniquely positioned to lead the path to recovery for companies by instilling a cash culture across the organization to deploy resources dynamically.

With the advantage of a bird's eye view that CFOs have of a company's overall financial position, they have a pivotal role to play in identifying and accelerating effective capital infusion measures, such as divestitures and joint ventures. Finance leaders, after all, have the pulse on when to acquire or expand, and when to shed the flab and spinoff, especially in times of crisis like the present one. Benefits include financial stability, a leaner book of debt, room to invest for optimum returns, and ultimately, improving overall shareholder value.

To further decipher a CFO's rationale behind such a move, let's first look at the various divestiture structures:

  • Equity Carve-Outs -
  • These transactions are tax-free because they involve an equal exchange of cash for shares. In this case, a parent company offers a portion of the stock it holds in a subsidiary to the public.

  • Spilt off followed by Spinoff -
  • A spin-off is a non-cash, tax-free transaction, in which a parent company distributes shares of its subsidiary to the shareholders. As a result, the subsidiary becomes a separate entity with tradable shares on the stock exchange. 

  • Direct asset sales -
  • The parent organization sells physical assets, such as real estate or equipment, to a third party. Cash is involved in these transactions that may result in a tax bill for the parent corporation, depending on various factors, such as retention of control on divested business, formation of a new legal entity, need for cash, and so on.  

A strategic approach to M&A has proved effective in past crises as well. According to a commentary by Ernst & Young, "Companies that divested during the 2008-10 global financial crisis (GFC) outperformed those that did not by 24 percentage points in median total shareholder return (TSR)." The pandemic has further underlined the fact that CFOs must not just consider but accelerate divestments for long-term liquidity requirements of businesses and free up capital for future-led investments.

The roiled markets and plummeting valuations because of the pandemic, has surely presented opportunities for CFOs to divest non-core operations at attractive valuations. CFOs certainly have the appetite for it. The 2021 Global Corporate Divestment Study by Ernst & Young states, "Over 90% of companies felt that changing technology and competitive landscape are directly influencing their divestment plans."

A deep diagnostic on the balance sheet to identify goodwill impairments, debt refinancing opportunities; inventory optimization, and streamlining accounts-payable and accounts-receivable, is a good point to start. This exercise can significantly extend the financial flexibility of a company in a tightened market, while also allowing leaders to focus on key metrics that will be crucial for future growth. A close review of other capital-intensive functions, such as R&D and IT infrastructure, must also be carried out to realign capital allocations, under reimagined business strategies. Due diligence plays a critical role in providing the depth of understanding of existing processes, scope, systems, applications, and future requirements.

Given the rapidly changing technology landscape, client preferences, and economic considerations, it is highly possible that priorities on projects would have shifted during the intermittent breakout phases of the pandemic. In a dynamically shifting demand and supply scenario, finance leaders need to act quickly and redistribute resources, both human and financial, to projects that are aligned to current market conditions.

While we were already on our way to digitalization, the pandemic has stressed the digital-first agenda even more. Organizations must strive to differentiate themselves based on connected, omnichannel experiences, to leverage the changing market, or be left behind. These factors are deeply influencing finance leaders to revisit their balance sheets and reimagine operations at scale. The re-evaluation process can work wonders in optimizing or consolidating operations, and subsequently, train higher focus on core business areas. Divestitures can effectively free up cash for companies and empower them to go after projects with higher returns, creating simplified, digital-first businesses of the future.

CFOs across industries are working in tandem with this renewed strategy born out of the chaos of the pandemic. What is different this time around is that the focus is not just to survive through the crisis but build a long-term roadmap by turning adversity into an opportunity to transform for good. From this point of view, it is even more critical for CFOs to quickly shift to a transformation mindset and dynamically reallocate resources for future growth while realigning portfolios through acquisitions and divestitures. This is the time to shelve the old and embrace the new. If it involves becoming leaner, so be it.

This article was first published by CFO Dive.