What are Divestitures?
Divestitures involve the disposal process of a company’s business unit or assets through either sale, exchange or closure. The four types of divestitures include sell-offs, spin-offs, split-offs and carve-outs.
Sell-off
As the name suggests, within Divestitures, a sell-off involves a company selling off a business unit or some of its assets to an acquirer. A sell-off is the most common form of all divestitures. As we already know, the purchaser of these assets would be performing an asset acquisition.
The seller can use the cash flow generated from the sale for whatever they please; they may reinvest this money into one of their more competent business operations or simply retain the cash as an asset on their balance sheet.
Spin Off
In a spin-off transaction, a company creates a brand-new subsidiary from an existing business unit or division. In this divestitures, shares of this new subsidiary are distributed to shareholders of the parent company on a pro–rata basis.
Spun-off subsidiary companies keep their assets and liabilities and will usually continue to receive support from their parent; the only difference in the new company is the management team and name. An example of a spin–off in Divestitures we will look at later is PayPal spinning off from its parent company, eBay.
Split Off
A split-off is very similar to a spin-off when it comes to Divestitures. Upon spinning off a business division into a new subsidiary, the current shareholders of the parent company are then given an option on which company they would now like to own shares in.
They can either continue holding shares in the parent company, exchange them for ownership in the new, spun-off company, or exchange only a partial amount of shares.
Carve Out
A carve–out is a post–spin-off option the parent company can take in Divestitures. It simply involves issuing a portion of shares of the subsidiary on the stock market, typically through an IPO. The parent company will remain in charge of the subsidiary if they hold the majority of shares, of course. For the carve-out to remain tax-free, no more than 20% of the subsidiary’s shares can be issued on the stock market.
Incentives and Benefits of Divestitures
Ultimately, companies conduct divestitures to generate more cash flow and to maximise shareholder value. The motivations behind divestitures and which asset or business to divest will vary depending on various factors, from the company’s industry to the widespread current economic conditions. We will look at two fundamental intentions behind divestitures: the disposing of non-core businesses and classifying their differentiated business lines.
As companies grow, they accumulate many assets and typically create new business divisions, potentially leading to inefficiencies, mismanagement and higher costs. If these issues are to be overcome, companies will have to restructure to avoid financial distress or even bankruptcy in the worst-case scenario.
Part of the restructuring process to do with divestitures involves identifying core and non-core businesses. Core businesses directly relate to the company’s primary focus and usually generate the most revenue, for example, Apple’s focus on consumer electronics. Non-core businesses are still important to the company; however typically generate only a tiny minority of revenue, for example, Apple’s autonomous vehicle line. If a non-core business is financially underperforming, companies may sell off the division to some external financial institution or investor to reduce costs and increase cash.
While not that prominent, there have been some forced sell-off divestitures mandated by the government in the past. The most famous example was the breakup of AT&T and Bell Operating Companies in 1984 when the United States government issued an anti-trust lawsuit against them as they feared AT&T was becoming a monopoly in the telecommunications sector.
Another restructuring process is differentiating business lines for more significant growth. A non-core business with an alternative focus to the company’s primary business can have the potential to grow and create more value from shareholders under different management.
Spin-off, split-off or carve-out divestitures will turn the business into a separate entity. The parent company can then realise financial gains in a few different ways.
A carve-out generates cash through an IPO of the subsidiary, or shareholders with a stake in a spun-off or split-off subsidiary have the potential to profit from their stake if the new entity performs strongly under its new management team.
Acquiring a company and divesting a business unit may be impractical for some companies. We would suggest looking at Joint Ventures when two companies want to work together more collaboratively and remain separate entities entirely.
Case Study of eBay’s Spin Off of Paypal
Founded in 1990, PayPal is now regarded as one of our era’s best online payment services. PayPal was later acquired by eBay in 2002 for $1.5 billion. eBay’s business remained relatively steady throughout the years, while PayPal was growing rapidly.
It wasn’t until 2013 when activist investor Carl Icahn noticed that eBay was undervaluing PayPal and suggested that it become a separate company with its own capital structure and management team. He suggested using Divestitures. At the time, PayPal contributed approximately 40% to eBay’s revenue. If PayPal was to operate as its own company, it could expand its business by building partnerships with eBay’s e-commerce rivals.
Hence they would have the opportunity to seize further market share against their rivals in the online payments industry, such as Stripe, Amazon Payments and Google Wallet. The divestiture finally occurred in July 2015, with PayPal going public again through a spin-off and carve-out. By the time both divestitures had been issued, and even today, PayPal was a prominent tycoon in the online payments industry. In 2022, PayPal had an outstanding market share of around 42%, while Stripe had only 19% and Shopify had 12%.
Sources and Further Reading
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