DECIDING to sell a business unit or subsidiary can be one of the hardest decisions chief executives have to make. Some cannot bring themselves to wield the axe: big disposals are often triggered only when a new boss takes over or a financial crisis forces a chief executive’s hand. But a growing body of evidence suggests that smart sellers can earn impressive returns.
The number of such sales worldwide has been growing steadily, from 10,074 in 2003 to 12,361 last year, according to data from Thomson Reuters, a research firm (see chart). Over the same period the total value of such deals soared from $539 billion to almost $1.5 trillion, as the average deal size increased. In each of the past three years, several disposals have exceeded $10 billion in value.
This year is shaping up to be a busy one for divestitures too, even though the broader mergers-and-acquisitions market is in the doldrums. Slowing economies are forcing companies to take a hard look at their activities. Corporate activists are also pressing firms to shed underperforming assets. On July 10th General Electric (GE), which has been trying to find a buyer for its home-appliances division, said it plans to spin off its entire Consumer & Industrial division to shareholders. Other transactions in the pipeline include Time Warner’s planned disposal of its cable-television business, Allianz’s scheme to sell Dresdner Bank, and Royal Bank of Scotland’s proposed sale of its insurance arm. General Motors (GM) is looking for a buyer for its Hummer brand, and this week Merrill Lynch was reported to be planning to sell all or part of its 20% stake in Bloomberg, a financial-news provider.
Most sales take place in rich countries, but emerging-market firms have begun to join in. In December 2007 Orascom Construction Industries (OCI), an Egyptian conglomerate, sold its cement business to France’s Lafarge for €8.8 billion ($12.9 billion) in order to concentrate on its fast-growing construction, natural-gas and fertiliser activities (see article). In February the firm snapped up a rival fertiliser company using some of the money raised from the deal.
Although OCI sold its business outright, many emerging giants prefer spin-offs, which involve distributing shares in a subsidiary to the parent’s owners or selling a minority stake to new investors. Take Bharti Airtel, an Indian telecoms giant, which last year spun off a $1 billion minority stake in its network-infrastructure business, Bharti Infratel, to a group of investment funds. Such deals highlight hidden gems in a portfolio, but allow parent companies to retain control. They also attract investors keen to buy into fast-growing industries: in February Kohlberg Kravis Roberts, a private-equity firm, invested a further $250m in Bharti Infratel.
Like many private-equity firms, which frequently shuffle their portfolios, companies that buy and sell a lot tend to shine too. Carsten Stendevad of Citi, an investment bank, notes that between 2002 and 2007 the returns of firms that used a balanced mix of acquisitions and disposals outperformed acquisition-focused companies by almost 5% a year.
Why? Part of the answer is that investors assume that active portfolio managers such as GE and Procter & Gamble (a consumer-goods giant which recently announced the $3 billion sale of its Folgers coffee business) are very focused on growth. They are also less likely to suffer from what academics call “capital allocation socialism”. In many firms, some businesses have excellent growth prospects whereas others are mature but produce lots of cash. Ideally, money from these “cash cows” should be redeployed to the stars, but the cash cows’ managers may fight to keep some of it for their empires. Several studies have shown that the investment in future stars rises sharply once laggards have been dumped.
This effect may help explain why a recent study of European asset sales by Morgan Stanley, another investment bank, found that firms selling large businesses tended to get a bigger share-price boost in the long run than those selling tiddlers. Investors seem to interpret a big asset sale as a signal that managers are serious about focusing on growth areas. If a company is in trouble, a big sale may be seen as an important part of a turnaround.
Of course, a firm will reap the benefits of a disposal only if it is handled well. Yet dealmakers say managers often put less effort into selling businesses than buying them, perhaps because they just want to focus on what’s left. Successful sellers, however, work hard to get the best possible prices for their assets, even if it takes months. GE is excellent at this. Its chief executive, Jeff Immelt, has been jetting around the globe recently trying to drum up interest in its household-appliances arm from the likes of China’s Haier and Sweden’s Electrolux.
As well as touting a division to potential buyers, managers must also assess the impact its departure will have on shared corporate resources, such as finance and legal services. “Firms that don’t do their homework carefully risk being left with lots of needless overhead,” warns Gerald Adolph of Booz & Company, a consultancy.
Timing is everything
The biggest difficulty of all, however, is deciding when to sell. Many experts say that firms often let go of assets too late in a business cycle, when prices are depressed. GM is likely to have trouble parking its Hummer division, for example, having decided to look for a buyer just as giant, thirsty vehicles are going out of fashion because of soaring oil prices.
Although luck is an inevitable part of the timing of any deal, hard-headed firms are always on the lookout for signs that it makes sense to sell even their most precious assets. One company that has made such a call is Ingersoll Rand, a diversified industrial holding company. In November 2007 it agreed to sell its Bobcat mini-excavator business, plus a couple of other divisions, to Doosan Infracore, a South Korean firm, for $4.9 billion.
An Ingersoll Rand spokesman says Bobcat was beating the firm’s margin targets. But it sold the business anyway because Bobcat’s return on capital had been shrinking and because the high prices paid in auctions of similar assets had convinced Ingersoll’s bosses that bidders would fall over one another to get their hands on Bobcat. Given what has happened to the construction industry since November, Ingersoll’s timing looks especially good.