Divestment: the new 'investment'

ASIAN conglomerates are increasingly seeing that some of their businesses may be holding them back. Divestments could be the way forward. But care must be taken.

Asian conglomerates need to consider divesting businesses as a way to improve overall value. Divesting can improve focus on a conglomerate's core business, or on particular sectors, or geographically.

And though there are risks, most companies benefit.

We are increasingly seeing Asian companies carefully taking this refreshing step. But still, some remain behind the game.

Asia's catch-up

Asian conglomerates are coming from behind when it comes to divesting.

In Asia, most of the largest companies are conglomerates and state-owned enterprises. For example, in South Korea, conglomerates account for about 80 per cent of the 50 largest companies by revenue. In India, the figure is as high as 90 per cent. And China's conglomerates - excluding state-owned enterprises - represent about 40 per cent of the nation's largest 50 companies, up from less than 20 per cent a decade before.

There has long been a belief in the region that conglomerates are worth as much as, or more than, the sum of their parts. But studies suggest otherwise. Markets are valuing conglomerates lower than other forms of corporations in the region. Research by EY has shown that there is a conglomerate discount in advanced Asian economies, including Singapore, Hong Kong, Malaysia and South Korea. We found that industrial conglomerates in Asia trade at a higher discount to market multiples than US industrial conglomerates do relative to US markets.

Yet divesting looks to be a growing trend in the Asia-Pacific. Our analysis of divestments since 2010 revealed that there were over 1,600 divestments by the Asia-Pacific companies. Conglomerates in South Korea and India have been leaders in creating shareholder value by separately listing portfolio companies through spinoffs. In China, the primary means of exit has been through trade sales. South-east Asia has seen a mixture of spin-offs and trade sales to strategic and financial buyers. The leading divesting sectors in the Asia-Pacific were financial services, industrials and consumer discretionary. The results overall look positive.

According to EY's Global Corporate Divestment Study 2015, 69 per cent of executives in the Asia-Pacific felt that their last divestment led to increase in valuation of the remaining business.

In our analysis of the over 1,600 divestments in the Asia-Pacific from 2010 to 2014 and based on the percentage change in valuation (EV/EBITDA) from three months before the announcement date to three months after, we found that two-thirds of the Asia-Pacific sellers enjoyed a positive valuation uptick, and the mean increase in seller valuation was 14 per cent. But there is great divergence between the best performers and the laggards when it comes to divesting. The changes in valuation after a divestment for the top and bottom quartile of sellers in our analysis were a 38 per cent increase and a 44 per cent drop, respectively.

So can divesting really help your business and how do you go about creating real value?

Why divest?

Divestment can help companies be more focused and push for growth. Our experience in the market has shown how pruning non-core units on a regular basis allows companies to reduce complexity and free up capital for growth businesses.

The benefits of divesting can be looked at from a strategic, financial or operational standpoint.

Strategically, there are various reasons to strip your company of a business unit: that the unit is non-core or in a weak competitive position; it is a better fit with another group; the market is unattractive; or that proceeds can fund future growth for the rest of the group.

From a financial perspective, a company can unlock value by reducing conglomerate discount or by raising money from an opportunistic sale. It may be that the company is in a distressed situation and needs to pay down debt.

From an operational standpoint, reasons to divest may include to focus the management's attention on the core of the company; to simplify operations; or because the business unit to be divested has limited synergies with the rest of the group.

Eighty-six per cent of the Asia-Pacific executives in EY's Global Corporate Divestment Study 2015 said they used funds raised from their most recent divestment to drive growth. Of those, 32 per cent were using the funds to invest in new products, markets or geographies; 28 per cent were investing in the core business; and 26 per cent were making an acquisition. Of the remainder, 9 per cent returned funds to shareholders and 5 per cent paid down debt.

Setting up for success

It is important to remember that divestment is not a strategy in itself, but should be part of a wider strategy of taking a hard look at the company's assets.

For Asian conglomerates, being open to divestment as part of a regular portfolio review process can help raise capital and free up management resources to transform the company into a global player in its chosen focus sectors. Asian companies, especially those that trade at a conglomerate discount, need to carefully define a portfolio strategy that assesses imbalances in capital allocation and drives a strategic approach to investment and divestment.

Deciding what, when and how to sell is fraught with risks that can erode value. Companies fall short in various ways. Some may not have made a clear strategic case for selling a business unit. Others may not have defined the stand-alone operating model well - perhaps because they have not understood entanglement with other business units; or their plans may have been insufficient, leading to delays.

Divestment is a complex journey that requires thorough planning and astute decision-making.

As a start, companies should regularly and thoroughly review their portfolio to identify options for business units. The question to answer is: will you invest, optimise, restructure or divest?

Companies should then crystallise on their strategy and concept by identifying the deal perimeter and deciding on the deal structure. There needs to be adequate planning for standalone operations, covering entanglement analysis, defining the standalone operating model, and identifying required financial and operational bridges.

Significant attention should also be paid to investor reporting and deal-signing, where companies should endeavour to provide a detailed view of the business for buyers, including financial vendor due diligence, and a seller information document covering operations.

In executing the separation of business units, it is important to set up a separation management office to manage the business transfer, including finalising the required transitional service agreements (TSAs), executing a separation-implementation plan, and preparing for day one.

Companies that have divested successfully often demonstrate the following qualities. They make informed decisions, knowing clearly what to sell, when to sell and how to sell (using TSAs etc). Critically, they follow through once they have announced their intent to sell; understand fully the trade-offs between value, speed and risk; and have a dedicated team to manage the divestment.

The way forward

Asian companies are, overall, looking forward when it comes to divestments, judging from how 60 per cent of executives in the Asia-Pacific are expecting an increase in strategic sellers in the market based on the aforementioned divestment study.

Companies need to ensure that they are thinking regularly and clearly about why they might need to divest. It then leaves them to act carefully and thoroughly to make sure they gain real value in return.