Don't forget to prune your portfolio

THERE are many reasons why executives shy away from divesting non-core businesses. They're reluctant to shed revenue, fear the market's reaction to a smaller company and don't want the challenge of stranded costs. They reason that the business could improve in time, or have trouble accepting the fact that it could perform better in another's hands.

But it's OK to divest. When strategically selected to clean up a company's portfolio and designed to command an optimal price, divestitures can generate significant shareholder value. They can also create a catalysing event for improving the remaining business. When done well, they reduce complexity and provide fuel for the company to pump back into its core.

As part of our ongoing work with divestitures, Bain & Company studied more than 2,100 public companies and found those engaging in focused divestment outperform inactive companies by about 15 per cent over a 10-year period, as measured by total shareholder returns (TSR). The results are even better for companies that combine focused divestments with a repeatable M&A model. They outperform inactive companies by nearly 40 per cent over a 10-year period and generate more than twice the sales and profit growth.

Among the 137 largest divestitures in the study, companies that divest to focus on their core saw their market cap rise by 7.9 per cent three months following the announcement. This compares with 1.4 per cent for companies that divest with the primary stated aim of raising cash to pay back debt.

From our experience working with companies across industries, we've identified four fundamental processes that enable successful divesting.

An important consideration: Include strong talent in the business in the pre-divestiture period. Good executives can help spur the growth and margin improvement that adds a lot of value.

A major US aerospace company believed that it would not find a buyer for one of its non-core business units - it was pursuing a sale process, although leadership internally believed that its only option was to spin off the business. In the process of preparing an equity story and separation programme for the business unit, it identified ways in which the business could thrive outside of the parent. The aerospace company saw far more potential than it had anticipated, in both revenue growth and cost opportunities, and it embarked on a broad-ranging cost initiative.

This process helped give confidence to a buyer, leading to a transaction in which the buyer later announced a synergy programme based heavily on that cost initiative.

While determining how to increase the value of the divested business, also define how to rightsize the remaining company - estimate the level of anticipated dis-synergies and develop a plan to offset them. Minimise stranded costs by adapting the infrastructure and the back office, as well as adjusting the IT architecture to match the smaller scale and shape of the post-divestiture business.

We find that the best companies establish a separation management office to plan and execute the carve-out while controlling one-off costs and managing TSA commitments. They develop a well-thought-out internal and external communications plan, optimising the remaining company's operating model and infrastructure for the future portfolio. They ensure robust TSA governance and then remove the associated costs.

Indeed, as more companies are discovering, divestitures are an important tool in a senior leadership team's arsenal. They are complex, however, and many companies' muscles are not as well-developed for divestitures as they are for acquisitions. As a result, divestitures need careful attention both before and after the sale to deliver outsized value. Companies that regularly prune their portfolio, take an active hand in preparing assets for sale, manage the separation and use the sale funds to acquire core assets in a repeatable M&A programme make divesting a win-win for buyers and sellers.