Mission Possible: Getting Rid of Value-Destroying Assets

Portfolio realignment as part of a broader business transformation can be a complex, gut-wrenching, time-consuming process. However, CFOs looking to unlock additional shareholder value may also find it a business imperative.
 
In Deloitte’s Q1 2014 CFO Signals™ survey, more than 20% of large-company CFOs in the US say they expect a substantial merger or acquisition in the next year, more than 15% expect a substantial divestiture, and about 14% expect to discontinue operation of a business unit.
 
Whether their efforts lead to an ‘advantaged portfolio’ – meaning a portfolio that is strategically sound, value-creating, and resilient – is not guaranteed, of course. And there is no one way to go about the process. While companies are increasingly using divestitures to realign their portfolios, this tactic alone is not enough to build value.
 
In this CFO Insights article, we examine the steps companies need to take to build an advantaged portfolio, and discuss how CFOs can foster the process.
 
Four Steps to Realignment
There are several reasons why portfolio realignment is becoming a business imperative. For one, some companies have been unwilling or unable to dispose of their value-destroying businesses. Consequently, these companies may now be finding their growth and profitability hampered by overly complex operations, uneven performance, and the need for fundamental improvements in business quality.
 
Other companies that did sell underperforming assets to raise cash may have ineffectively utilized the resulting proceeds. Today these organizations may be discovering that they are not well-positioned to take advantage of changing economic and credit conditions.
 
Finally, some companies view portfolio realignment as part of a broader, ongoing revitalization process of adding new assets and shedding old ones to address globalization and value migration, or to align with a fresh corporate vision.
 
Whatever the driver, there are four major steps to creating an advantaged portfolio:
 
  • Analyze and disaggregate the current portfolio and dispose of value-destroying businesses
  • Improve the profitability of established businesses
  • Grow new business through internal development and/or M&A
  • Evaluate and reevaluate the new portfolio’s fit with advantaged-portfolio criteria
 
Step One: Analyze and Dispose
Improving the core of the organization begins by assessing the present and future position of each business, and then defining its appropriate role.
 
When disaggregated, many corporate portfolios exhibit a surprisingly wide range of contributions to shareholder value. Equipped with that information, a company can develop a picture of how individual business units are creating or destroying value, and better determine its investment solutions going forward (see chart below).
 
Divest, invest or harvest?
Source: Portfolio Realignment: A Business Imperative, Deloitte Development LLC 2013
 
This first step is an important part of a self-funding approach – one that generates cash for reinvestment – by increasing investment potential among core portfolio businesses. After all, some business units may consume a large amount of corporate assets while making little or no contribution to overall value.
 
One possible indicator: these underperforming assets often perform poorly when measured by return on capital (ROC), which correlates highly to shareholder value and is central to many capital- intensive industries, such as manufacturing, energy, and consumer products.
 
Case in point: An ROC analysis of a chemical company’s business portfolio identified a business unit that was destroying enterprise value despite the fact that it generated 28% of the company’s EBITDA. The ROC analysis suggested that as much as US$7.70 per share in value was lost due to owning the business.
 
Although selling off the business unit dropped EBITDA by 30% and required a book loss at the time of sale, the parent company’s share price rose approximately US$7 per share when the deal closed. The value increase was nearly identical to the estimated value lost by holding the business.
 
CFOs should address both the strategy and the structure of each business to help identify drivers and destroyers of value, structural costs, and growth opportunities by asking the following questions:
 
  • Where is the “magic” made in the business? What does the business do that is different and creates value and profits?
 
  • How does the business strategy create value? Is the strategy clearly articulated and understood?
 
  • Which assets, customers, markets, and products create value?
 
  • Are the company’s sources of growth and innovation engines clearly defined?
 
  • How should business units be redefined to work with strategic and transaction planning?
 
  • Which businesses are currently creating or destroying value?
 
Companies should resist the urge to move directly to high-growth opportunities without first removing existing impediments to success, either by divesting, shrinking, or not growing businesses with low returns.
 
Assessing whether an underperforming business can or should be fixed requires careful thought. A changing competitive landscape, maturing markets, or large, outdated assets in the wrong part of the world can make transformation a difficult task that consumes precious management attention and resources that could be better applied elsewhere.
 
Step Two: Structurally Improve Profitability
The next step for the organization is to make the remaining assets more accretive to value by improving returns or generating profitable growth.
 
Structural improvements that CFOs can look to in order to drive increased returns and improve profitable growth within an individual business unit include:
 
  • Supply chain or operational improvements
  • Customer and channel enhancements
  • Product and value proposition innovation
  • New business models (for example, value-priced total customer solutions)
  • Asset-light restructuring
  • Geographic expansion
 
Step Three: Grow New Businesses
Expansion can be done through internal development and/or mergers and acquisition that support long-term vitality and align with company strategy.
 
The direction and goals of new business growth should be focused on the previously mentioned portfolio analysis questions as they pertain to organic growth opportunities. Creating an advantaged portfolio requires as much discipline when growing businesses as it does when evaluating divestiture candidates. After all, growth solely for the sake of growth consumes critical cash and corporate management attention, and can lead to value destruction rather than value enhancement.
 
This same lens should be employed when evaluating M&A opportunities. A useful tactic to help screen M&A candidates is to evaluate them against designated criteria, such as geographic location, innovation, and management-oversight needs. These factors may help executives gauge the relative risk and corporate focus required to manage the investment as compared with other opportunities.
 
Step Four: Evaluate and Reevaluate
Finally, the realigned portfolio, including any new businesses, should be regularly evaluated to determine its fit with advantaged-portfolio criteria. To help evaluate whether a portfolio remains “advantaged,” CFOs should ask whether the portfolio as a whole meets the following criteria:
 
  • Is it strategically sound? In particular, is it weighted toward competitive advantage? Does it carry an optimal innovation mix? Is it configured to create synergy?
 
  • Is it value-creating? That is, does it maximize “intrinsic” value? Are we the best owners of the portfolio and each of its components? Are there capital market– driven reasons why we need to alter the portfolio?
 
  • Is it resilient? Does it effectively weigh feasibility and risk? Will it be robust across future scenarios? Does it create optionality in the face of near-term uncertainties?
 
Conclusion
For CFOs looking to embark on successful portfolio realignment, the following elements need to be embraced:
 
Holistic, top-down approach. Such an approach, which includes enlisting strong executive leadership, is essential, since asset ownership issues—as well as elements of corporate strategy—are involved.
 
Dispassionate data analysis. There should be no sacred cows or so-called lemonade stands (small assets). Preconceptions, personal history, and bias can impede success.
 
Transformational, not incremental, change. Portfolio realignment is not only about cleaning up assets, it should also be driven by an enterprise-wide strategy for growth and renewal.
 
Leveraging informed estimates. Precision is not always possible in making the decisions necessary to retool a portfolio. Expect multiple iterations to get the data both “right” and representative.
 
Without a doubt, portfolio realignment takes time and patience. Shedding businesses that management has spent years, even decades, nurturing can be a painful process. Moreover, there is always a cost involved in acquiring or divesting. Companies may also have to overcome resistance to selling businesses that are low growth/low return because they may still reduce total net income/EBITDA.
 
Still, given the correlation to increased share price, finance chiefs need to consider cleaning up their companies’ portfolios to get rid of underperformers and value destroyers. And by approaching the process holistically and rigorously, they can help construct a portfolio of businesses that supports the company’s strategic vision and creates sustained shareholder value.
 
About the Author
This Deloitte CFO Insights article was developed with the guidance of Dr. Ajit Kambil, Global Research Director, CFO Program, Deloitte LLP and Lori Calabro, Senior Manager, CFO Education & Events, Deloitte LLP. For more information about Deloitte’s CFO Program, visit www.deloitte.com/us/thecfoprogram
 
Copyright © 2014 Deloitte Development LLC. All rights reserved.  
 

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