Capital markets are rewarding divesting companies with increased valuations, according to an M&A report by The Boston Consulting Group.
BCG’s analysis of more than 8,300 divestitures over the last 24 years shows that the stock price of the average seller increased by 1.4 percent in the days following the divestiture announcement.
Because divesting companies expand their EBITDA multiples by an average of 0.4 times on top of an already improved operating margin, investors bid up divesting companies’ share prices immediately following an announcement in anticipation of these increases.
Not all divestitures are created equal, however. Investors reward companies that have credible exit strategies and punish those whose rationales and execution are unconvincing.
BCG research shows that 55 percent of all divestitures created value, as measured by the average cumulative abnormal return (CAR)—the change in market value over a seven-day window centered on the transaction announcement date—compared with a broader index.
Successful sellers received an average increase in CAR of 6.6 percent, while the other 45 percent saw an average drop in CAR of 4.8 percent.
“Companies often have a potent value-creating weapon in their strategic arsenals, and more and more CEOs are using it,” said Jens Kengelbach, a BCG partner and coauthor of the report. “The truly strategic question any company or CEO needs to ask is whether one company’s assets could have a higher value for another company, and thus a better owner. Increasingly frequently, the answer is yes.”
For divesting companies, maximizing value depends substantially on choosing the right exit route.
Companies have three basic alternatives: a straight trade sale to another buyer; a spin-off to the company’s existing shareholders; and a carve-out, in which the parent company sells a partial interest to the public while retaining ownership---often a controlling interest.
In a surprising and counterintuitive finding, BCG found that investors reward spin-offs most highly of the three principal divestiture routes, even though spin-offs generate no cash for the seller and typically take more time than trade sales to execute.
The post-announcement return for spin-offs was 2.6 percent—double the 1.3 percent and 1.2 percent generated by trade sales and carve-outs, respectively.
Spin-offs are not an automatic answer, however—far from it. Three factors play critical roles in the divestiture decision-making process and combine to determine the optimal divestiture path.
Capital markets aggressively examine the situation of the parent company (including financial strength, profitability, and strategy); the asset’s own attributes (its core industry, quality, and innovativeness); and the market environment at the time (volatility, valuation levels, and point in the business cycle), which means the parent company needs to assess all three dimensions simultaneously before deciding the optimal exit route.
“Market conditions and the specific attributes of the transaction will determine the best exit strategy,” said Alexander Roos, a BCG senior partner and coauthor of the report.
“But market conditions in particular can change quickly. Companies can keep their options open by pursuing multiple tracks simultaneously until the time comes to make a final decision.”
Divesting assets or business units that no longer fit with corporate strategy also leads to improved performance for the company’s remaining operations.
BCG’s analysis of 6,642 divesting companies since 1990 shows that EBITDA (earnings before interest, taxes, depreciation, and amortization) margins increase by more than 1 percentage point between the time of the divestiture announcement and the end of the company’s fiscal year.
For the average seller, this translates into an increase of $170 million in EBITDA (on a revenue base of $14 billion).
The impact is even more pronounced for distressed sellers. By divesting assets, these companies improve their EBITDA margins by 14 percentage points on average after the divestiture, moving from negative EBITDA to better than breakeven.
Investors have become highly receptive to the idea of divesting.
While more than half of investors surveyed in 2012 were ambivalent as to whether companies should pursue divestitures more aggressively (assuming solid strategic and financial rationales), in 2014 almost 80 percent believe that they should.