Changing Mindsets Around Corporate Divestitures
by Kate Faust and Ben Giusto, Rockwood Equity Partners
The market is changing and so is the mindset of maintaining the status quo. The global pandemic has created an astonishing change in attitude for many, but especially the management teams of companies who need to stay afloat and find new avenues of propitiousness. According to a 2020 Global Corporate Divestment Study conducted by EY that interviewed CFOs of various industries, 72% believed they held on to assets too long in Q1 2020. This, compared to previous years, is the highest by nearly 10%.
Their apparent concerns are supported by precedent. During the Great Recession, companies that divested assets outperformed non-divestors by 24% in shareholder returns. Retrospectively, companies want to learn from their mistakes. As a result, nearly 60% of CEOs reported that they plan to divest within the next 12 months. The majority plan to reinvest the transaction proceeds in their core assets for growth.
Dreadful market conditions have generated hesitation and, therefore, a less active M&A market. While overall US M&A activity has seen a decrease since COVID, corporate divestitures have seen less of an impact. Tom Cane at Mergermarket shared that “According to Mergermarket data, US M&A in the first half was down 71% by value overall compared to the first half of 2019, but corporate divestiture activity was only down 21%. We’re seeing signs that corporate divestitures will be a key driver in the overall recovery of M&A deal flow, with several ongoing sale processes and many corporates announcing they are commencing or looking at asset sales. The uptick in divestitures in recent years has been driven by a focus on core assets, as companies look to shed non-core assets and invest in technology and automation. Against the background of the pandemic, meanwhile, companies in many sectors will turn to asset sales to help deleveraging efforts, while others find themselves in the cross-hairs of shareholder activists pushing for divestitures.”
The Balancing Act
The troubling market conditions coupled with the need for internal portfolio adjustments create a balancing act for management. The balancing act is among the following: (i) the right time to sell, (ii) what to sell, (iii) what to do with the capital.
i. The Right Time to Sell: The future outlook may seem grim, but it might not be. There may be a buyer right now that is willing to pay a healthy valuation for non-core assets. For example, Nestle SA [SWX:NESN] is considering a potential sale of a majority of its Nestle Waters business in North America, which could see valuations in the 9x-10x EBITDA range. For more troubled divestitures, a lower valuation now might still be better overall for the parent in the long-term.
ii. What to Sell: Companies are retrenching and focusing on their core businesses. If a company has not been investing in a division or does not see a path to support its growth, it may be the right time to sell and deploy capital elsewhere. AZZ [NYSE:AZZ], which provides galvanizing and metal-coating, announced on their July 9, 2020 earnings call that their energy business will “continue to focus on our core businesses and seek to divest things that are not core to our future strategic interests.” Similarly, Harsco Corporation [NYSE:HSC] CEO Nick Grasberger said the company will eventually consider selling its rail division in order to focus on environmental solutions.
iii. What to Do With the Capital: Retrench, redeploy or reinvent. As companies look ahead to life after a pandemic, having a war chest can allow them to invest in their core businesses organically or through acquisition or fund transformational efforts that will position them for future growth. The playbook has changed, so companies need to decide what game they are in.
SOURCE: 2020 Global Corporate Divestment Study conducted by EY:
SEE MORE: Rockwood Corporate Divestitures