Don't Forget to Prune Your Portfolio

This article originally appeared in The Business Times.

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.

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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 percent 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 percent three months following the announcement. This compares with 1.4 percent 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.

  • Proactively manage your portfolio. Start with the basics of understanding how all of your portfolio businesses contribute to your core and regularly assess them for fit. What is each business's competitive position and ability to win? Do you have the right resources and capabilities to take it to full potential? If not, are there other companies where it would be a better fit? Only by systematically assessing your portfolio can you identify the business units that would deliver more value in another owner's hands. In the pharmaceutical industry, for example, Bain recently found that companies that combine category leadership with portfolio focus deliver annual total shareholder returns that are more than twice those of companies with diversified portfolios that maintain a tail of smaller positions.

  • Thoroughly plan and prepare to optimise value. Don't race to sell the asset. Create a blueprint for making it attractive prior to selling—even better, begin implementing some of those initiatives prior to sale. We have found that 6-12 months is the right length of time to establish the blueprint and demonstrate progress. This allows you to improve the value of the business while you still own it and also demonstrates to a potential buyer what is possible. Both of these can help you achieve a higher price.

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.

Read the full article at The Business Times.

Jim Wininger and Usman Akhtar are Bain partners in Atlanta and Jakarta respectively and are leaders of M&A practice.