Executives of most of the company are generally geared up to buy assets rather than to sell them. Executives’ resistance is reasonable due to reduction of top-line, fear of market’s reaction and to avoid hassle process. Some of them have a view that present valuation multiple is not justifiable and company should stay invested until business cycle ascends. Numerous empirical studies are conducted to examine the performance of divesting firm and divesting unit. A study [1] which took sample of 155 spinoffs from 1975 to 1991 found that long-run performance of both divesting firm and the divested unit is strongly positive, provided that the spin-off increases the company’s focus. Similarly, Bain & Company study [2] concludes that an “active firm” having both divestment and M&A strategy outperforms inactive companies by nearly 40% over a 10-year period (2005-15) and generate more than twice the sales and profit growth.

The factors driving divestment strategy vary across company, industry and economy. There are strong rationales for Indian companies to follow this strategy now. Stressed assets in India have registered a steady growth since 2011 leading to INR 8409.58 billion (10.41%) of Gross Non Performing Assets (GNPA) of scheduled commercial banks in December 2017. Credit growth [3] has slowed down sharply from 18.3% in Q1 FY 2011 to 5.9% in Q1 FY 2018. Share of banks’ advances to large borrowers accounts to ~45% of total advances whereas share of stressed assets to large borrowers in total stressed assets amounts to ~70%. Large borrowers dominated by different conglomerates are losing more money as the cost of capital is higher than return of capital across different business.

Simultaneously, M&A activity in India has increased steeply 53.3% to $77.6 billion in 2017. Indian companies was also able to raise INR 1.6 trillion ($24.96 billion) through the primary market in 2017. The median EV/EBITDA multiple on India M&A transactions was 12.8 times in 2017 indicating a healthy pricing trend for India. Global PE funds/SWFs/Pension funds are also looking for the best deals in the market as total dry powder (uncalled capital) rose to record high of $1.7 trillion in December 2017 with India-focused funds carrying ~$9 billion in dry powder [4]. Despite credit crunch, availability of risk capital and attractive valuation multiple, many larger borrowers with stressed assets are reluctant or delayed in realizing to shrink first and to deploy capital into a business with higher returns.

Divestments motives differ across different companies, however, the three most consistent factors for divesting assets are a) Divesting non-core business b) Generating cash and paying out debt c) Improving operational performance. Deciding to divest is much easier decision than how to unlock the full value of the assets. As one’s company decides to sell, problems start arising i.e. struggling to figure out exactly what should be included in sale, costs related to residual business, employee issues, regulatory hurdles etc. Divesting firm must do appropriate preparation in making their divesting assets attractive i.e. the scoping of deal in detail, addressing the stranded costs and managing the concerns of employees etc. This will require establishing a dedicated team which will create blueprint and implement these initiatives. A company can divest in three ways a) trade sale to another buyer b) a carve-out, in which the divesting firm sells a partial ownership to the public ; and c)a spin-off to the company’s shareholders . Choosing the right option depends on a combination of factors from valuations, tax and regulatory factors, process clearances to market timing. In case a company is looking to deleverage, as in many stressed business in current economic scenario, trade sales could be a preferred option. This is the quickest and simplest option which generates immediate cash that divesting firm can use to invest in its remaining businesses or pay down its debt. Anil Ambani-led Reliance group selling Mumbai power business to Adani group and Essar group selling Essar Oil to a Rosneft-led consortium are recent deals of such strategy to pare down debts at group level. Second option, i.e. Carve outs divestment generally involves an IPO of some portion of the business and divesting firm retains the balance, which it can keep for the long term or dispose of in a secondary offering at a future date.The detailed preparation, statutory approvals and slow transaction speed could be hurdle in the carve-out process. This exit strategy could be worthy of consideration given recent buoyant Indian primary capital market and high valuation multiple. During 2017, there were 38 IPOs with total amount raised was INR 754.75 billion [5] which is the highest in last 10 years. Third option i.e. spin-off could be a purely strategic decision to focus the portfolio as this strategy does not generate cash rather creates value to stakeholders. Spin-off is generally tax advantageous and give more freedom to divested unit. Companies looking to deleverage from their stressed assets may not find this option suitable.

Divestment is rarely a onetime activity. Company shall formulate an active strategy, develop a systematic and effective approach to execute the strategy and choose the right course of divestment. Indian executives should pluck up courage to break the company when they are no longer the best owners of the business. Companies equipped with such strategy have the potential to thrive in different business cycles and deliver substantial value to the shareholders.

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