Divesting for value
Proactive portfolio management
Barriers to success
Proactive portfolio management includes:
- Communicating a value-creation model supported by appropriate metrics. Establish clear financial criteria, such as generating economic returns above the cost of capital.
- Balancing strategic and financial goals. Understand how each business fits into the company’s overall strategy. Develop clear guidelines on what constitutes core versus noncore holdings, and periodically evaluate the portfolio against those guidelines. In leading companies, the head of strategy and the corporate development officer work together to combine strategic insights with the discipline of corporate finance.
- Matching the allocation of capital against strategic value. Don’t overinvest in components not worthy of resourcing. This may lead to inadequate capital to fund strategic growth areas.
- Establishing meaningful units of analysis. Portfolio management may focus on individual key assets, business units or geographies. Ask whether each value chain activity (research, design, manufacturing, sales, etc.) is best owned by the corporation.
- Capturing the appropriate information. IT systems and accounting policies help rigorous portfolio management when they supply accurate data to monitor returns on invested capital. Inputs should include consistent, economically rational cost allocations, reliable balance sheets for each business and knowledge of each entity’s tax attributes and role in the parent’s overall tax strategy.
- Calculating threshold values for each business. Determine an up-to-date threshold value for keeping each business in the portfolio. Consider past and future financial performance, industry outlook, management strength and product or service offerings. This analysis helps determine whether a business is worth more to another owner. It also helps the board of directors respond quickly to unsolicited acquisition interests.
- Scanning the external environment. Even if a business fits strategically and generates healthy returns, it may be worth more to someone else. Portfolio managers should be on the lookout for buyers with synergistic profiles and keep track of market valuations for similar businesses. Be alert to industry developments — new entrants, regulatory changes, demographic shifts, technological breakthroughs — that could put a business unit at a disadvantage or make it an attractive property for someone else.
- Challenging the “conglomerate rationale.” There are good reasons for conglomerates to exist, but these reasons are frequently overwhelmed by the costs of maintaining a multi-business firm. Without a compelling explanation for how the corporate parent adds value, the whole may be worth less than the sum of its parts.
- Consider business cyclicality. Active portfolio management can help prevent overexposure to the ups and downs of the business cycle by proactively identifying ways to offset business cycle sensitivities in the portfolio through strategic acquisitions or divestitures.
Why don’t more companies take a systematic approach to portfolio management? There are many factors. These can include:
- Misaligned incentives. When the primary financial metrics that drive executive compensation are deal size, revenue growth and earnings per share, operating managers will be reluctant to consider selling off portions of the portfolio.
- Negative connotations. Divesting is often perceived as an admission of failure; executives are rarely celebrated for a well-executed divestiture.
- Conflicting interests. A good portfolio management process relies in part on judgment and information from managers and staff. These people may be directly affected by a divestiture and therefore unwilling to share complete information related to it.
- Corporate complexity. In contrast to private equity-held portfolios, large conglomerates often don’t have the resources to provide the equivalent of a hands-on, independent board — for each business — that stays in touch with the environment, closely monitors industry developments and makes quick changes.
- Redeployment concerns. The question of how to use the proceeds from a sale sometimes prevents prompt execution. The redeployment decision — whether to reinvest, acquire, pay debt or build cash balances — should be considered separately from the divestiture analysis.
- Board focus. The Sarbanes-Oxley Act of 2002 led many boards to focus on risk management. Opportunity costs to shareholders from ineffective portfolio management are less visible and more difficult to measure than the effects of poor financial risk controls.
- Employee perceptions. While selling may be the right approach to maximizing shareholder value, it can be unsettling for employees who think their business unit may be sold even if it’s performing well.
Establishing world-class portfolio management requires that the top of the organization commit to align incentives, structure, processes and tools.
Proactive portfolio management brings strategic benefits and improves divestiture outcomes; a rigorous process helps enhance shareholder value.
- Conduct thorough and regular portfolio reviews
- Objectively assess the contribution of each business
- Identify a threshold value for each asset or business and identify potential buyers
- Identify potential gaps in the portfolio to enhance balance and drive growth
- Rethink performance metrics that emphasize revenue growth over profitability and strategic value
- Challenge corporate culture to view divestitures in a strategic light
At a time when corporate growth is difficult to achieve and efficient capital allocation is a priority, actively managing corporate holdings and divesting non- core businesses can add substantial shareholder value.
Proactive portfolio management provides a current picture of the contributions of each business, aligns corporate and business unit strategy and drives managers to be explicit about how they will deliver value. Corporate portfolio management uses clear performance metrics and views all holdings as potential sale candidates — for the right price.
Establishing world-class portfolio management with aligned incentives, structure, processes and tools requires a strong commitment from the top of the organization. The effort involved is considerable, but worth the results: well-timed divestitures, stronger balance sheets and increased readiness for strategic acquisitions through a better understanding of portfolio gaps.
For portfolio management to be effective, executives must understand that the process itself can add value and that divestitures do not indicate failure. Incentive systems must reward value maximization rather than growth alone.
Companies can reduce barriers to effective portfolio management by instituting systematic, independent processes and systems that produce timely and accurate economic returns on capital.
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