6 minute read 5 May 2021
Close up peacock with feathers fanned

Why divestments should be a catalyst for CEOs to reimagine RemainCo

Authors
Rich Mills

EY Global and Americas Sell and Separate Leader

Leader of complex divestitures that help enhance shareholder value and drive more efficient capital allocation. Dedicated husband and father.

Paul Murphy

EY Asia-Pacific Divestiture Advisory Services Leader

Change advocate. Focused on due diligence and best practice divestment for large corporates.

6 minute read 5 May 2021

A company’s divestment rationale should include the benefits to the remaining company’s future business.

In brief
  • A divestment should be an opportunity to strengthen and reimagine the remaining business. 
  • EY analysis shows that divestments coupled with RemainCo transformation deliver significantly greater returns. 
  • CEOs should evaluate the enterprise structure and operating model required for RemainCo’s future growth.

Executives often regret not using a divestment as an opportunity to transform the remaining company and drive long-term value, according to the 2021 EY Global Corporate Divestment Study. A company’s divestment rationale should include the benefits to RemainCo’s future business, yet 63% of companies acknowledge not placing enough emphasis on RemainCo during their last carve-out or spin-off.

Their concern is well-founded. An EY analysis of 51 recent significant US divestments reveals that companies where RemainCo was simultaneously transformed delivered significantly greater returns than those that only executed a divestment. In fact, our experience shows that if RemainCo is not transformed during this window, the difference in returns grows over time and investors become more likely to ask questions about RemainCo’s future and put pressure on the CEO and board. 

 

Addressing RemainCo’s future business archetype and the operating structure that supports the archetype early in the divestment process can help position RemainCo for outsized growth. 

In one case, a major global industrial company lagged competitors in total shareholder return. It was set to announce a transformational divestiture, but the CEO was concerned that investors would react negatively if the company didn’t provide clear guidance on how RemainCo would create value in the coming years. The CEO delayed the announcement, mobilized the leadership team, conducted a series of workshops to redesign the remaining business and identified multiple value-creation opportunities. Once the CEO had confidence in the reimagination plan, the company announced the proposed divestiture along with the plan to unlock over half a billion dollars of value in RemainCo over the course of three years.

Significant divestments require more than eliminating stranded costs

The separation of a large (e.g., representing >20% of overall revenue) or highly entangled business should involve more than a stranded cost exercise for RemainCo. It should be a catalyst to reimagine RemainCo as a leaner, more efficient organization. In fact, 60% of executives say they should have done more to improve RemainCo than simply eliminate costs, and 56% say they should have focused on RemainCo earlier in the process.

RemainCo figure 1

CEOs should begin to reimagine RemainCo as part of the portfolio review process. Planning for RemainCo operations based on the company’s long-term vision should be more closely examined once it’s determined which businesses and assets will be included in the deal perimeter versus which elements stay with RemainCo. 

During a divestment, every function of the organization is disrupted as resources and infrastructure are pulled to create the divested business. But leading organizations see this as a chance to challenge the status quo and rebuild an organization for the future — not just looking to cut costs, but also identifying areas where investment can generate greater returns in the core business and which functions can be centralized or even outsourced. 

Create a RemainCo enterprise structure that is fit for purpose

The corporate strategy that led to the divestment can form the basis for developing a new enterprise structure, or archetype, for RemainCo. The archetype should focus on how the business will create value and provide a competitive advantage. For example, a significant divestment could leave a company that had multiple business lines with one primary product, requiring a new archetype that moves away from product centric to geocentric. 

Business archetype examples include:

  • Product centric: focus on characteristics of the end product and drive excellence in those products, with an improved centralized cost structure 
  • Market centric: support unique commercial and operational requirements across geographies, with a strong link between regional sales and service delivery 
  • Value-chain centric: streamline operations based on manufacturing processes with competitiveness in each step of the value chain 
  • Function led: produce cost savings with a lean corporate structure and push control to regional, product or value-chain level 
  • Hybrid model: combine elements of the above to fit the corporate strategy

Develop a new operating model to increase efficiency and generate outsized returns

The old operating model may need to be changed to fit the new archetype. For example, in a product-centric archetype, R&D spend would be determined centrally by the product owner, while in a market-centric archetype, R&D would be heavily influenced by regional leaders.

Five areas that executives can tackle to revamp the operating model are: 

  • Process: Can automation be used to streamline some processes, such as order fulfillment or back-office accounting? 
  • People: Are there too many layers for the organization to run efficiently? Fifty-five percent of companies said they failed to achieve the intended RemainCo management structure streamlining during the divestment. At the same time, consider whether parts of corporate functions, such as human resources or finance and accounting, can be combined into “centers of excellence” and if less strategic, but essential, activities like accounts payable processing can be moved to lower-cost labor centers or even outsourced. 
  • Systems: A major divestment, with IT already being disentangled, is a perfect time to evaluate the organization’s systems. It could make sense to shift from data centers to the cloud. It could also make sense to consolidate systems, such as enterprise resource planning (ERP), from several down to one. IT spend as a percentage of revenue should also be analyzed. 
  • Suppliers: Companies can examine spending with third-party vendors, consolidate products and services under fewer vendors, and negotiate new terms for those economies of scale. 
  • Assets: Does the company need to continue to own the assets it has to run its business, or are there areas to monetize those assets and create a more flexible cost structure by selling the assets and contracting with the buyer to use them? RemainCo may also not need to own transportation and distribution assets like truck fleets and distribution centers. A smaller company will also be able to rationalize its real estate assets, a process that has already been spurred by the COVID-19 pandemic and by more businesses allowing people to work from home post-pandemic.
RemainCo figure 2

Four ways to manage post-divestment change at RemainCo

Divestments can be disruptive for a company, its employees, customers and other stakeholders. Reimagining the RemainCo adds another layer of complexity. Management should stay focused on the following areas: 

  • Stay relentlessly focused on the customer. Be in constant contact with customers to help prevent the business relationship from being disrupted. 
  • Keep employees motivated through a period of prolonged change and uncertainty. Possible incentives include financial rewards or potential career opportunities in RemainCo. 
  • Know what to reduce and what to grow. For example, a bloated finance and accounting organization could be reduced, while R&D spending, which could lead to future revenue, could be increased. 
  • Communicate how the disruption will lead to long-term benefits for stakeholders. Regular strategic messaging makes stakeholders more accepting of a change where benefits may not be seen in the first year.

Key takeaways for CEOs

  • Divestments are a catalyst to challenge the status quo and reimagine RemainCo for the future because the organization is already mobilized for change and the operating model is being re-examined. 
  • Re-evaluating your purpose and vision may require a redesign of your enterprise business archetype to focus on product, market, value chain, function or a hybrid model. 
  • The operating model should be changed to support the new archetype. All aspects should be challenged, including processes, systems, assets, people and third-party vendors.

Summary

A large or entangled divestment is an opportunity to reimagine RemainCo while the organization is already primed for change. Keep the future state of RemainCo in mind while deciding to divest and start transforming RemainCo as soon as the divestment is in motion. Companies that simultaneously transform RemainCo while divesting deliver greater stakeholder returns. This transformation may include changing the business focus or archetype and then remodeling operations to support the new business. Download the 2021 EY Global Corporate Divestment Study (pdf) to learn more.

About this article

Authors
Rich Mills

EY Global and Americas Sell and Separate Leader

Leader of complex divestitures that help enhance shareholder value and drive more efficient capital allocation. Dedicated husband and father.

Paul Murphy

EY Asia-Pacific Divestiture Advisory Services Leader

Change advocate. Focused on due diligence and best practice divestment for large corporates.