Content M-2: Transforming corporate portfolios: Diversification and divestment

Question 1

What are three types of corporate restructuring?

Answer 1

• Asset (financial) restructuring
  > Management buy-outs
  > Leveraged buy-outs
  > Asset sell-offs
• Portfolio restructuring
  > Diversification
  > Divestitures
  > Dissolutions
  > Mergers & Acquisitions
• Organizational restructuring
  > Change of organizational structure, systems, practices’
  > Downsizing of workforce

Question 2

What are some examples of portfolio matrices (six examples included here)?

Answer 2

1. BCG Matrix
2. GE/McKinsey Matrix
3. BU/Competitiveness matrix
4. Value innovation portfolio
5. Innovation portfolio matrix
6. Heartland matrix

Question 3

Due to what 3 reasons do industries change?

Answer 3

1. Macro environment changes
2. Industries evolve
3. Industries converge
   > A major reason why inter-business synergy creation is gaining prominence (e.g. autonomous vehicles).

Question 4

Recap: Two “general” types of synergy?

Answer 4

• Cost-reducing synergies
  > Also called “Subadditive”
• Revenue-enhancing synergies
  > Also called “Superadditive”

Question 5

What are two ways to transform a portfolio?

Answer 5

• Refocusing: Elimination of peripheral activities to strengthen the core
• Repositioning: Striking a new path by establishing a new core business

Question 6

Traditional diversification studies make a distinction between four types diversification based on specialization ratio and a related ratio.

Extra info:
Specialization ratio = % of sales from firm’s major activity as a percentage of total sales.
Related ratio: % of total sales which are related to one another

Which four type of diversification are there?

Answer 6

1. Single business: who/what/how are all the same.
2. Dominant businesses: who/what/how are the same for two out of three
   > Constrained
   > Linked
   > Unrelated
3. Related businesses: who/what/how are the same for one out of three
   > Constrained
   > Linked
4. Unrelated businesses: who/what/how are different for every business.

Question 7

Type and competitiveness of synergy is driven by resource similarity and the need for modification. How do you assess relatedness?

Answer 7

Assessing relatedness is more informative in assessing whether:
- Resource (dis)similarity has value creation / rent generation potential
> Combination of similar resources does not necessarily create value
> Resources may be dissimilar but still related

• Resource modifications are possible, feasible, and valuable
  > Integrating and modifying dissimilar resources may not be purposeful
  > Value derived from resource modification depends on complementarity of resources.

Question 8

When are activities or resources “complements”?

Answer 8

They are complements if doing more of any one of them increases the returns to doing more of the others.

Or, in a payoff function: if the marginal returns to one variable are increasing in the levels of the other variable.

Question 9

What are the four types of rents?

Answer 9

• Ricardian rent : scarcity value)
• Monopoly rent: (scarcity value)
• Schumpeterian rent (entrepreneurial value)
• Pareto rent (association value)

Question 10

A taxonomy of rents identify four types of rents.
What are Ricardian rents?

Answer 10

Excess returns provided by a resource compared to another, similar resource (of less value)

Question 11

A taxonomy of rents identify four types of rents.
What are Monopoly rents?

Answer 11

Excess returns provided through a (legally enforced) monopoly.

Question 12

A taxonomy of rents identify four types of rents.
What are Schumpeterian rents?

Answer 12

Excess returns provided by innovation until innovation diffuses

Question 13

A taxonomy of rents identify four types of rents.
What are Pareto rents?

Answer 13

Excess returns by keeping a resource in its current use; or excess returns by putting resource to better use.

Question 14

What are two criteria for choosing a candidate to divest?

Answer 14

• Financial
  > Growth
  > Margin
  > Return on Capital
• Strategic
  > BU impact on the rest of the corporation
  > Corporation’s impact on BU
  > BU ability to beat market expectations
  > Corporation’s overall portfolio

Question 15

What are six types of divestment?

Answer 15

1. Spin-out
2. Sell-off
3. Carve-out
4. Leveraged buyout (LBO) / Management buyouts (MBO)
5. Spin-off
6. Split-off / Split-up

Question 16

What does a spin-out entail?

Answer 16

Entrepreneurial ventures founded by an employee of an existing player’s firm, leaving the parent. Often competes int he same industry as the partent.

Question 17

What does a sell-off entail?

Answer 17

A firm sells a division, business unit, product line, or subsidiary to another firm in exchange for cash. Parent has no connection with the divested unit.

Question 18

What does a carve-out entail?

Answer 18

A new, independent company is created by detaching part of the parent’s business and selling the shares of the new company in a public offering. The parent generally maintains possession of a substantial fraction of the equity of the carved-out company.

Question 19

What does LBO entail? And MBO?

Answer 19

LBO = Leveraged buyout.
> A group of private investors uses debt financing to purchase a corporation or division. The characteristics of an LBO are high leverage, management ownership, active corporate governance and investors’ loss of access to liquid public equity markets.

MBO = Management buyouts
> Managers replace public stockholding of the parent company. MBOs are normally financed with large debt issues, and the new stocks are normally held by an existing player’s managers and some external investors.

Question 20

What does a spin-off entail?

Answer 20

The detached division, BU, product line, or subsidiary becomes an independent company whose shares are distributed tot he parent’s stockholders.

Question 21

What does a split-off? And a split-up?

Answer 21

• In a split-off, the parent’s shareholders receive stocks of the new company in exchange for parent company stocks.
• A split-up occurs when the parent ceases to exist and the divested unit remains in the market.

Question 22

When do you choose for what type of divestiture? Based on which two dimensions?

Answer 22

Two dimensions:
1. Synergy test (Pass vs Fail)
2. Is there a better parent? (Yes vs. No)

Results in 2-by-2 matrix:
- Passed synergy test & better parent present: Sell-off
- Passed synergy test & no better parent: (1) Keep, (2) Equity carve out, (3) Spin-off
> Depends on degree of ownership
- Failed synergy test & better parent: (1) Sell-off (if high premium, low taxes), (2) Spin-off (if low fees)
- Failed synergy test & no better parent: Spin-off

Question 23

There are also challenges in divestiture. These can also be mapped in a 2-by-2 matrix. Based on which two dimensions? And which four options do they result in?

Answer 23

Dimensions:
1. Management of divestiture at unit level for development of understanding (Low vs. High)
“How well BU managers understand the reasons behind the divestiture”.
2. Perceived capabilities for unit independence (Low vs. High)
“Whether BU managers believe that they have means to manage the BU as an independent company.”

• Low perceived capabilities & high management of divesture for developing understanding.
  > Abandonment
• Low perceived capabilities & low management of divesture for developing understanding.
  > Capabilities challenge
• High perceived capabilities & high management of divesture for developing understanding.
  > Opportunity
• High perceived capabilities & low management of divesture for developing understanding
  > Information challenge

Question 24

What are reasons (antecedents) for divestiture?

Answer 24

• Performance
  > poor firm/BU performance
  > failed diversification
  > performance of acquired units
  > performance of larger units (spin-offs)
• Strategy
  > corporate fit
  > lack of synergies
  > required resource commitment
• Governance
  > shareholder pressure for control
  > Executive turnover
  > Owner retirement
• Environment
  > industry entry rates
  > environmental uncertainty
  > institutional investors and analysts

Question 25

What are three downsides of divestiture?

Answer 25

• Employee uncertainty
• Employee turnover
• Executive turnover

Question 26

What are three upsides of divestiture?

Answer 26

• Change of firm strategy
• Change of diversification level
• Increasing firm performance (esp. spin-offs)

Question 27

What are barriers to divestiture?

Answer 27

• Structural/economic
  > specificity of the resources
  > owner concentration
  > inertia
• Strategic
  > complementarity of business/resources
  > shares resources
• Managerial
  > information asymmetries
  > overestimation of synergy

Question 28

Whatever the costs of divesting a business, holding on to a unit too long also imposes costs, both on the entire corporation and on the unit itself. Which three forms can these costs take?

Answer 28

1. Cost to the corporation: stability can hamper growth in different ways (e.g. long-held, low-growth businesses ay provide the cash to thrive today, but can hinder it from preparing of a prosperous tomorrow; wrong mix of businesses can confused the customer).
2. Cost to the unit: Few corporations actively consider whether they are adding unique value to each of their businesses. They may be harming the units’ prospects and undermining the morale of their people.
3. Depressed exit price: final cost of postponing divestitures is the direct impact on shareholder returns. A well-timed divestiture can contribute to shareholder value but a poorly timed one can destroy value.

Question 29

What are the five-steps in the process for firms to get proactive divestiture programs off the ground, build support and incorporate in their strategy?

Answer 29

1. Prepare the organization
2. Identify candidates
   > Four factors to keep into account:
   » The BUs impact on the rest of the corporation
   » The corporation’s impact on the BU
   » The unit’s ability to beat market expectations
   » The corporation’s overall portfolio
3. Structure the deal
4. Communicate the decision
5. Create new business

Question 30

What is corporate diversification?

Answer 30

a firm trying to enter a new business, starting from an existing one

Question 31

What is organic growth? (context of diversification)

Answer 31

the process by which a firm enters a new business on its own (incl hiring/creation of a new project or BU / repurposing an existing BU).

Question 32

What is inorganic growth? (context of diversification). Which three categories do you have?

Answer 32

1. Non-equity alliances
2. Equity alliances
3. Mergers and Acquisitions

Question 33

What is the diversification test?

Answer 33

The diversification test captures the combined effects of 3 considerations:
1. The standalone attractiveness of the business (relative to cost of entering the business).
2. The importance of synergies
3. The costs and benefits of entry under different partners.

Question 34

Which two requirements need to hold true to pass the diversification test?

Answer 34

• Bargains (paying less of a firm than its standalone value) are present. OR
• Synergies (synergies exist whenever jointly operating 2 firms creates more value than the sum of their standalone value) are present.

Question 35

What are the five-steps in the five-step approach to the diversification decision?

Answer 35

1. Are there potential synergies between the old and new business?
2. Identify the resource gaps
3. Identify candidates for resource acquisition through inorganic growth
4. Optimal partner-mode combination for inorganic growth
   > For each identified candidate, consider best choice: alliance or acquisition
5. Compare with value from organic growth

Question 36

Highly diversified firms trade at a discount, so-called “diversification discount”. What is that?

Answer 36

When diversified firms are worth less than a collection of single business firms that operate in the same businesses at the diversified firms.

Question 37

What are common mistakes to avoid in diversification?

Answer 37

• Diversification for the wrong reasons
• Don’t assume a blanket diversification discount
• Consider relatedness in terms of the value chain, not in products or customers.
• Use the growth tree iteratively: consider all the branches of the three. Even if organic growth seems unattractive, don’t rule it out immediately as it might be more attractive than the other options.

Question 38

In simple terms, what is divestiture?

Answer 38

The process of reducing the portfolio of the businesses a firm owns.

Question 39

Recap: based on on which two decisions should a parent decide to divest?

Answer 39

1. Failing the synergy test
2. When another corporate parent is a better owner