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Corporate breakups: divestments climb the board agenda

By Simon Watkins

This article is brought to you by FT Specialist’s Agenda, a publication that focuses on corporate boards.

Breakups were a theme last year: in November alone, Toshiba, General Electric and Johnson & Johnson announced that they were demerging their businesses.

While UK companies are unlikely to match that US fervour, they are not immune. In 2018 GlaxoSmithKline announced a plan to split its consumer healthcare and drugs businesses. That move is likely to take place soon after GSK in January rejected Unilever’s £50bn bid for its consumer health business.

The previous month SSE, the energy group, came under pressure from Elliott management, the activist investor, to hive off its renewables business. In a letter to Sir John Manzoni, chair of SSE, Elliott said: “The market’s failure to ascribe fair value to SSE and its portfolio is directly attributable to the company’s inefficient conglomerate structure and confusing equity story.”

While SSE resisted a split, pressure from activists can push boards into considering divestment. The UK governance model of strong investor communications and non-executive directors means that activists do not have the brute power they enjoy in the US but their influence has grown, says Charles Honnywill, transactions partner and divestiture leader at EY London.

“Much of their impact is behind the scenes. They do influence boards, particularly [chief financial officers],” he says, adding that boards and executives need to anticipate what activists might do.

In some cases, activists give business leaders the push they need. EY’s 2021 Global Corporate Investment Study found that many board members recognise they may be too slow to consider divestment – some 78 per cent of executives said they held onto assets too long when they should have divested them.

And investors could have a point about the value of divestment. Research by Boston Consulting Group, which examined 840,000 deals made between 1980 and 2021, found that, on average, two-year relative total shareholder returns increased from 1.5 per cent for deals announced in 2014 to 4 per cent for deals announced in 2019.

The study also said that when the economy is strong, companies see higher total shareholder returns when divesting non-core assets. It is up to executives and directors to time divestitures correctly to unlock economic benefits and gain negotiating power, the report points out.

Wider markets and macroeconomic conditions are another driver of divestment, says Honnywill. There is a high availability of capital with low interest rates and a buoyant stock market. The rise of special-purpose acquisition companies has been one sign of markets being in overdrive.

A mature private equity sector and a wider range of international buyers, not least from China, are also factors, says Honnywill. “Valuations are almost eye-watering in some sectors. If it's worth more to someone else, arguably it's your responsibility to sell,” he says.

For some experts, however, the trend towards splits is driven by a fundamental shift in corporate philosophy. “It is clear that the conglomerate model does not work,” says Bill George, a senior fellow at Harvard Business School and former chairman and chief executive of Medtronic. “We will see more breakups as we are in a very active and robust M&A [mergers and acquisitions] market.”

Others are less keen to declare a change; large companies have always had to balance disparate segments of their portfolios. As the BCG study pointed out, timing is everything with spin-offs.

“Successful large companies have always had to navigate across their portfolios of risky, fast-growing businesses and older legacy businesses,” says Sheila Hooda, founder of Alpha Advisory Partners.

The benefits of divestment are threefold, says Honnywill. “The first is the need to simplify a business because the world has got more complicated. One of the best ways is to stop doing some things: sell them and get some value.

“The second is all about capital reallocation, particularly in the world of technology. Whatever sector you’re in, you need more technology and more R&D [research and development]. You need to reallocate capital to that. One of the best ways of doing that at scale is divestment,” he says.

The third reason, he says, is about “getting the strategy clearer” and “building a better culture” in the remaining company.

Whatever the rationale and the external pressures, boards must remain aware of divestment risks. “It always takes more time than you want or expect,” says Honnywill.

“There is a danger that it becomes all-consuming and that you never get the benefits – you don't quite sell for the price you want, and you don't quite get round to the new focus because all the corporate energy is focused only on the divestment.”

We are in a period in which the potential value of divestment is huge. Turning that potential into reality will require cool heads in the boardroom.

This article is an edited version of a piece published by Agenda.

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