Divestiture makes for hot topic in lean times
CEOs must weigh pros and cons of parting with noncore assets
- By John Allen
- Jun 02, 2010
Divestitures are again becoming a hot topic in corporate boardrooms. The reason: Smart, well-timed corporate divestitures can be an important value creation tool for company executives.
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During much of the past decade, the mantra of most companies in the defense and government services sector was “buy” rather than “sell.” Active consolidators were rewarded with historically high valuation multiples. Also, the capital to support acquisition efforts was plentiful and cheap. There wasn’t much incentive for chief executive officers to divest noncore assets because they could earn a high valuation on the profits from such businesses and didn't have a need for cash.
But lingering effects of the credit crisis and the broader economic downturn have created a new urgency for CEOs in the defense and government services industry to explore divestitures. Several such rationales are:
- Unlock hidden value. Average price-to-earnings ratios for publicly traded defense and government services companies are in the 15x to 23x range, a 25 percent decline from post 9-11 highs. Most certainly, though, many contractors have smaller pieces of business in their portfolios that would garner much higher valuations than prevailing industry averages were they to be separated from their corporate parents. Cybersecurity assets represent a great example of an opportunity to unlock value. Businesses in the right area of cybersecurity are routinely selling for multiples of 10 times earnings before interest, taxes, depreciation and amortization. This represents a premium of approximately 20 percent to 30 percent above average company valuations of diversified defense and government services companies. Of course, divestiture strategies to create value can go in the opposite direction. Companies might also sell larger, lower value assets to become more concentrated in a higher value area, potentially resulting in an increased valuation for the divesting company. The bold nature of this approach means it is employed less frequently, but with risk comes reward.
- Raise capital to invest in growing core business. With capital no longer a commodity, there is increased interest on the part of CEOs to divest noncore assets as a way to raise capital to support growth activity in core business areas. The reduced multiples of public defense and government services companies make it easier to offset the potential earnings dilution of divestitures. Meanwhile, the capital raised from the divestiture can be deployed into more productive value-enhancing business activities.
- Mitigate conflicts of interest. Many business leaders predicted that Northrop Grumman's divestiture of TASC would lead to a rush among large companies in the defense and government services sector to shed businesses that have the potential to create organizational conflicts of interest. Instead, would-be sellers have been much more deliberate in thinking through organizational conflicts-of-interest divestitures. There is still uncertainty with regard to specific agencies’ plans for managing OCI issues. As a result, companies have been reluctant to make divestiture decisions without clarity, but they should remain ready to act to satisfy customers’ objectives. At present, there remains a stable of buyers looking to acquire OCI businesses to become trusted advisers to the government. As the appetites of those buyers are satiated, companies late to proceed with OCI-related divestitures could see lesser valuations than their early-to-market peers.
In today’s market, there are many compelling reasons to divest non-core assets. Look for companies to turn to this tried and true tool to build shareholder value and be ready to take advantage of the opportunities they create.
John Allen is founder and CEO of Bluestone Capital Partners. He previously served as co-head of the defense and government services group at BB&T Capital Markets|Windsor Group.