To improve identification of potential divestments most companies need to initiate or increase the frequency of portfolio reviews, engage with third parties to remove bias, provide better guidance on what is core and non-core relative to company strategy or change an approach to these reviews: use forward-looking measures in tandem with backward-looking KPIs like return on invested capital.
These KPIs can be applied to businesses in the portfolio to help identify divestment candidates:
Return on invested capital (ROIC)
Profitability Growth
Revenue Growth
Earnings per share
Economic Value Added (EVA)
Total Shareholder Return (TSR)
The metrics also need to help with the challenge of forecasting future growth as companies try to determine which pandemic-driven behaviors will remain part of everyday business and which are temporary. Using external data sources, such as vaccination rates, social media mentions, cellphone data and others may provide useful insight or reveal patterns in fast-moving areas like customer buying patterns or mobility.
KPIs also should not remain static. If a KPI turns out to not be a predictor of future growth, or if business priorities change, new KPIs should be considered. Similarly, scorecard weightings need to be revised in light of the business’s performance.
Management’s compensation can also pose an unforeseen obstacle to decisive portfolio management. It is important to avoid incentivizing the senior team to retain businesses through revenue-based pay and rewards tied to short-term performance that could be adversely affected by divestments.
Divesting is one way that management can demonstrate that it is looking to maximize shareholder value by carving out non-core or underperforming businesses.
While ESG is not yet a prominent factor in identifying target companies, environmental and social considerations are emerging, as they grow more associated with long-term value. ESG has become a focus area for boards, with sustainability committees increasingly part of the governance structure. Diversity and inclusion issues are also posing a reputational risk for some companies.
Now it is a great time to be a seller or a buyer, including private equity firms with a propensity to acquire corporate carve-outs, as the market is flush with cash in this low-interest-rate environment. Companies should not wait to act until growth has stalled or for an investor to come calling.
Even if a divestment decision is more challenging while a business is still healthy, it is far more saleable at this point. And even smaller businesses that do not require much capital investment can still be a management distraction.
Should you need any help or have questions, My Best CFO Team is always happy to help.
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