In the modern world, so many organizations are using several strategies to enhance their performance and improve their competitive advantages. Some of the mostly relied on strategies are divestitures or mergers & acquisitions. The two though somehow different have some similarities.
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Mergers and Acquisitions refers to two companies combining together to form a single entity or one parent company absorbing another company and completely eliminating the entity of the target company to incorporate its operations in the parent company (DePamphilis, 2008).
Divestitures or rather divestment on the other hand is the opposite of investment and refers to the reduction/addition of the firm’s partial assets or complete sale of an existing business by a firm due to some ethical or business reasons. One of the reasons behind the above corporate strategies is to increase the firm’s chances of survival in a market environment characterized by many competitors and in particular perfect market industry.
This is because every firm is trying hard to retain a significant market share and increase its shareholder’s equity. In the recent past mergers & acquisitions and divestitures are increasingly being used by the organizations to strengthen their operations and increase their marketing penetration as well as expansion of their business activities (Harwood, 2006).
No single firm is willing to be left behind in formulation and implementation of strategies that will enable it beat its business rivals in provision of the expected services or goods. The following brief report tries to focus on divestitures and how various firms, its advantages, risks and other associated financial aspects, have used it.
The concept of Divestitures
As pointed out earlier, the principal goal underlying divestitures is the improvement of business performance and gaining of more competitive advantages in the market. Divestitures take place in four different but interrelated forms (Weston, Mitchell & Mulherin, 2004). Firstly, there is complete sale of firm’s entire division or unit to another firm for cash or stock in the acquiring firm.
Spin-off divestitures involve the entity’s owners being granted new stock that represent different and separate ownership rights in the specific unit that was divested. Once divestment has been accomplished, the specific unit creates its own directors and becomes a separate company. The shareholders own shares from two different companies rather than one but no cash is transferred in the entire process.
In curve-out divestiture, the firm’s minority interest in a subsidiary company is disposed to new stockholders therefore, the parent company gains new equity financing and end up retaining the control. Finally, there is liquidation divesture in which the assets of a particular unit are sold off piecemeal instead of as an operating entity (Weston, Mitchell & Mulherin, 2004).
The divesture entails restructuring of the company’s operations to improve the overall performance of the firm. This means the divested firms aim at changing the corporate strategy as well as improving the performance.
Reasons for divestitures
There are several reasons behind carrying out divestitures. A particular firm may opt to sell part of its businesses that are not part of its core operations in a move seen to make the firm concentrate on the activities that it can pursue better (Rosenbaum & Joshua, 2009). This can be linked to specialization.
When an organization realizes that, its inefficiency is caused by incorporation of some activities that the particular firm cannot operate effectively, it sees no reason for the retention of those activities. An organization may be too indebted and is facing financial constraints such that it cannot repay the dues within the stipulated time period. In such a situation, the business entity may too opt to sell some of its businesses for the purpose of generating the required funds.
When it is realized that the liquidation of an entity is likely to bring out more returns than the overall assets combined, it is advisable to sell what is worth more to be liquidated than retaining the assets (Rosenbaum & Joshua, 2009). Creation of financial stability is another reason that can motivate a firm to divest its businesses. This happens when some section of the firm is too volatile and unpredictable that it may pose some risks to the company.
The best thing to solve such a problem is to get rid of the section that is likely to be affected by unforeseen economic fluctuations. Failure of some firm’s sections to perform as expected may lead to divestitures in order to cushion out the organization from incurring unnecessary excessive costs.
Motivational objectives for divestitures
Any firm interested in executing divestitures does that as a result of specific motivational objectives. The desire to attain broadened global presence is one of the motivational goals making organizations to change their business activities and distribution channels. This happens when a firm wants to extend its distribution channels over a wide area or to operate in other foreign countries (DePamphilis, 2008).
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Due to the fear of competition from other firms in the country where the parent firm wants to operate, it may decide to collaborate with another target company in the foreign country to make its market penetration a little bit easier. Global presence can be also achieved when the acquiring firm buys some businesses from a global known operating firm that has maintained its good reputation and goodwill for a long period of time.
An existing firm may also divest its business activities through additional acquiring of subsidiary branches to achieve geographical expansion. Geographical expansion is important to a firm as it helps it increase its popularity over a wide area hence improving the marketability of its goods and services and wider penetration (Harwood, 2006).
As witnessed out by many firms that underwent divestitures in the United States in the year 1998/1999, some firms were aiming at achieving economies of scale (Weston, Mitchell & Mulherin, 2004). Economies of scale occur when a firm spreads its fixed costs over a wide number of units produced by a firm. The unit per cost of production reduces and the firm is in a position to minimize its costs to a greater extend thus leading to higher profitability on the part of the company.
However, this is only possible when a given organization is in possession of some production equipments (fixed) that are not optimally utilized and there is room for improvement of the productive capacity of such assets. Marketing integration can induce a firm to undertake divestment. This might be either vertical or horizontal integration.
Horizontal integration is similar to expansion and takes place when a firm sells or buys some businesses of another one that are in the same level of production. The idea here is to reduce the operating costs through economies of scale concept. The mostly adopted integration in divestment is that of vertical integration. In most cases, this involves relatively large firm buying businesses of relatively smaller firms and the two should be in the same line of businesses but in different production levels (Weston, Mitchell & Mulherin, 2004).
Requirements for companies anticipating to execute divestment
Any entity anticipating to execute divestiture need to meet certain financial requirements before venturing in divestiture. This includes both the parent and the target company. A company need to have a better understanding of each other’s financial performance and its ability to have a positive impact once the divestment has been successfully implemented.
This is in particular the recent performance of the firm in question. This is indeed if the overall goal of improved performance is to be achieved. The parent company is actively concerned in confirming the business activities it is likely to acquire will lead to improved financial performance of the newly created entity and will expand the shareholder’s equity (Rosenbaum & Joshua, 2009).
Proper analysis of the business activity of the other firm is essential as it gives an assessment of the firms’ compatibility and the possibility of achieving the desired goals after the divestment. This is due to the fact that not all the divestures give out the desirable outcomes. A firm need to establish the nature of ownership of the other interested firm in terms of shareholder’s right to determine their current rights and how their ownership might be affected together with the capital structure of the firm once it has been acquired (Harwood, 2006).
A slight miscalculation might end up bringing unimpressive results to the company and subsequent incurring of huge losses. This is why it is fundamental for the Chief Executive Officer (CEO) to involve the firm’s key associates before making any recommendations and discuss on the type of divestiture to adopt. This corporate strategy needs to be given too much attention and deep thought before any decision is made.
Analysis of the provided case study with regard to divestitures
The case study provides a list of companies that have undergone divestment in the year 1998/1999. This has been provided to determine the wealth effects of the divestitures to the companies and their shareholders. To understand the effects well, the company’s stock values have been provided before and after the divestitures. All the six provided cases that involved the complete sale of their assets gave out positive results. The wealth creation was enhanced from two perspectives.
Firstly, there were higher returns for the company as well as increased market share in the market. This is a clear indication of how the divestitures can yield impressive results and bring about excellent performance on the part of the company. The divestitures take place for the betterment of the two companies involved and that is why there are associated advantages to the both the divesting parent companies and the buying companies as provided in the case study as a result of the sale (Weston, Mitchell & Mulherin, 2004).
Advantages to the divesting company
The divesting companies benefited much since the divestitures led to generation of the required cash to cater for the firm’s financial needs. Properly structured divestitures offers an opportunity to distribute the highly valuable assets and other operations to the firm’s shareholders without necessarily affecting taxable event for the divesting company and its stakeholders (DePamphilis, 2008).
The companies were able to get rid of some parts of businesses that were rendering their inefficiencies and thus enabling them to move forward with their efficient operations. Once the divesting firms have divested the anticipated units, the employee performance could be significantly recognized since their efforts could only be diverted to those units in which the companies could perform better.
The improved employee performance can be attributed to the fact that when a unit is being divested, the parent company may opt to retain the key productive employees and sell the divested unit with less efficient and unproductive employees (Harwood, 2006). Another advantage that accrued from the divestment on the part of the divesting company was that their existing good reputation that could be ruined by the continued poor performance was avoided by retaining only those units in which the companies could produce better.
Customer satisfaction and retention was also achieved and the divesting companies are able to deliver high quality products to their esteemed customers. Other advantages that were realized include preservation of shareholders’ value, maintenance of positive market reception and minimization of risks associated with inefficiencies.
Advantages to the buying firm
The advantages that accrue to the buying firm are more numerous than the ones accruing to the divesting firms. It should be noted that the buying firms are the ones that initiate the entire process. As it was observed on the results that were released after the divestures that the shareholders equity expanded and subsequent increase in the profitability of the firms.
It is quite evident that the firms’ competitive advantage has significantly increased and their performance improved relative to their competitors. Just like the divesting firms, the buying companies are having increased market share in the industry and subsequent expansion has led to the economies of scale. The operating costs have been reduced to a greater extend and increasing their future prospects.
The buying firms that pursued the divestures due to vertical integration motive succeeded in offering their products more efficiently (Weston, Mitchell & Mulherin, 2004).The overall advantages to the buying companies are more as compared to the advantages accruing to the divesting firms.
Reasons why deregulation is associated with Divestitures
Deregulation is an act of giving market players freedom to operate. Various restrictions are scrapped and the forces of law and demand dictate the output to be availed into the market and the prices to be charged on the commodities (Harwood, 2006). In the case study provided, most of the divestitures took place in the electric utility industry.
The reason why governments introduce deregulation in the markets is to enhance the strengthening of the operations in the markets, improvement of their performance and provision of high quality services and goods to the target consumers. The principal goal here is efficiency. Similarly, the firms willing to carry out divestitures have the same goals like those aimed by deregulation mechanisms.
In all the countries of the world, energy sector is the principal driving force for the economic growth and development. Consumers are depending on energy either directly or indirectly for their living. The prices of all the consumer goods are determined by the energy prices and therefore their welfare can be adversely affected due to inefficiencies in the sector.
The United States government reduced control over this specific sector to allow the willing firms participate freely in formulating the strategies that could improve the efficiency in the sector and that is the reason why many firms went ahead and pursued divestures as a strategy to improve the performance. Due to the principle of self-interest, in the process of executing divestitures by the firms to maximize their wealth, they deliver the expected and high quality services to the consumers.
One of the most focused divestitures in the energy sector that attention was paid to was that of DuPont and Conoco as reflected in the case study. The reason behind this divestiture was purely due to change of strategy for the company. DuPont bought Conoco Oil Company to diversify the risks it predicted might affect its operations (United States Securities and Exchange Commission, 2010).
The risks were linked to the Organization of Petroleum Exporting Countries (OPEC) whose newly adopted tactics could threaten the existence of weak and inefficiency firms in the industry. Though the predictions were false since the volatility of oil prices were not witnessed, the firm still uses Cocono plant as an insurance against its inefficiency besides some claims from some DuPont management that the ownership of Conoco is of less strategic importance.
The case study concerning the Divestiture of Conoco by DuPont
From the case study provided, DuPont is anticipating the possibility of initiating divestures on Conoco plant. Initially the firm had made partial divesture on Conoco (United States Securities and Exchange Commission, 2010). However, this is not inadequate and considering the pros and cons of each divestiture mode, the complete divestiture is more beneficial than the initial partial divestiture.
The plan that needs to be formulated needs the recommendation of the company’s shareholders that may or may not approve it. This is because this is a strategy decision that should incorporate all the key stakeholders of the company. Therefore, the Chief Financial Officer (CFO) need to present a comprehensive report citing all the reasons as to why the company need to have full divestiture of Conoco plant from a financial perspective.
The argument should also be based on the recent divestitures that took place in the United States at the eve of 1999. Such a critical strategy like this calls for opinions of various key associates of the company whose recommendations have to be incorporated in coming up with final recommendation. The CFO need to consider how and what extend will the company benefit from acquiring a 100 percent of Conoco rather than the existing 50 percent percentage.
Despite the fact that DuPont has benefited significantly in its marketing and customer outsourcing due to ownership of 51-60 percent of Conoco since 1980s, the company can still benefit much if it goes a step further and claim the divestment of the remaining percentage. However, several considerations need to be put in place.
Firstly, are whether DuPont is capable enough of accessing the remaining part of Conoco and how costly the venture will be. The company should also weigh how the Conoco has contributed to the company’s performance since its initial divestiture in the 1980s. DuPont has also to look at the compatibility of its operations to those of Conoco and predict to what extend the newly created capital structure might bring about positive impacts to the company.
The goals that need to be achieved or the motive being pursued in the proposed divestiture by the part of the company for instance, whether the company is after the complementary of its services, expansion of its geographical coverage or vertical integration motive that is directly linked to the activities of each individual company. All the mentioned considerations have to be viewed from a financial perspective and the analysis of the two companies becomes vital.
Brief analysis of DuPont Company
DuPont has been a successful company since its formation more than 200 years ago. Its success is based on market-driven science that provides unique, distinct and high value to its customers. Even during the periods of hard economic downturns, the company has been able to overcome them and perpetrate its core values of creating its own destiny through technological innovations and inventions to ensure the customers’ expectations are adequately met (United States Securities and Exchange Commission, 2010).
DuPont operates in a manufacturing industry specializing in agriculture and nutrition, building and construction materials, electronics and electrical materials among others. DuPont is striving hard towards creating a sustainable and lasting solutions required for a better, safer, and healthier life for all the people all over the world. Currently the company has its operations spread to over 90 countries all over the world.
The company has been able to implement successful strategies to ensure the better performance of all its established units. It should be noted that this is not the first time the company is taking divestitures since it has executed it before and successfully achieved the intended objectives.
Financial analysis of DuPont Company
DuPont has had significant financial performance in the past, a success attributed to its commitment in ensuring the consumers get the highest services from the company. Through the information filed in the United States Securities and Exchange Commission (SEC), the company’s financial results reflect how the company is capable of executing a complete divestiture with another company to improve its performance and expand the shareholders’ equity.
The DuPont’s overall revenues for the fiscal year 2010 amounted to $31.5 billion representing a 21 percent increase up from the previous year’s $26.1 billion (United States Securities and Exchange Commission, 2010). The total sales volume increased by 17 percent. Despite the company’s history of high performance, the fiscal year 2009 recorded a decline of 14 percent from $30.5 billion in 2008.
The strong performance is attributed to company’s excellent marketing strategies and its ability to offer high quality services to its customers. The figures below illustrate the company’s financial performance in terms of sales for the past three years, an indicator of its strength in attaining high sales volumes to maintain its strong performance.
|Dollars in millions||2010||2009||2008|
The excellence performance was a contribution of all the company’s subsidiaries both in the United States and outside. The major percentage change was observed in Asia Pacific, which had an overall increase of 40 percent hitting $7.3 billion. The United States alone recorded $11.5 billion; a 17 percent increase while Europe, Middle East and Africa combined had the smallest percentage increase of 14 percent contributing $8.1 billion to the company’s net total sales. The figures and their associated contributions are illustrated below (United States Securities and Exchange Commission, 2010).
|Dollars in billions||2010 Net Sales||Percentage change vs 2009||Local Price||Currency effect||Volume||Portfolio|
Europe, Middle East and Africa
Brief analysis of Conoco Plant
Conoco Company is one of the largest energy producing companies in the United States. It offers a variety of products and services meant specifically for the consumer. The company delivers fuel and fuel related products in the United States and Europe under different brands (ConocoPhillips, 2010). In addition, the company offers numerous high quality lubricants to the consumers.
The company’s five proprietary blending facilities are located in the United States and supplies the lubricants to the entire United States and more than 50 countries all over the world. The company is actively committed to conducting its operations to ensure maximum return value to its shareholders while making use of optimal resources including its experienced and skilled team of employees.
The company delivers its energy in a safe and environmentally friendly manner. The company’s performance is aimed at maintaining its global market competitive position.
Cocono’s analysis of Financial Performance
The company’s financial performance has been significant. In the fiscal year 2010, the company’s quarterly dividend rate went up by 10 percent marking a $15.4 percent billion. The company’s annual earnings increased to $11.4 billion (ConocoPhillips, 2010). These achievements were realized besides the recent global economic downturn. These significant achievements can give DuPont enough reason to divest in Conoco.
For any company to pursue a strategy like this, it has to ensure that the company it anticipates to divest the businesses in is performing well financially.
The possible risks – DuPont and Conoco
DuPont and Conoco are likely to be affected by various risks that may threaten their existence as well as their after divestiture capital structure.
It is quite evident that these risks are beyond the company’s control. While analyzing the potential risks that are likely to affect the performance of the company, its past financial performance may be insignificant for the future performance of the anticipated divestiture and therefore the historical trends may be left out while anticipating company’s results in future.
One of the risks that may have adverse effects on the part of the company is the escalating prices for energy and other raw materials. The company’s manufacturing industries require huge amounts of energy and other relevant raw materials that are affected by the global supply and demand and therefore they are not within the company’s control (United States Securities and Exchange Commission, 2010).
Huge fluctuations in energy costs that reflect market prices for the company have required raw materials that may affect the company’s financial performance. Another risk that may affect the country is its inability to develop and flood new products as well as maintenance of product life cycles that could maintain DuPont’s competitive advantage.
Bearing in mind the competitive nature of the US market, the failure to have the products that meet customer expectations become a major challenge. The prevalence of unfavorable economic factors such as inflation and currency exchange rate fluctuations among others may impact negatively on the company’s operations bearing in mind that most of its activities are global and may involve foreign currency transactions.
Just like DuPont, the operations of Conoco Company are prone to very serious risks that may seriously disrupt its operations. There is foreign currency exchange rate risk that has been unstable over the time. This risk is a threat to the company due to the fact that some of the company’s operations are globally based.
The other risk is fluctuating economic conditions that may affect the demand of various consumer products hence the company’s profitability (ConocoPhillips, 2010). The company is also unable to have full access to exploratory acreage thereby disrupting the company’s drilling activities to get more oil and petroleum products. There are also forecasted chances of experiencing low demands for company’s products due to existing and forecasted federal rules and regulations.
Why the divesture in Conoco is likely to bring about positive outcome
From the analysis of the two companies’ history and performance, DuPont need to carry out the complete divestiture of the Conoco Company. This is because the possible results of the divestiture are likely to impress the shareholders. Conoco is an international company with good international image and has had strong financial performance besides offering high quality products at affordable prices.
One of the most important factors that need to be considered before carrying out a divestiture is the company’s strength and its ability to enable the buying company achieve the desired goals behind the entire process (Rosenbaum & Joshua, 2009). Conoco Company has all what it requires for an interested company to establish any form of divestiture.
In addition, DuPont’s financial stability can enable it acquire the Conoco and that will be like increasing the company’s investments. As observed from the risks that are likely to affect the operations of DuPont Company, there is problem of increased energy prices and other raw materials (United States Securities and Exchange Commission, 2010).
On the other hand, Conoco is major energy supplier in the United States and other European countries. Therefore, DuPont’s acquiring of Cocono may be of significant benefit to the company as a whole and shareholders in particular.
Based on the information availed by the two companies, the recommendation need to be based on a financial perspective. DuPont should adopt complete divestment on Conoco and not partial divestiture. This will result in increased shareholders’ equity and yet the improvement of the company’s performance.
The only way to reduce some of the risks that are most likely to affect the company’s operations and performance is to do divestiture with Conoco Company. After the divestment, the shareholders should be given the option of retaining the existing share ownership or shift their ownership to the newly divested company.
Many US companies to enhance their competitive position in the market industry have applied divestment strategy. Many companies that have used the strategy have either done so to change their strategy or improve their business performance (Weston, Mitchell & Mulherin, 2004). The divestment in the United States was mostly witnessed in the energy sector where the government was putting more efforts to see effective deregulation took place.
DuPont Company having acquired partial divestiture in the past is qualified to go ahead and divest 100 percent of Conoco as suggested by one of its associates. The divestment of DuPont Company on to the Conono is likely to bring good future prospects for the shareholders and benefit the ultimate consumers of the company’s products to a greater extend.
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Rosenbaum, J. & Joshua, P. (2009). Investment banking: Valuation, leveraged buyouts, and mergers & acquisitions. Hoboken, NJ: John Wiley & Sons.
United States Securities and Exchange Commission. 2010. E.I. du Pont de Nemours & Company. Web.
Weston, J. F., Mitchell, M. L., & Mulherin, J. H. (2004). Takeovers, restructuring and corporate governance. 4 Edn. New Jersey, NJ: Upper Saddle River.