Today, banks are adjusting business models and portfolios to address ongoing economic and competitive pressures―a prolonged low rate environment, rapid changes in customer preferences, and rising competition from alternative providers. Divestitures of non-core businesses can provide the funds to invest in the core business—to make banks more competitive in digital capabilities, which have taken on even greater importance since COVID-19. Pruning the portfolio also has additional benefits: removing time-consuming distractions and boosting market valuations.
The divestment challenge
Diversification has helped banks meet customer needs and explore new sources of growth. But diversification can also lead to suboptimal financial performance if the new businesses fail to generate the same, or better, rates of return as the core business. Moreover, the market assesses a “diversification discount” on shares of companies that operate many disparate businesses—the greater the disparity (in rates of return and in business focus) the greater the discount.
Identify divestiture candidates
The process begins with a strategic and financial review. If a business is not aligned with the overall strategy and financial goals of the bank – and if it is not contributing to future value creation—it may be a candidate for divestiture. Identifying underperforming businesses is often the easy part. The more complicated tasks include analyzing the ultimate financial performance of each business, and then weighing the portfolio choices and capital allocation tradeoffs. This analysis requires a complete strategic and financial review, a thorough exploration of options, and a realistic plan for reinvesting in higher performing businesses. We also recommend at this stage that companies identify barriers to divestiture.
How to divest successfully
- Phase one: program launch and sell-side due diligence
Divestiture planning is an important step in order to understand the timelines, operational risks and level of effort required to execute the divestiture. This helps refine expectations for the likely valuation of the asset being sold. There are four steps:
- Standalone costing
- Transaction perimeter definition
- Stranded cost management
- TSA identification, costing and service-level setting
- Entanglement mapping
- Phase two: Diligence readiness, transition, and separation
There are many potential pitfalls in finalizing the transaction and executing a clean separation. A Separation Management Office (SMO) establishes the rules for the separation, works with the buyer on handoff strategies, and manages Day 1 readiness. Oftentimes, TSAs must be established, and sellers and buyers should collaborate on change management activities that will help the seller’s employees transition to the buyer. Phase Two involves work in four areas:
- Change management
- Sign-to-close readiness
Reinvest divestiture proceeds in higher-performing businesses
Reinvesting the proceeds carefully is a critical part of the divestiture. To realize the full value, the capital generated from the sale must be applied to higher-performing businesses. The initial portfolio review that led to the sale should also provide perspective on which remaining businesses in the portfolio will benefit most from an infusion of capital and generate the best returns. Aligning capital allocation with the highest value businesses in the portfolio will also help to lessen the diversification discount and improve the overall value of the enterprise.
By Jack Whitt
About the author: Jack Whitt is Principal, Advisory Strategy, KPMG US.
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