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In a divestiture, companies must overcome the complexities of disentanglement.
Divesting a business unit creates value when other owners can extract more value from it than the current owners can. This is known as the “better owner” principle. Often, new owners change the operating model of both the divested business and the parent company because large companies frequently impose mismatched operational requirements on diverse business units. For example, high-growth, high-margin businesses may require operating models that are different from those of low-margin, mature businesses.1 Breaking up the business units can help both entities develop a fit-for-purpose operating model.
Moreover, divesting noncore business units can help free up management attention and allow for better resource allocation decisions within the core businesses. Finally, divestments can improve capital allocation decisions while making it easier for the divested entity to raise capital as a pure-play company, versus competing for funding with all other lines of business.
The value created in a divestment for a parent company is the price received minus the value forgone minus separation costs incurred by the parent. The value forgone is the value of the divested business, as operated by the current management team, plus any synergies it has with the rest of the parent’s businesses. This forgone value represents the cash flow that the parent company has given up by selling the business. The costs of separation include the costs the parent incurs to disentangle the business from its other businesses, plus the so-called stranded costs of any assets or activities that have become redundant after the divestment—costs that, as we will see, can often be substantially mitigated by restructuring central and shared services in the parent company.
This article, an excerpt from the eighth edition of our book Valuation: Measuring and Managing the Value of Companies (Wiley, May 2025),2 discusses these synergies and costs. It also examines practical challenges relating to legal and regulatory issues, as well as pricing and liquidity of the businesses.
More in the article:
Lost synergies and stranded costs
One-time disentanglement costs
Stranded costs
Legal and regulatory barriers
Pricing and liquidity
There is no guarantee that divestitures will create value. The best divestitures indeed outperform the market, but those at the bottom fall even further behind. To increase the chances of a successful divestiture, executives should thoroughly identify the implications for the economics of the remaining businesses and consider these implications when structuring the divestiture agreement. Executives should also take care not to underestimate the time and effort required to complete a divestiture.