Boards Trimming Down to Core Businesses

Agenda, August 18, 2014

By Tony Chapelle Major

U.S. corporations are on pace to sell off more of their business units in 2014 than at any time over the past five years. Board directors have sliced off non-core divisions at Procter & Gamble, Merck, Chesapeake Energy, Carlson, American International Group and Waste Management, among others. Management consultants at Bain & Co. cite statistics that the majority of corporations acquire three businesses for each one they divest. So most corporate teams and boards are prepared to buy, not sell, assets.

But experienced directors say that boards should consider divestitures in general at least once a quarter. They also should review specific portfolio holdings at least once a year. “One of the board’s biggest [jobs] is to focus on strategy. Assets that are not core detract from the strategy,” advises Robert Ryan, chairman of the finance committee at General Mills and a director at Citigroup and Stanley Black & Decker. According to data from S&P Capital IQ, the number of divestment deals greater than a billion dollars is on track to exceed last year’s 41 sales by about 28%. But the total dollar value of those deals is predicted to come in about 6% below that of 2013.

Fred Hassan, a former chairman of several Fortune 500 companies, adds that there’s more deal activity in 2014 because the cost of debt is still artificially low. “This will not be a ‘new normal,’” Hassan writes in an e-mail, because the government’s extraordinary fiscal policy cannot last for many years. Also, much of the present divestment activity is a result of corporate America’s catching up with bottled-up demand during the slow recovery.

Dawn Hudson, vice chairman of strategic advisory firm Parthenon Consulting Group and a director at Lowe’s, Interpublic Group and Nvidia, says one useful exercise is for boards to instruct managers at all firms to run a growth-share matrix (a Boston Consulting Group tool) analysis on a company’s orphan or stagnant assets. What’s the trajectory of the market sector and the business unit’s place? What’s the investment required to turn around such units? Why hasn’t that been made yet? With reasonable investment, which units would grow and which wouldn’t bring required return? “Sometimes activist investors see these units and think they could be handled better. This is no reason to be defensive. Make a decision on these assets; don’t just let them linger,” Hudson concludes.

Frankly, large investors have called for more divestitures. For example, Paul Allen and activist Carl Icahn have clamored for selling off Microsoft’s Web browser Bing and eBay’s payment platform PayPal, respectively. Neither parent company budged. But last month, hedge funds Barrington Capital Group and Starboard Value were successful in getting the board of Darden Restaurants to depose Chairman and CEO Clarence Otis for moving too slowly to shed poorly performing units. Darden had already disposed of the Red Lobster chain for $2.1 billion. Darden board members will pay a price, too. While the board has offered to give Starboard three of the current 12 board seats, Starboard has launched a proxy fight to replace the entire board with various experts nominated by the fund (see story on page 11).

Sophisticated investors don’t want a company that straddles sectors, explains Jonathan Foster, a director on four public company boards, including Lear and Masonite International, and founder of private equity firm Current Capital. Foster says that operating different businesses requires serving different client bases and acquiring different operating expertise. Investors, meanwhile, prefer to buy, hold or sell their sector investments as pure plays.

This month, Procter & Gamble’s CEO, Alan Lafley, told Wall Street analysts that within two years P&G will either sell or drop up to 100 of its smallest personal care and household brands. That’s equivalent to 10% of current revenues. The cuts will not only free managers to grow the company faster; they’ll play to the changing market. Today’s consumers want fewer choices so as to “keep life simple and convenient,” Lafley said. In one of many transactions to come, on August 1, P&G closed a $2.9 billion sale of its pet foods division to Mars. Waste Management announced in July that it would sell 17 waste-to-energy facilities and a handful of other electricity-generating businesses it owns or operates. The company will use the $1.94 billion in proceeds to buy assets more in line with its core strategy of waste collection, recycling or landfills. That should drive shareholder value, President and CEO David Steiner said in a company announcement, partly through “reducing earnings volatility related to electricity sales.” If the Federal Energy Regulatory Commission approves the transaction, Waste Management officials hope to repurchase shares and pay down debt, which supposedly would result in a two-cents-per-diluted-share accretion. That’s tangible shareholder value.

“Operating multiple businesses under one organizational structure adds complexity and hidden complexity costs to a business,” writes Stephen Wilson, co-founder of management consulting firm Wilson Perumal. “The trend now is to simplify and root out complexity that has eroded margins and performance.” That even applies to businesses that consistently generate profits.

To be sure, if officials can’t articulate why disparate business units should be kept together, investors may hit companies with a “conglomerate discount” valuation, writes Hassan. Hassan is now a director on the audit and finance committee at Time Warner and is managing partner of private equity firm Warburg Pincus. He recommends that all boards consider and, if warranted, ratify divestments during capital allocation strategy sessions. That discussion should usually occur in conjunction with the quarterly dividend discussion, another part of capital allocation strategy. Formerly a chairman of Avon Products and Bausch & Lomb, Hassan points out that one key tipping point for directors to cut loose a business is when an outsider will pay a substantially larger net present value than the asset is producing. Robert Ryan considers three tests for divesting.

Ryan, who has been a McKinsey consultant, CFO at Medtronic and lead director at Hewlett-Packard, says he first asks managers how important the business is over the long term and whether it contributes to or takes away from shareholder value. Next he asks how much time and resources managers would need to shape up the business for the required return. Finally, he asks at which stage in its life cycle the business is in. “You have to balance all of those,” Ryan concludes.

Jon Barfield notes that directors should bring in experts to test managers’ conclusions about a sale only on “close calls,” and then only on deals most important to shareholder value. Barfield was formerly a director at Motorola Mobility Holdings before Google acquired it in 2012 and at Dow Jones before News Corporation bought it in 2007. “Forming truly independent judgments is critically important and also supports the business judgment rule defense,” Barfield writes in an e-mail. Both of those will likely be necessary if investors target directors in lawsuits after transactions. Finally, consultants at Bain found that over a 20-year period, the best companies at divesting created full-time teams to sell businesses. In a 2008 study of 7,300 deals by 742 companies, the Bain researchers learned that companies that devoted as much planning and resources to divestitures as they did to buy-side operations reaped capital proceeds to grow the core.