What is divestment?

Divestment is the action of an organization or government selling or liquidating an asset or a subsidiary. In the absence of an asset sale, divestment also refers to reductions in capital spending, which can facilitate the reallocation of resources to more productive areas within an organization or project funded by the government. Divestment can be made for a variety of reasons, some of which are described below. Whether a divestment action results in the disposal or reduction of funding, the main objective is to maximize the return on investment (ROI) of expenses related to capital goods, labor and infrastructure.

Understanding divestment

Divestments, in most cases, are primarily driven by value for money to deliver maximum returns. To achieve this objective, divestment can take the form of a sale, a spin-off or a reduction in capital expenditure. Divestments can also be made for political or legal reasons.

Commoditization and segmentation

In the target market for commoditized products, a company can identify product segments with higher profitability than others, while the expenses, resources and infrastructure required for manufacturing remain the same for both products.

For example, a company may determine that its industrial tools division is growing faster and generates higher profit margins than its consumer tools division. If the difference in profitability of the two divisions is large enough, the company may consider selling the consumer division. After the divestment, the company was able to allocate both the proceeds of the sale and recurring investment expenses to the industrial division in order to maximize its return on investment.

Divestment of ill-adjusted assets

A business may opt to divest certain assets from a business it has acquired, particularly if those assets do not match its overall strategy. For example, a business focused on domestic operations may sell the international division of a business it has purchased, due to the complexity and costs of integration, as well as operating it on an ongoing basis. Following divestment, the acquiring company can reduce the total cost of the purchase and determine the optimal use of the product, which may include reducing debt, maintaining cash on the balance sheet, or making capital investments.

Political and legal divestments

Organizations can decide to divest from holdings that no longer correspond to their social, environmental or philosophical positions. For example, the Rockefeller Family Foundation, which derives its wealth from oil, ceded its energy holdings in 2020 due to false claims by oil companies regarding global warming.

Companies considered to be monopolies may be legally required to divest their holdings to ensure fair competition. For example, after being recognized as a monopoly after eight years in court, AT&T sold its seven regional operating companies in 1984. After the divestment, AT&T retained its long distance services, while the operating companies, called the Baby Bells, provided regional services. services.

Key points to remember

  • Divestment occurs when governments or organizations sell or liquidate assets or subsidiaries. It can take the form of a divestment or a reduction in funding.
  • Divestment is carried out for various reasons, from strategic to political and environmental. For example, several institutional investors have started selling their fossil fuel assets under pressure from clients and non-profit organizations.

Example of divestment

Divestment in fossil fuels is the largest and most recent example of political and environmental divestment. In 2020, students on university campuses began demanding their endowment foundations, which are among the wealthiest institutional investors in the world. are starting to divest themselves of their stakes in fossil fuel companies because they were major carbon polluters.

The move spans 37 countries and has resulted in a $ 6.2 trillion divestment of assets, according to a September 2020 report from Arabella Advisors. A thousand institutional investors, including insurance companies, sovereign wealth funds and pension funds, have committed to sell the fossil fuel assets. The report attributes the sharp increase in fossil fuel divestments to moral pressure, which has given way to financial and fiduciary imperatives as the movement increases and the stocks of major oil companies fall.

Weyerhauser Co. (WY) is an example of strategic divestment. The Washington-based company was a manufacturer of paper and paper products until 2004. Since that year, it divested its activities by selling its pulp manufacturing operations and moving into wood and real estate.

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