Dynamic Portfolio Strategy: Rebalancing Using Divestitures

Many companies find themselves burdened with a portfolio of businesses that no longer align with their strategic goals. By shedding non-core or underperforming assets, businesses can redirect resources towards strategic priorities, improve overall efficiency, and create long-term value for shareholders. 

In this article, Jerome Combes-Knoke, SVP of Strategy and Corporate Development at Dotmatics, discusses how optimizing your portfolio through divestitures reshapes its growth.

“It’s important to frame the divestiture as a positive move for both companies. The best divestitures occur when each company is in a better position to pursue new opportunities after the split.” – Jerome Combes-Knoke

Portfolio rebalancing and its challenges

Over time, business units can drift away from the core strategy, creating misalignment and potentially diluting growth. This misalignment can arise from underperforming assets, non-core businesses, or operational redundancies. This is where portfolio rebalancing through divestitures comes in. 

By proactively evaluating and pruning the portfolio through divestitures, companies ensure that their assets are owned by the entities best positioned to develop them. According to Jerome, this process is often challenging and often avoided due to biases against selling. Divestitures can be perceived as admitting failure, even if the decision is strategically sound. 

However, this strategy can strengthen the company's identity, purpose, and shareholder returns, while also setting the spun-off units up for greater success under more focused ownership.

Getting buy-in and alignment from the board and key stakeholders

Jerome notes that actively rebalancing a company's portfolio using divestitures is crucial for maximizing shareholder value and avoiding undervaluation. Without proactive evaluation, businesses risk misalignment and missed growth opportunities. 

However, people often have a strong emotional connection to the businesses they're involved in, making it difficult to consider divesting. In this case, companies must prioritize effective communication, data-driven analysis, and clearly articulating the divestiture’s strategic benefits. To do that, Jerome suggests asking these calibrated questions to gain buy-in:

1. Why are we in the businesses we’re in?
2. What gives us the right to own these businesses?
3. What should we be looking for in our next acquisition?
4. How do we think about excess capital, and what should we do with it?

Framework for portfolio rebalancing

Once companies answer the questions above and have ensured alignment, they can then develop a framework for rebalancing the portfolio. Jerome breaks down three dimensions of this process:

1. Aligning with strategic goals – Identify which industries the company wants to be in and understand why it believes it has a competitive advantage in those industries. The goal is to align the portfolio with the company's core strategy.
2. Look at the financial angle – Evaluate the economic contribution of the different business units within the portfolio. The goal is to understand each business unit's financial impact and how it contributes to or detracts from overall company performance.some text
   • Dynamic portfolio modeling:  Develop a dynamic portfolio model that allows for the simulation of different scenarios. In this model, business units can be toggled on or off to see the impact on earnings, growth rates, margins, and other financial metrics for the remaining company. This helps assess the potential benefits of divesting certain units and how it could improve the company's financial health and investor appeal.
3. Feasibility - Consider entanglements between different business units. Separating these units can be as complex as surgically removing conjoined twins. It’s crucial to consider whether each unit will do well on its own, whether additional capabilities need to be created, or if a transitionary period is necessary.

Executing a divestiture for portfolio rebalancing

Executing a divestiture for portfolio rebalancing is a lot of work, but there are great ways to approach it to ensure success. Jerome highlights these factors when considering a divestiture for portfolio rebalancing: 

1. Secure executive sponsorship: Executive sponsorship is huge. Secure very strong alignment, if not a mandate, from the board of directors. The leadership team also needs to be very aligned with that.
2. Define the operating model early - Think early and hard about the operating model for both the remaining company and the company being spun out. Have an early definition of what that looks like so that different functions know what they’re working towards. 
3. Identify and manage interdependencies - Recognize the many interdependencies between the pro forma operating model for the company that’s separating and the acquirer of that company. There will be different answers, but having a strong hypothesis early on is key.
4. Seek external help - Get external help. Some companies specialize in advising on these sorts of carve-outs. They’ll still miss things, and you’ll still have to be very involved, but at least you can benefit from their experience and the reps they’ve had.
5. Involve key functions early - Overcome the hesitation to involve functions early on. Before you know you're doing it, keep a small team. But once you know it’s happening, you’ll need the expertise of people within those functions to uncover the entanglements. 

Conclusion

Portfolio rebalancing is essential for long-standing companies to maintain strategic focus and maximize value. When using divestitures, understand that they are an extremely challenging and labor-intensive process that requires strong leadership, early planning, and clear communication. 

A divestiture is successful when it leads to a stronger, more focused company that ultimately trades at a higher share price, even if this takes time and involves initial investor turnover.

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