Ready to split?

Many years ago I wrote a digest for accountants called Breaking up is hard to do. In many ways, breakups are as hard for businesses to execute as they are for people. They are emotional affairs and need managing not just at a strategic and financial level, but also at a political and emotional level too.

So who, if anyone, has been good at divestment? Richard Branson, for one.

He split off and sold his music business Virgin Records as well as Virgin Megastore. In both cases, his timing was impeccable – particularly with Virgin Records, an exit which must have been particularly hard as it was Branson’s first business.

One of his first signings to Virgin was the punk band Sex Pistols, who he heard playing in a club. He immediately tried to sign them but they were already on EMI’s books. Fortuitously, they then appeared on a TV news programme hosted by a namesake of mine, Bill Grundy. The interview ended in a flurry of expletives when Bill became overly forward with one of their entourage, punk musician Siouxsie Sioux; soon after, EMI dropped the band and, after a brief stint with A&M Records, they finally signed up with Branson. And so Virgin Group, more or less, was born.

It must have been like tearing his own heart out selling that business. But Branson is famous not only for his passion for starting new businesses but also for his dispassion when it comes to selling old ones nearing the end of their shelf life.

Before divesting, you should take these steps:

• Do a portfolio analysis of the business and identify possible candidates for disposal.
• Consider what the options might be for turnaround with a cunning plan.
• Consider the disposal options.
• Evaluate all these options.

Portfolio analysis

To analyse the business, it is useful to split it up into different business units. Each of these can be analysed according to its inherent market attractiveness and competitive position.

Inherent market attractiveness is a combination of environmental analysis – ie the PEST (political, economic, social and technological) factors – plus market growth drivers and the competitive forces of buyer power, entry barriers, substitutes, rivalry and supplier power.

Competitive position requires you to think about areas such as relative market share, brand awareness, customer service, perceived value for money, relative cost structure, innovation, skills and systems.

These two dimensions can be represented on a simple three-by-three matrix known as the ‘GE grid’ (after General Electric), with ‘market attractiveness’ on the vertical axis and ‘relative competitive position’ on the horizontal. Any business in the most extreme quadrant of low market attractiveness and weak relative competitive position is an obvious candidate for divestment.

In addition, you might pinpoint candidates that have a strong competitive position but where the market attractiveness is about to head south on the grid – ie where the market attractiveness may well decline over the next few years, but this may not be so evident at that point to a buyer of the business.

Finally, businesses that are strong on both market attractiveness and competitive position might attract a large premium.

Turnaround options

Where a business is in poor shape, then you should still spend at least some time seeing what possible steps can be taken before casting the business into new ownership. Not only may this preliminary exercise suggest that disposal is not actually necessary but it will also strengthen your bargaining power in getting a good price for it. The more options that you have, the more bargaining power you will have.

One example of this was when a friend of mine was CEO of a chain of health clubs. One of his clubs was located in Bristol. It had negative earnings before interest, tax, depreciation and amortisation, and while it was not a very big cashflow drain it was something of a sore. We got talking about Bristol and he said that he was thinking of selling it.

‘But John,’ I said, ‘it’s not like you to admit defeat. What possible different business models might save the business? What could be done if you started playing with the key value drivers, such as volumes, pricing, margins, member acquisition costs, costs of member attrition and operating costs per member?’

I also challenged the cost base on the grounds that at the health club I was a member of, I found that the staff could sometimes get in the way and stop me from having a great experience. I suggested that he consider getting rid of almost all the staff. This and his thoughts on using lower price to leverage much higher volumes became further ingredients of a very different business model.

Bristol became a big success and John was able to replicate that model initially in new sites, then by franchise and finally by rebranding his old clubs and transforming his business model, which is now copied by others.

An interesting story? Yes, as without those ideas being generated and then evaluated on a napkin, that business might not be with us today.

Turnaround might not always come off, but it is worthwhile trying first by looking at the business from fresh and novel perspectives.

Sometimes a business is in such a poor shape that it is simply unrealistic to conceive of a viable disposal, let alone a sale.

I once had as a client a distributor of electronic games that was losing more than 10% of its turnover. On the GE grid we positioned it in the worst cell. The incumbent management could not come up with a single option to turn it around; they appeared depressed, dispirited and to have given up – a big part of the problem. It was losing so much that the solution was a no-brainer.

As the cost of closure wasn’t that enormous I challenged the group CEO and FD: ‘I will bet that the payback period on closure is 12 to 18 months. I also bet that you are too embarrassed to admit this venture was a mistake. Just tell the shareholders you have done a strategic review and you are now boldly and in a mature way biting the bullet.’ The business was subsequently closed.

Disposal strategies

The next step is to think of disposal strategies. These break down into what to dispose of, how, to whom and when.

There is a huge variety of variables to explore here. For instance, you might dispose of all or part of the business, especially where there are brands – different brands may be worth more to different buyers.

Alternatively, you might look at a trade sale, disposal to a private equity company or flotation. While disposals are often associated with a weaker business (one in a poorer position on the GE grid), this is not necessarily the case and you may have one that is simply worth more to another corporate buyer. When Virgin sold its music business, this was probably in the very best and top cell of the grid.

If a trade sale is contemplated, you would identify the different type of buyer and assess the kind of value the business might bring to them, then model that through economic value analysis, as covered in my second series of articles.

Also develop your own strategic plan and put a similar value on that; you can then argue that much of the value another owner could harvest would come out anyway in your business plan. Your goal is to maximise the premium relative to your own uplifted plans rather than current share price or steady-state projections.

Option evaluation

In the very last stage of the four-step divestment process, you list the options and sub-options for turnaround, closure and disposal. Split the sub-options between, for example, who to sell to and how, and then evaluate on the basis of:

• strategic attractiveness
• financial attractiveness
• implementation difficulty
• uncertainty and risk
• stakeholder acceptability.

Follow these steps faithfully, and you may find yourself in Branson’s league when it comes to divestments.

Dr Tony Grundy is an independent consultant and trainer, and lectures at Henley Business School