Parthenon-EY: Divestments can help technology firms bolster operations

Despite unprecedented divestment activity in the technology industry, many companies in the technology sector still aren’t fully benefiting from using divestitures as part of a broad strategy to position themselves better for coming disruptions. According to Barak Ravid, a managing director at strategy consultancy Parthenon-EY, divestment of non-core units can serve as an effective way to streamline the business and free up capital to support growth.

Analysis from EY shows that the volume of global tech company divestments valued over $100 million grew 37% from 2015 to 2016 — and the trend is magnified for divestments of over $1 billion, which rose by 300% to a global total of 28. Many large tech firms made bold, strategic decisions to shed non-core assets. These included some of the industry’s biggest names: Hewlett Packard Enterprise carved out its software and services businesses in separate multibillion dollar mergers, and Dell sold its services business for $3 billion. 

However, according to a global survey of 900 respondents across all industries, fewer tech firms are planning further divestments in the near future than companies in other industries. Just 28% of the 182 technology executives surveyed said they expect to make divestments in the next two years — much lower than the 43% across all sectors.

Perhaps they should reconsider. At Parthenon-EY, it is believed the same trends that drove divestments in 2016 are set to continue, and in some cases intensify in 2017 and beyond. In most industries, many large companies have reinvented themselves more than once to maintain their leadership over the decades. As part of each transformation, they have typically divested non-core assets while making growth-focused acquisitions. 

In contrast, the technology industry has historically been much more focused on growth than on reinvention — and accordingly, has placed much more emphasis on acquisitions than on divestments. This is partly because the technology industry is still relatively young, as are many of its leading companies. Robust corporate growth can tend to paper over the cracks in a company’s portfolio: when parts of the industry are growing at 20% to 40% a year, it’s easy to see why difficult divestment decisions get put off. 

Now, though, many large technology firms are several decades old, and have reached a point where they need to be more proactive in trimming and reinvigorating their portfolios. The pace of innovation and market change is increasing, shortening technology cycles and putting pressure on companies to reinvent themselves more quickly to keep up. 

Technology-led disruption

As one wave of innovation peaks — driven by cloud computing, mobile devices, and analytics — the next transformative wave is already building, based on such technologies as machine learning and augmented reality. Many companies find that their portfolios include aging assets that cannot easily be adjusted to these innovations, such as older software applications not designed for delivery in the cloud or as a service. While they may still be valuable in the right context, these older assets can slow growth and create a drag on business performance.

Divesting these non-core units is an effective way to streamline the business and free up capital to support growth, including acquisitions that position companies for the next wave of disruptive forces.

At the same time, the pool of potential buyers for technology assets is growing ever larger, driving up the value of divestments. Private equity firms have become a powerful force in technology deals — PE tech acquisitions rose 61% in 2016 to reach a record $90.1 billion, according to EY research — and they still have record stockpiles of cash to invest. They have also become increasingly comfortable with buying “hidden gems” — non-core businesses within larger companies that may be underperforming because of a lack of funds and corporate attention. 

This unprecedented confluence of driving forces means that CFOs and other executives at tech companies should be investing even more time and attention into evaluating their portfolios and determining where rationalization makes sense. 

A proactive, strategic approach to portfolio review — based on a longer-term view of industry trends and their effect on business performance — can identify parts of the portfolio that weaken growth and profitability. A recent EY capital budgeting survey found meaningful differences in capital allocation between well-positioned and poorly positioned technology companies.

Given the fast pace of the technology industry, well-positioned companies pursue a more fluid, decentralized process, budget more frequently, and use a predictive rather than a reactive focus that helps them proactively adjust the company’s business to the changing environment.

Portfolio review

Still, amid the intensive deal activity in the technology sector, many companies find it challenging to dedicate specialised resources to portfolio review. C-suite involvement can help ensure the business mobilizes the required resources, including people who have suitable expertise combined with a sufficiently independent perspective.

Once a potential divestment has been identified, doing the heavy lifting of sale preparation is essential to maximize value. In general, the more prepared you are the higher the value you are likely to achieve. In contrast, inadequate preparation is a recipe for value erosion.

But sale preparation may take considerable work. At many technology firms, assets tend to be integrated into the overall business rather than operating as standalone units. It is important to clearly position the asset, define its perimeter, and be able to explain the factors that affect its performance so that buyers quickly get a clear picture of their potential acquisition.

Our survey showed that the technology sector lags others in this all-important sale preparation. Only 38% of  tech companies created a standalone operating model for divestments, compared with half of the executives across all sectors responding to the global survey. Further, this was the step that tech executives most regretted not taking — more than a third felt it would have provided the greatest benefit to the divestment outcome. 

Successful divestment involves navigating myriad complexities, such as solving intellectual property issues, avoiding disruption for large enterprise-wide customers, managing the separation of employee teams, and protecting the interests of all stakeholders including the employees who will transfer to the new owner.

Among the many potential obstacles, untangling intellectual property (IP) issues can rise to the top, cited as a challenge by 80% of executives. Tech companies often have complex webs of cross-licensing agreements stitched together over many years, including agreements with competitors or even potential buyers. It’s important to identify ownership and devise workable solutions as early as possible, to avoid problems later. 

The accelerating pace of technology change will require many tech companies to reinvent themselves, just as other sectors have been forced to do. Divestments may be more difficult and time-consuming than acquisitions, but they are essential to streamline the business and free up capital for growth.

Tech companies that continue to serially acquire without engaging in healthy portfolio pruning will be less prepared to lead as a wave of disruptive forces reshapes the technology sector — again.

Related: M&A deal activity likely to remain robust on corporate growth demand.