Beware divesting core business

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A rare example of clear and useful academic research from Emilie Feldman at Harvard [but treat it with care – see below]. Emilie “investigates “legacy” divestitures, the sale or spinoff of a company’s historical core business. Firms appear to divest their legacy businesses within the context of larger efforts to reshape their identities. I find that operating performance deteriorates in the years following legacy divestitures, and this decline appears to be linked to a loss of intangible resources embedded in the legacy businesses, as well as to the disruption of synergies between legacy businesses and other units within the divesting firms. These results illustrate the challenges associated with divestitures that impact firms’ resources in unexpected ways and shed light on the difficulties firms may experience when they attempt to overhaul their identities.”

Warning – its an academic paper, but get it here. And .. it’s another finding based on answering the wrong question. It’s entirely possible that these divestitures decrease profitability, but increase growth in free cash flow, which is what investors actually value, because the firms immediately start spending to exploit growth opportunities that will deliver future cash flows whilst holding down short-term profitability. It is even probable that the divested core business was making OK returns [ROIC] because it was mature and [a] didn’t justify any spending on growth and [b] could be sold at a good price in a consolidating industry.

Nevertheless, it should give cause to think carefully before buying into a transformation. Remember, strategic transformations are very rare, and even more rarely successful.

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