A STUDY OF MERGERS AND ACQUISITIONS – CORPORATE DIVESTITURE: A STUDY OF RETURNS TO SHAREHOLDERS

Abstract

Mergers and acquisitions (M&A) are tools by which companies reorganize their scale and scope, yet the objectives of acquisitions are often not fully realized. Many buyers go on to sell parts of their organizations. Such divestitures around M&A are common. Early US studies reported that 30-45% of M&A transactions resulted in divestitures of previously acquired units. A recent global study found that 13% of acquisitions were accompanied by at least one divestiture. In this study’s sample, 1,232 of 4,711 acquisitions (26%) made by publicly listed buyers from Brazil, Russia, India, China and South Africa (BRICS) between 2000 and 2020 were accompanied by a divestiture in the window from one year before the acquisition announcement to three years after its completion. This rate implies that they are too frequent to be treated as an exception. Yet there is no clear consensus on why these divestitures happen or what they mean for shareholders. The same event may be read as distress, failure or astute portfolio management, with very different consequences for how securities are priced and managers judged. The review of literature, anchored in a bibliometric analysis of 170 articles from 110 journals published between 1982 and 2023, identified several gaps in the literature. First, much of the research in this area is dominated by developed markets with not even one of the BRICS countries appearing among the top ten countries by citation per publication. Market dynamics in BRICS and developed countries vary in terms of liquidity for corporate assets, disclosure norms and regulatory action, and therefore, developed market findings cannot be assumed to hold in BRICS. Second, the jury was still out on theoretical explanation of divestitures around M&A including reasons and their impact. Correction of a prior mistake and active portfolio management had been competing explanations in extant literature. Similarly, there had been contradictory evidence on whether financial constraints improve divestiture outcomes signaling relief or worsen them due to fire-sale. These are usually treated as rival findings; this study treats them as potentially complementary and seeks the conditions under which each holds. Third, majority of research in the area considered only divestitures after the acquisition, ignoring those used to prepare for or finance a deal or to pre-empt regulatory action. Fourth, several effect of such divestitures on subsequent operating profitability and strategy were thinly studied even globally. To the best of the researcher’s knowledge, this is the first comprehensive framework for divestitures around M&A in BRICS. It examines these events from four different construct on the same sample. These include reasons and likelihood of divestiture, announcement returns, impact on subsequent operating profitability, and impact on strategy. The study had four objectives. First, to identify the factors influencing the likelihood of divestitures post acquisitions and to create a model to predict such divestitures. Second, to analyze the impact of divestitures around acquisitions on shareholder’s returns and identify the factors influencing the same. Third, to evaluate the impact of divestitures on subsequent profitability of the buyer of focal M&A deal (i.e., seller in case of divestiture). Fourth, to analyze the impact of past learning through divestitures on future strategy. S&P Capital IQ and World Bank were the main data sources. The main sample was of 4,711 M&A deals announced by BRICS publicly listed buyers between 2000 and 2020. Deal data from 1995 was extracted to measure prior deal experience and up to 2023 to observe deals for three years post-deal window. 1,232 of the deals had a divestiture associated with them of which 13% occurred in the year before the acquisition announcement, 6% between announcement and completion and 81% within three years of completion. Logistic regression was used for identifying the reasons for divestiture and for analyzing the impact on future strategy. Multivariate linear regression was used for analyzing the impact of divestiture announcement on cumulative abnormal returns (CAR) and to identify the factors influencing the same. Multiple linear regression was used to evaluate the impact of divestitures on subsequent profitability. This study found that buyers that divest after acquisition are larger, experienced but financially stretched. Low free cash flow, low ROA, high leverage, obligation to pay dividends all increased the likelihood of divestiture as firms needed resources unlocked by divestiture to relieve financial constraints. Consistent with agency theorists’ views, cross border deals were found to be less likely to be divested as they increased the complexity of organization, thereby, protecting management’s interests. Poor acquisition announcement returns were found to increase the likelihood of divestiture. This was the only area where correction of prior mistake theory found support in this study. The study also identified areas where BRICS behaved differently from developed markets. Stock volatility and risk of regulatory action were found to reduce the likelihood of divestitures in BRICS while developed market focused studies reported them to increase likelihood. BRICS countries have relatively poor liquidity for corporate assets and turbulent circumstances, for example, stock volatility and risk of regulatory action, lead to fire-sale and depressed valuation. Thus, managers avoid undertaking divestitures in BRICS when faced with these challenges that are public knowledge. The combined model correctly classified 83.2% of deals – whether divestiture happened or not post an M&A. In a model that combined all BRICS countries except China, divestitures were found to add value to the restructuring process, in-line with global research. Only China was the exception with negative coefficient for divestiture return but it was statistically insignificant. Planned divestitures were rewarded by the market. Risk of regulatory action was also found to add to divestiture announcement returns. Prior divestiture experience was rewarded by the market but prior acquisition experience had no bearing on the returns. The study reconciles conflicting evidence on financial constraints by separating their level from their direction. Existing constraints, such as high leverage and low cash, were rewarded because the sale relieves them. Worsening constraints, such as rising leverage and low free cash flow were penalized as the sale was read as too little, too late. Good stock performance was rewarded but worsening stock performance was penalized. Correction of prior mistake theory was not supported as prior acquisition announcement returns had no statistically significant impact on divestiture returns. Divestitures around M&A amplified the performance that preceded them. They also did not have a uniform impact on all organizations. High performers were able to continue to build on their prior performance. Post divestiture, they quickly deployed the proceeds into productive assets, likely through acquisitions, that further increased their ROA by increasing revenue faster than the growth in SG&A, and increasing their net income faster than the growth in assets. Low performers sold to survive and were unable to deploy proceeds within one year and saw their ROA fall with net income that contracted faster than the fall in assets. Divestiture did not have any significant impact on R&D profile for either group within the one-year horizon. Both acquisition and divestiture experience were found to contribute to learning and increase the likelihood of divestiture, however, the learning impact of past divestiture experience was much stronger than that of past acquisitions. If divestitures were failures, experience of them wouldn't make firms more likely to divest again. Hence, correction of prior mistake theory is not supported here also. The study found support for vicarious learning theory from the flipside of acquisitions and also that organizations learn better from rare events and varied events instead of repeated ones. The study makes several important contributions and implications for researchers, managers, shareholders and other stakeholders such as employees, analysts, and policymakers. The study showed that portfolio management theory is a much better framework to understand divestitures around M&A instead of treating these as evidence of correction of prior mistakes. It also distinguishes the level of financial constraints from their direction reconciling previously conflicting findings. The study also finds support for agency theory, vicarious learning and the complementary Penrose effect. Very importantly, the study also maps where BRICS markets diverge from developed markets and provides a first-of-its kind comprehensive framework to understand divestitures around M&A in BRICS. Managers now understand that planned divestitures are rewarded and unplanned ones are not. They can estimate the likelihood of a divestiture at the time of acquisition decision itself and plan for it. Managers can also note that rising leverage and deteriorating free cash flow are the warning signs of an unplanned, penalized sale. In thin BRICS markets, deferring a sale during stock market volatility or risk of regulatory scrutiny may be prudent. However deferral that prolongs weak performance also carries a cost. These findings are also relevant for shareholders as they can now evaluate the likelihood of divestitures at the time of acquisition as well as have a framework to price a divestiture around M&A. Policymakers should understand that anti-trust remedy playbook cannot be directly replicated from developed markets as BRICS countries have lower M&A liquidity where non-structural remedies may work better in certain situations. For employees, such divestitures are predictable, and high performers expand after divesting while low performers contract. Divestitures around M&A in BRICS are better understood as a complementary portfolio management tool than as the reversal of something that went wrong. Large, experienced and financially constrained buyers divest. The market prices these events according to whether they relieve constraints or confirms deterioration, and whether it was planned. The operating performance follows the buyer’s pre-existing trajectory. Divestiture experience is more valuable than acquisition experience. The study is limited to listed buyers, buyer-side variables and a one-year profitability horizon. Extending it to private buyers, target characteristics, divestiture sub-types, longer horizons and other emerging markets is natural next steps.