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Olivetti Sells Losing Assets

News

Ailing Italian high-tech group Olivetti announced on October 3 that it will quickly sell off a money-losing personal-computer unit and other businesses, vowing to return to profitability by 1998. New Chief Executive Officer Roberto Colaninno told financial analysts that he planned to divest Olivetti's ailing PC business and three other units by Dec. 31, raising some 800 billion lire ($526 million).

Olivetti expects to bring in 1 trillion lire ($665.5 million) to 1.2 trillion lire ($796.5 million) through asset sales.

Analysis

I would like to use this story to raise two issues. (1) Why would any other company be willing to buy a losing business? (2) If Olivetti had other alternatives to raise the above cash, why did they choose this particular path?

Once again the issue has to do with valuation. First, a losing business might still have positive value if its assets are expected to generate positive future cash flows. Second, if someone is willing to buy an asset that is losing money, the acquiring company must believe that the ailing company’s assets are worth more to it than to their current owner.

Thus, the question becomes, why would Olivetti’s PC assets be worth more to someone else? Using the discounted cash flow (DCF) approach, this can come from either a boost in cash flows and/or a lower cost of capital as measured by the discount factor. The acquiring company might expect for example to do a better job at selling the product (see, for example, the story on Gillette acquiring Duracell, (+Value, September 16, 1996), or reducing operating costs as in this issue’s HMO merger story.

Alternatives
A natural alternative to selling assets is always selling additional shares on the market. Why didn’t they choose this alternative?

Assuming a rational decision, their choice suggests that raising new capital must be an inferior strategy. But how do you measurer "inferior?" The adopted alternative creates "more value to shareholders." Actually, issuing new shares might even destroy value if the current stock holders end up with diluted share values. Once again, the objective of the manager is to act in the best interest of shareholders by adopting strategies than maximize shareholders’ stock value.

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