Corporate Restructuring 3

8/4/2019 Corporate Restructuring 3

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MODULE 3


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Corporate restructuring is a process ofexpanding or contracting businessactivities either by asset restructuring orownership restructuring.

On the other hand financial restructuring

refers to changing only debt-equity mix ofthe firm

The process of restructuring may involve

regrouping companies of the same groupor regrouping the various divisions /departments or merging some companiesor hiving off some departments/ divisionsand building some new ones.


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FORMS OF RESTRUCTURING

EXPANSION ORINTED RESTRUCTURING:These activities result in expansion of size, increase in productportfolio, market reach of the firm

CONTRACTION ORINTED RESTRUCTURING:

Contraction leads reduction in the size of the firm either to havemanageable size or core competitiveness.

CORPORATE CONTROL ORINTED RESTRUCTURING:Restructuring for corporate control refers to a process by whichcontrol over management is established

CHANGE IN OWNERSHIP STRUCTURE:These activities will result in the changes in the ownership pattern of a

company. Rather than the regular capital structure other variablesare used to try out new operating strategy, new capital structure, anddifferent cash flow pattern.


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What are the FORMS OF RESTRUCTURING ?EXPANSION ORINTED RESTRUCTURING:These activities result in expansion of size, increase in product portfolio, market reach of the firm1.Mergers-in the form of consolidation-in the form of an acquisition1.Tender offers2.Asset Acquisition

3. Joint venturesCONTRACTION ORINTED RESTRUCTURING:Contraction leads reduction in the size of the firm either to have manageable size or corecompetitiveness.1.Spin-offs2.Split-offs3.Split-ups4.Divestitures5.Equity Carve outsCORPORATE CONTROL ORINTED RESTRUCTURING:Restructuring for corporate control refers to a process by which control over management isestablished.1.Premium buy backs2.Stand still agreements3.Anti takeover amendments4.Proxy contestsCHANGE IN OWNERSHIP STRUCTURE:These activities will result in the changes in the ownership pattern of a company. Rather the regularcapital structure other variables are used to try out new operating strategy, new capital structure, anddifferent cash flow pattern.1.Leveraged Buy Outs2.Exchange offers3.Going Private4.ESOPs and MLPs5.Share repurchase


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Tender Offers

In a tender offer generally an acquirermakes an open offer to the shareholdersof the target firm to seek control in the

target

Tothe shareholders

Of the target

Firm

AcquirerTender offer to purchaseShares

Sell shares in responseTo the offer


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Tender offer is an attempt to takeover

It provides an opportunity to replace the existing BODs

These offers will not affect the legal entity of theacquirer or target

Affect on Acquirer Co Affect on Target Co


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Joint ventures A JV is an agreement between two or more companies

to provide certain resources (capital, technical know howetc) towards the achievement of common business goal.A JV can be for a limited duration and may haveseparate legal entity apart from the JV partners.

ICICI Bank and Prudential Plc UK set up ICICI PrudentialLife Insurance Co Ltd

JVs are considered as market entry strategy by MNCs

It pools resources and the best of the skills

Joint venture is most suitable when resources are to beshared for limited duration and does not requirecomplete merger.


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Reduction of risk for each partner,

Economies of scale,

Technology exchanges, Competitive advantage,

Avoiding heavy governmental regulations,

Facilitating initial international expansion,

Advantage of a nearly vertical integrationlinking the complementary contributions ofeach partner in a value chain.

Why make a Joint-Venture


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Financial contributions

Knowledge of local market and and of local

business practices Commercial contacts and networks

Know-how and technologies

Qualified and/or cheap workforce

Raw materials: facilitated access

Contribution of trademarks

What are the respectivecontributions in the Joint-Ventures

The joint-venture enables to share means andcompetences


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Why do Joint Ventures Fail?


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Partners do not manage to get on well with

each other,

Partners market are disappearing,

Managers from each partner company do notmanage to work with one another in the Joint-Venture,

Managers of the Joint-Venture do not manageto work with those of parent companies.

Reasons for failures of Joint-Ventures

Failure Joint-Ventures


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Other Reasons cited are:

Wrong Strategies

Incompatible Partners

Weak Management

Unrealistic or inequitable Deals

Regulatory changes


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Divorce??

According to a recent survey, only 44% ofCEOs of JVs characterized their venture asvery successful*

The most common causes of failure citedby CEOs are:

Cultural differences (49%)

Poor or unclear leadership (30%)

Poor integration process (21%)


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CONTRACTIONcertain restructuring activities result in reduction in the

size of the firm

Spin-off

A Spin-off is setting up a subsidiary through distribution of allequity shares held by the parent company to the shareholders ofthe parent company, on pro-rata basis. The new subsidiary willhave separate management and is run independently from theparent company. A spin-off does not result in any fresh cash inflow

Eg: Air India has formed a separate company named Air IndiaEngineering Services Ltd by spinningoff its engineering division

Why Spin-off? To give operational autonomy to a division which requires special

attention


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Air IndiaAssume a capital

base of 100

Air India EngineeringServices Ltd

Assume a capitalbase of 30

The shareholders of Air India will get shares in Air India Engg Ltd in proportionto their holding in Air India. Resultantly the shareholders will have the sharesof both the companies.The spin-off company will have a separate legal entity and a separate BOD


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Split-off

A split-off also creates a separate entity for its subsidiary

through distribution of share held by the parentcompany to its shareholders but in exchange of theshares held by them in the parent company. Hence thecapital base of the parent company is reduced reflecting

the downsizing of the firm. This activity does not result inany fresh cash inflow.

A CoCapital of 100 A Co

80

AB Co20

A Co is split into2 Cos

If the shareholders wishes to obtain the shares in AB Co they will have toSurrender the shares in A Co and in exchange obtain the shares in AB Co


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Split-ups

A single company is divided into two separate entities and theparent entity ceases to exist. A fresh class of shares for the newentities is created and the shareholders can exchange their sharesin any of the split companies. A split-up is also considered as aseries of Spin-offs.

A Co AB Co AC Co

A co ceases to exist. A fresh class of shares are issued to the shareholders ofA co in either AB Co or AC Co in exchange of their share holding in A.


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Equity Carve-out

Equity carve out involves the selling of a portion of thebusiness for cash inflow through fresh issue of shares tothe outsiders. In other words, a parent firm makes asubsidiary public through an initial public offering of

shares, amounting to a partial sell off. A new publiclylisted company is created, but parent keeps a controllingstake in the newly traded susidiary.

A Co B Co

A Co creates B Co through fresh issue of shares to the public which in turnWill determine the BOD. B Co will obtain the cash inflow to sustain its operations and

the parent Co is not responsible for it.


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Equity carve out & spin off

In a spin off, a distribution is made pro rata to theshareholders of the parent firm as dividend aform of non cash payment to the shareholders. Inan equity carve out, the stock of the subsidiary is

sold in public markets for cash which is receivedby the parent.

In spin off, the parent firm no longer has controlover subsidiary assets. In carve out, the parent

generally sells only minority interest in thesubsidiary & maintains control over subsidiarys

assets & operations.


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Divestiture ( sell off )

The sale of a portion of the firm to an outside party is calleddivestiture.

It results in Fresh cash inflow to the business

Is carried out when a division is no more suitable with the mainactivity carried out.

Divestiture of intangible assets like an established brand is alsopossible for fresh cash inflow.

Thus it helps in right sizing of the firm. For the buyer this results inpurchase and expansion of his activity.

A sell off can be opportunistic planned or

forced Eg: Tata Steel Sold its cement division as a part of its turnaround

startegy; as they wanted to focus only on steel. This sell off resultedin fresh cash inflow to the Tata Steel.

B fit f B fit f


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Sell-off

A sell-off is anintercorporate

transaction betweentwo independentcompanies

Benefits forthe buyer

Benefits forthe seller

A better strategic fit Cash flow could

be put to moreprofitable use inother biz.

Increased market

share & marketpower

To mitigate

financial distress

Synergic benefits Elimination ofnegative synergy

Value addition Sharpening ofstrategic focus onthe remaining biz

Tax benefits Release of

managerialresources


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Factors driving a divestiture

Economic

Psychological

Operational

Strategic and

Governmental or legislative


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Economic Low rewards on investment

Whatever the efforts put in the ROI is not up to the desired levels

Continual failure to meet the goals Either continuous down fall in profits, failure to meet the set

milestones

Tax considerations:

The loss making units could be eyed by the heavy tax payers Asthe accumulated losses can be set-off against the profits

Shrinking Margins: Pressure on margins due to heavy competition. Sell-off may lead

to reduction in the number of rival firms and contribute to theimprovement in margin

Profits: Lack of profits is the most noted reason behind sell-offs


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Psychological

To avoid being a loser:

It is depressing to be a loser as it may lead to

moving away of all the stakeholders. It can act asa demotivating factor

Bad apple theory As one rotten apple spoils the entire basket of

apples, the inefficiency in one unit may spill overother units

Hence management always desires to keepperforming units

O


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Operational

Lack of inter company synergy Product lines should assist in synergy benefits. If management is

unable to consolidate the operations to increase profitabilityliquidation or sell-off is an alternative

Labor considerations Such as labor unrest, increasing wage, lack of skilled employees

may force the sell-off of a unit

Competitive reasons When the competition is intense it is better to withdraw before

the drastic affects

Management deficiency Inability of the management to run a business efficiently may

force a sell-off

Eliminating inefficiency Before marginally earning firms turn into sick units a sell-off can

take place


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Strategic Change in corporate goals

The effort to sell-off a loss making unit is often marked by the statementof change in corporate goals

Change in corporate image If there is an attempted shift in the image, it may require divestment of

certain divisions which does not add to the effort of being lean.

Technological reasons Many companies undertake divestment programs to technologically

upgrade operations. Poor business fit

As a result of an attempt to focus only on core competency, the firm mayfind certain divisions unfit. This might result in a sell-off of such unitswhich no longer match with their core business activity

Market saturation It is a situation where a cash cow is turning into a dog and is a perfect

candidate for divestiture

Takeover defense If the unit is considered as a crown jewel (major attraction for the

acquisition of a company) the unit can be divested to make the companyless attractive


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Governmental or legislative

If the merger of firms result in anti-trustproblems, in order to avoid litigation some ofthe firms could be divested under therestrictive trade policies


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Advantages of sell-off

Generation of cash

Strategic business fit

Tax benefits to the buyer

Efficiency gain and refocus

Change in investment strategy positively


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Leveraged Buyout

A leveraged buyout is a takeover of a company, or of a controllinginterest in a company, using borrowed money, usually amounting to

70% or more of the total purchase price (with the remainder being

equity capital).

In this scenario, a company is provided with a combination of equity

and debt capital. The debt capital is used to build the critical mass the company

needs for a successful exit.

This can be achieved through acquisitions, product development,

operational improvements, leverage, etc., all of which serve tocreate economies of scale in terms of overhead, procurement,

distribution, marketing, manufacturing, etc.

The buyer will typically seek a 25% - 35% return on its equity

over a three to five year horizon.


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Leveraged Buyouts (LBO) LBOs are a way to take a public company private, or put a

company in the hands of the current management, MBO.

LBOs are financed with large amounts of borrowing(leverage), hence its name.

LBOs use the assets or cash flows of the company to securedebt financing, bonds or bank loans, to purchase theoutstanding equity of the company.

After the buyout, control of the company is concentrated inthe hands of the LBO firm and management, and there isno public stock outstanding.


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What are the stages of an LBOoperation?

LBO Stages

1st StageResource

mobilisation

2nd StageGoing Private

3rd

StageStrategic &OperationalChanges

4th StageAgain Going

Public


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The first stage :Resource mobilisation

Raising the cash required for Buy out &devising the management incentive system

10% of BO is usually contributed by thefirms top managers and buyout specialists

The incentive for the management is equityparticipation. Hence their contribution will bearound 30%

60 to 70% of the required money is raisedthrough debt using the assets of the firm At this stage they also identify the venture

capital firms, banks, FIs who can finance theBO


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Second Stage: Going Private

This stage is also termed as Structuring LBO It involves making the firm private. It can happen either in the stock purchase format (Cash

flow LBOs) or asset purchase format (Bust up LBOs) In case of asset purchase format the buying group forms

a new privately held corporation. This is seen in Acquisitions of diversified public

companies where the equity markets may not reflect thefull value of the Company

The finances of the Bust-up transaction depend upon

the values of the assets of the various individual unitsthe acquirer can subsequently sell off the units togenerate cash and retire the debt.

These forms of LBO are rare


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Cash flow LBO is most common in management ledtransaction that requires repayment of acquisitionfinancing through operating cash flows.

Equity investors receive returns through thereplacement of debt capital with equity Debt is retired from the operating income of the

company Selective Bust-up/Cash flow LBO deals (Hybrid)

It uses both the techniques Involves the purchase of a fairly diversified company

and the subsequent divestiture of selected units to retirea portion of the acquisition debt. The acquirer gets thecontrol of a smaller group of assets which are best

suited for longer term leverage and have captured apremium on the assets which have been sold. Theremaining assets form the operations of a cash flowleveraged buyout.


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Third stage: Strategic & operational

Changes

The management tries to increase the profitsand cash flows by cutting operating costsand changing marketing strategies. Some of

the suggested changes that can be broughtin are: Strengthening or restructuring production facilities

Change product quality

Change in product mix Customer service

Reconsidering the pricing

Improving inventory management &

Accounts receivable management


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Fourth stage The investor group may again take the

company public if the goals of the LBO areachieved.

This process is called a reverse LBO

This is termed as SIPO ie. Secondary IPO The whole purpose is to provide liquidity to

the existing shareholders.


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Successful LBO Strategies

Finding cheap assets

buying low andselling high (value arbitrage or multipleexpansion)

Unlocking value through restructuring:

Financial restructuring of balance sheet improved combination of debt andequity

Operational restructuring improvingoperations to increase cash flows

L B Ul i


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Leverage Buyout: UltimateGoal Buy low, sell high!

An equity investor expects that the Company willgrow in value.

How does Private Equity Firm create value?

Cost cutting (outsource ) Selecting operating executives and boards of directors

Industry consolidation or acquisition strategies


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Power of Leverage

Why borrow capital (debt) to fund buyout transaction?

Transaction Structure: Cash Purchase LBO

Purchase Price Today: $100 million $100 million

Equity $s Invested: $100 million $30 million (30%)

Selling Price (1 year later):

$125 million $125 million

Profit: $25 million $25 million

Simple Return Calc: $25 (profit) / $100 (investedamount) = 25%

$25 (profit) / $30 (investedamount) = 83%


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Who are LBO Targets

Firms with large cash flows

Firms in less risky industries with stableprofits

Firms with unutilized debt capacity


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Management Buy outs:

A MBO is a special type of LBO where the

management decides that it wants to take itspublicly traded company or a division of thecompany to private.

Since large sums are necessary for such

transactions the management has to usuallyrely on borrowing to accomplish suchobjectives

There should be a premium to be givenabove the MPS to convince the shareholdersto sell their shares


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The pros and cons of MBO The advantages of MBO

1. The risks are high the potential rewards are also high2. MBOs are less risky than starting a new company

altogether

3. The firms bought out operate at a high level ofefficiency as the shareholding employees takes thedecision to benefit both

The disadvantages:

1. The MBOs are risky for the buying management as itmay result in loss of personal wealth as well as

established jobs2. The new problems may arise post MBO. For eg: there

are chances of loosing the customers if they considerthe existing firm to be too risky


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Management Buy-ins

A Management buy-in occurs when a group of

outside managers buys a controlling interest ina business

MBI is effective when the existing managementis weak and need to be replaced with the more

efficient managers. The main disadvantage of an MBI is the

resistance from the existing employees

The new management may focus on the shortterm gains instead of the long term prosperityof the business

G i g i t


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Going private

Going private refers to the transformation of

a public company into a privately heldcompany.

The small group of investors buy the entire

equity which are publicly traded in the market Going private may involve either MBO (

when bought by the incumbentmanagement) or LBO ( when bought by the

third parties) or MBI

M Li i d P hi


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Master Limited Partnerships

MLPs are limited partnerships in which the

units of partnerships are publicly traded

General partner

Ltd partner 1

Ltd partner 2

GP runs the business and bearsUnlimited liability

The Units of partnership that is money contributed by these partners can beDistributed as units which can be actively traded on an exchange


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Features of MLP

Unlimited life

Unlimited liability to general partnersand limited liability to limited partners

and unit holders Centralized management

MLPs do not have separate legal entity

MLPs typically specify the limited liabilityof 100 years


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Types of MLP Roll up MLP:

It is formed by a combination of two or more partnerships into

one publicly traded partnership Liquidation MLP

It is formed by a complete liquidation of a corporation into MLP

Acquisition MLP: It is formed by an offering of MLP interest to the public with the

proceeds used to purchase the interest Roll out MLP:

It is formed by a corporations contribution of operating assets inexchange for general and limited partnership interests in theMLP

Start up MLP: It is an MLP formed by a partnership that is initially privately held

but later offers its interest to the public in order to finance internalgrowth


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Advantages of MLP

Best of Both:

It has the benefits of both a Corporation and apartnership firm

Tax benefits

It is superior to Corporation as income isdistributed as cash distribution to the unit holderson a pro-rata basis and this is taxed at individualtax rates , not at corporate tax rates. Corporate

tax rates are higher than the individual tax rates

Limited liability

The unit holders enjoy limited liability

Di d t


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Disadvantages Non-suitability to all type of business : Master Limited Partnerships are limited by US

Code to only apply to enterprises that engage incertain businesses, mostly pertaining to the useof natural resources, such as petroleum andnatural gas extraction and transportation. Some

real estate enterprises may also qualify as MLPs. Unlimited liability General partner runs the business and his liability

is unlimited

Rigidity of management: General partner cannot be changed even if he is

ineffective. He can only be removed under thecharges of fraud

Employee Stock Ownership


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Employee Stock OwnershipPlans (ESOP)

ESOPs are the right to buy the employersstock at a specified price

It works on a theme of pension plan

In case of restructuring exercise the ESOP isused as a financing vehicle in case on M&Asor LBOs

It can also be used as an anti takeoverdefense

Wh ESOP?


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Why ESOP?

ESOPs are used as a compensation tool

To generate a sense of ownership

Aligning employee goals with theorganisation goals

Encouraging initiatives & entrepreneurialdrives

Improving Corporate performance

To transfer the profits to the employees

Corporate Restructuring 3

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