Corporate Restructuring
Unit: D
Corporate Restructuring
Any change in a company’s operations or change in
the capital structure / ownership of the corporate
body s called corporate restructuring.
Motives of Restructuring
• Operating economies
• Improved management
• Wealth transfers
• Tax reasons
• Leverage gains
• Management’s personal agenda
Categories
A. Operational restructuring
B. Financial (or Debt or Ownership)
restructuring
Operational restructuring
Outright or partial sale of companies or product
lines or to downsize by closing unprofitable or
non-strategic facilities. It is also known as
divestiture. (i.e. The divestment of a portion of
the enterprise or the firm as a whole). It
removes non-core assets so that company
could better focus on core activities.
It may be through the following:
• Liquidation -- The sale of assets of a firm, either
voluntarily or in bankruptcy.
Continued
• Sell-of -- The sale of a division of a company, known
as a partial sell-of, or the company as a whole,
known as a voluntary liquidation.
• Spin-of -- A form of divestiture resulting in a
subsidiary or division becoming an independent
company. Ordinarily, shares in the new company
are distributed to the parent company’s
shareholders on a pro rata basis.
• Equity Carve-out -- The public sale of stock in a
subsidiary in which the parent usually retains
majority control.
Financial (or debt or Ownership)
restructuring
Actions by the firm to change its total debt and
equity structure, i.e., share repurchase, adding
debt or lower overall cost of capital.
It may be through any of the following ways:
1. Going Private
2. Leverage Buyout (LBO)
Ownership Restructuring
Going Private -- Making a public company
private through the repurchase of stock by
current management and/or outside private
investors. The most common transaction is
paying shareholders cash and merging the
company into a group owned by a private
investors.
Ownership Restructuring
Leverage Buyouts:
A primarily debt financed purchase of all the
stock or assets of a company, subsidiary, or
division by an investor group. The debt is
secured by the assets of the enterprise
involved. Thus, this method is generally used
with capital-intensive businesses.
Management buyout Vs.LBO
A management buyout is an LBO in which the pre-
buyout management ends up with a substantial
equity position.
The diference between leveraged buyouts and
ordinary acquisitions:
1. A large fraction of the purchase price is debt
financed.
2. The LBO goes private, and its share is no longer
trade on the open market.
Defensive Tactics
• The company being bid for may use a number of defensive tactics
including:
– (1) persuasion by management that the ofer is not in their
best interests, (2) taking legal actions, (3) increasing the
cash dividend or declaring a stock split to gain shareholder
support, and (4) as a last resort, looking for a “friendly”
company (i.e., white knight) to purchase them.
White Knight -- A friendly acquirer who, at the invitation of a
target company, purchases shares from the hostile bidder(s) or
launches a friendly counter-bid in order to frustrate the initial,
unfriendly bidder(s).
Joining of Companies
When two companies join to form one new firm, it
can be:
Merger:
– The combination of two firms into a new legal
entity
– A new company is created
– Both sets of shareholders have to approve the
transaction.
– Voluntary.
Types of Merger
1. Horizontal
• A merger in which two firms in the same industry combine.
• Often in an attempt to achieve economies of scale and/or
scope.
2. Vertical
• A merger in which one firm acquires a supplier or another
firm that is closer to its existing customers.
• Often in an attempt to control supply or distribution channels.
3. Conglomerate
• A merger in which two firms in unrelated businesses combine.
• Purpose is often to ‘diversify’ the company by combining
uncorrelated assets and income streams
4. Cross-border (International) M&As
• A merger or acquisition involving a Canadian and a foreign
firm a either the acquiring or target company.
Continued
Takeover
– The transfer of control from one ownership
group to another.
– Forced.
Amalgamation
– A genuine merger in which both sets of
shareholders must approve the transaction
– Requires a fairness opinion by an independent
expert on the true value of the firm’s shares
when a public minority exists.
Continued
Acquisition
– The purchase of one firm by another
Strategic alliances:
- An agreement between two or more independent firms
to cooperate in order to achieve some specific commercial
objective. It is usually occur between (1) suppliers and their
customers, (2) competitors in the same business, (3) non-
competitors with complementary strengths.
Joint venture:
- JV is a business jointly owned and controlled by two or
more independent firms. Each venture partner continues to
exist as a separate firm, and the joint venture represents a
new business enterprise.
Motivations for Mergers and Acquisitions
1. Synergy:
The primary motive should be the creation of
synergy. Synergy value is created from
economies of integrating a target and
acquiring a company; the amount by which
the value of the combined firm exceeds the
sum value of the two individual firms.
Creation of Synergy Motive for M&As
Synergy is the additional value created (∆V) :
[ 15-1]
VV
A A
T-(V V
T)
Where:
VT = the pre-merger value of the target firm
VA - T = value of the post merger firm
VA = value of the pre-merger acquiring firm
Continued
Operating Synergies
1. Economies of Scale
• Reducing capacity (consolidation in the number of firms in the industry)
• Spreading fixed costs (increase size of firm so fixed costs per unit are decreased)
• Geographic synergies (consolidation in regional disparate operations to operate on a
national or international basis)
There are several types of economy of scale:
• technical economies, when producing the good by using expensive
machinery intensively
• managerial economies, by employing specialist managers
• financial economies, by borrowing at lower rates of interest
• commercial economies, by buying materials in bulk
• marketing economies, spreading the cost of advertising and promotion
• research and development economies, from developing better
products
Continued
Economies of Scope: Combination of two
activities reduces costs
Complementary Strengths: Combining the
diferent relative strengths of the two firms
creates a firm with both strengths that are
complementary to one another.
Efficiency Increases
– New management team will be more efficient and
add more value than what the target now has.
– The combined firm can make use of unused
production/sales/marketing channel capacity
Continued
Financing Synergy
– Reduced cash flow variability
– Increase in debt capacity
– Reduction in average issuing costs
– Fewer information problems
Strategic Realignments
– Permits new strategies that were not feasible for
prior to the acquisition because of the
acquisition of new management skills,
connections to markets or people, and new
products/services.
Continued
Tax Benefits
– Make better use of tax deductions and
credits
• Use them before they lapse or expire (loss
carry-back, carry-forward provisions)
• Use of deduction in a higher tax bracket to
obtain a large tax shield
• Use of deductions to ofset taxable income
(non-operating capital losses ofsetting taxable
capital gains that the target firm was unable to
use)
• New firm will have operating income to make
full use of available CCA.
Managerial Motivations for M&As
Managers may have their own motivations to pursue
M&As. The two most common, are not necessarily
in the best interest of the firm or shareholders, but
do address common needs of managers
1. Increased firm size
– Managers are often more highly rewarded
financially for building a bigger business
(compensation tied to assets under administration
for example)
– Many associate power and prestige with the size of
the firm.
Continued
2. Reduced firm risk through diversification
• Managers have an undiversified stake in the
business (unlike shareholders who hold a
diversified portfolio of investments and don’t
need the firm to be diversified) and so they tend
to dislike risk (volatility of sales and profits)
• M&As can be used to diversify the company and
reduce volatility (risk) that might concern
managers.
Diseconomies
There are sometimes problems that can afect
integrated firms. These are known as
‘diseconomies of scale’
• firms are too big to operate efectively
• decisions take too long to make
• poor communication occurs
Additional Topics
Friendly Takeover
In friendly takeovers, both parties have the opportunity to structure
the deal to their mutual satisfaction including:
1. Taxation Issues – cash for share purchases trigger capital gains so share
exchanges may be a viable alternative
2. Asset purchases rather share purchases that may:
• Give the target firm cash to retire debt and restructure financing
• Acquiring firm will have a new asset base to maximize CCA deductions
• Permit escape from some contingent liabilities (usually excluding claims
resulting from environmental lawsuits and control orders that cannot
severed from the assets involved)
3. Earn outs where there is an agreement for an initial purchase price with
conditional later payments depending on the performance of the target
after acquisition.
Hostile Takeover
A takeover in which the target has no desire to be acquired and
actively rebufs the acquirer and refuses to provide any
confidential information.
The acquirer usually has already accumulated an interest in the
target (20% of the outstanding shares) and this preemptive
investment indicates the strength of resolve of the acquirer.
The typical hostile takeover process:
1. Slowly acquire a toehold (beach head) by open market purchase
of shares at market prices without attracting attention.
2. File statement with OSC at the 10% early warning stage while
not trying to attract too much attention.
Continued
– Accumulate 20% of the outstanding shares through
open market purchase over a longer period of time
– Make a tender ofer to bring ownership percentage
to the desired level (either the control (50.1%) or
amalgamation level (67%)) - this ofer contains a
provision that it will be made only if a certain
minimum percentage is obtained.
During this process the acquirer will try to monitor
management/board reaction and fight attempts by
them to put into efect shareholder rights plans or to
launch other defensive tactics.
Takeover Defenses
White Knight - Friendly potential acquirer sought by a
target company threatened by an unwelcome suitor. In
this the target seeks out another acquirer considered
friendly to make a counter ofer and thereby rescue the
target from a hostile takeover
Shark Repellent - Amendments to a company charter
made to forestall takeover attempts.
Poison Pill - Measure taken by a target firm to avoid
acquisition; for example, the right for existing
shareholders to buy additional shares at an attractive
price if a bidder acquires a large holding.
Continued
Shareholders Rights Plan
• Known as a poison pill or deal killer
• Can take diferent forms but often
Gives non-acquiring shareholders get the right to buy
50 percent more shares at a discount price in the
event of a takeover.
Selling the Crown Jewels
• The selling of a target company’s key assets that
the acquiring company is most interested in to
make it less attractive for takeover.
• Can involve a large dividend to remove excess
cash from the target’s balance sheet.
