MODULE 3

Corporate restructuring is a process of expanding or contracting business activities either by asset restructuring or ownership restructuring.
On the other hand financial restructuring refers to changing only debt-equity mix of the firm The process of restructuring may involve regrouping companies of the same group or regrouping the various divisions / departments or merging some companies or hiving off some departments/ divisions and building some new ones.

FORMS OF RESTRUCTURING

EXPANSION ORINTED RESTRUCTURING:

These activities result in expansion of size, increase in product portfolio, market reach of the firm

CONTRACTION ORINTED RESTRUCTURING:

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

CORPORATE CONTROL ORINTED RESTRUCTURING:

Restructuring for corporate control refers to a process by which control 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 variables are used to try out new operating strategy, new capital structure, and different cash flow pattern.

What are the FORMS OF RESTRUCTURING ? EXPANSION ORINTED RESTRUCTURING: These activities result in expansion of size, increase in product portfolio, market reach of the firm 1.Mergers -in the form of consolidation -in the form of an acquisition 1.Tender offers 2.Asset Acquisition 3. Joint ventures CONTRACTION ORINTED RESTRUCTURING: Contraction leads reduction in the size of the firm either to have manageable size or core competitiveness. 1.Spin-offs 2.Split-offs 3.Split-ups 4.Divestitures 5.Equity Carve outs CORPORATE CONTROL ORINTED RESTRUCTURING: Restructuring for corporate control refers to a process by which control over management is established. 1.Premium buy backs 2.Stand still agreements 3.Anti takeover amendments 4.Proxy contests CHANGE IN OWNERSHIP STRUCTURE: These activities will result in the changes in the ownership pattern of a company. Rather the regular capital structure other variables are used to try out new operating strategy, new capital structure, and different cash flow pattern. 1.Leveraged Buy Outs 2.Exchange offers 3.Going Private 4.ESOPs and MLPs 5.Share repurchase

Tender Offers

In a tender offer generally an acquirer makes an open offer to the shareholders of the target firm to seek control in the target
Acquirer Tender offer to purchase Shares To the shareholders Of the target Firm

Sell shares in response To the offer

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 the acquirer or target

Affect on Acquirer Co

Affect on Target Co

Joint ventures

A JV is an agreement between two or more companies to provide certain resources (capital, technical know how etc) towards the achievement of common business goal. A JV can be for a limited duration and may have separate legal entity apart from the JV partners. ICICI Bank and Prudential Plc UK set up ICICI Prudential Life 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 be shared for limited duration and does not require complete merger.

Why make a Joint-Venture

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 integration linking the complementary contributions of each partner in a value chain.

What are the respective contributions in the JointVentures

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
The joint-venture enables to share means and competences

Why do Joint Ventures Fail?

Failure Joint-Ventures
Reasons for failures of Joint-Ventures Partners do not manage to get on well with each other,

Partners market are disappearing,

Managers from each partner company do not manage to work with one another in the JointVenture, Managers of the Joint-Venture do not manage to work with those of parent companies.

Other Reasons cited are:

Wrong Strategies
Incompatible Partners Weak Management

Unrealistic or inequitable Deals

Regulatory changes

Divorce??
According to a recent survey, only 44% of CEOs of JVs characterized their venture as very successful* The most common causes of failure cited by CEOs are:

Cultural differences (49%) Poor or unclear leadership (30%) Poor integration process (21%)

CONTRACTION
certain restructuring activities result in reduction in the size of the firm

Spin-off A Spin-off is setting up a subsidiary through distribution of all equity shares held by the parent company to the shareholders of the parent company, on pro-rata basis. The new subsidiary will have separate management and is run independently from the parent company. A spin-off does not result in any fresh cash inflow Eg: Air India has formed a separate company named Air India Engineering Services Ltd by spinning off its engineering division Why Spin-off?
To give operational autonomy to a division which requires special

attention

Air India Assume a capital base of 100

Air India Engineering Services Ltd Assume a capital base of 30

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

Split-off

A split-off also creates a separate entity for its subsidiary through distribution of share held by the parent company to its shareholders but in exchange of the shares held by them in the parent company. Hence the capital base of the parent company is reduced reflecting the downsizing of the firm. This activity does not result in any fresh cash inflow.
A Co is split into 2 Cos A Co 80 AB Co 20

A Co Capital of 100

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

Split-ups

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

A Co

AB Co

AC Co

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

Equity Carve-out
Equity carve out involves the selling of a portion of the business for cash inflow through fresh issue of shares to the outsiders. In other words, a parent firm makes a subsidiary public through an initial public offering of shares, amounting to a partial sell off. A new publicly listed company is created, but parent keeps a controlling stake in the newly traded susidiary.
A Co B Co

A Co creates B Co through fresh issue of shares to the public which in turn Will determine the BOD. B Co will obtain the cash inflow to sustain its operations and the parent Co is not responsible for it.

Equity carve out & spin off

In a spin off, a distribution is made pro rata to the shareholders of the parent firm as dividend a form of non cash payment to the shareholders. In an equity carve out, the stock of the subsidiary is sold in public markets for cash which is received by the parent. In spin off, the parent firm no longer has control over subsidiary assets. In carve out, the parent generally sells only minority interest in the subsidiary & maintains control over subsidiarys assets & operations.

Divestiture ( sell off )

The sale of a portion of the firm to an outside party is called divestiture. It results in Fresh cash inflow to the business Is carried out when a division is no more suitable with the main activity carried out. Divestiture of intangible assets like an established brand is also possible for fresh cash inflow. Thus it helps in right sizing of the firm. For the buyer this results in purchase 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 resulted in fresh cash inflow to the Tata Steel.

Benefits for the buyer

Benefits for the seller

Sell-off

A sell-off is an intercorporate Increased market transaction between share & market power two independent Synergic benefits companies
Value addition Tax benefits

A better strategic fit Cash flow could be put to more profitable use in other biz. To mitigate financial distress Elimination of negative synergy Sharpening of strategic focus on the remaining biz Release of managerial resources

Factors driving a divestiture

Economic Psychological Operational Strategic and Governmental or legislative

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 As

the 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 the improvement in margin

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

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 as a demotivating factor

Bad apple theory

As one rotten apple spoils the entire basket of

apples, the inefficiency in one unit may spill over other units Hence management always desires to keep performing units

Operational

Lack of inter company synergy

Product lines should assist in synergy benefits. If management is

unable to consolidate the operations to increase profitability liquidation 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

Strategic

Change in corporate goals

The effort to sell-off a loss making unit is often marked by the statement

of 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 may

find certain divisions unfit. This might result in a sell-off of such units which 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 company less attractive

Governmental or legislative

If the merger of firms result in anti-trust problems, in order to avoid litigation some of the firms could be divested under the restrictive trade policies

Advantages of sell-off
Generation of cash Strategic business fit Tax benefits to the buyer Efficiency gain and refocus Change in investment strategy positively

Leveraged Buyout
A leveraged buyout is a takeover of a company, or of a controlling interest 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 to create 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.

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 secure debt financing, bonds or bank loans, to purchase the outstanding equity of the company. After the buyout, control of the company is concentrated in the hands of the LBO firm and management, and there is no public stock outstanding.

What are the stages of an LBO operation?

LBO Stages

Stage Resource mobilisation

1st

Stage Going Private

2nd

3rd Stage Strategic & Operational Changes

4th Stage Again Going Public

The first stage :Resource mobilisation

Raising the cash required for Buy out & devising the management incentive system 10% of BO is usually contributed by the firms top managers and buyout specialists The incentive for the management is equity participation. Hence their contribution will be around 30% 60 to 70% of the required money is raised through debt using the assets of the firm At this stage they also identify the venture capital firms, banks, FIs who can finance the BO

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 the full value of the Company The finances of the Bust-up transaction depend upon the values of the assets of the various individual units the acquirer can subsequently sell off the units to generate cash and retire the debt. These forms of LBO are rare

Cash flow LBO is most common in management led transaction that requires repayment of acquisition financing through operating cash flows. Equity investors receive returns through the replacement 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 retire a portion of the acquisition debt. The acquirer gets the control of a smaller group of assets which are best suited for longer term leverage and have captured a premium on the assets which have been sold. The remaining assets form the operations of a cash flow leveraged buyout.

Third stage: Strategic & operational Changes

The management tries to increase the profits and cash flows by cutting operating costs and changing marketing strategies. Some of the suggested changes that can be brought in are:

Strengthening or restructuring production facilities Change product quality Change in product mix Customer service Reconsidering the pricing Improving inventory management & Accounts receivable management

Fourth stage
The investor group may again take the company public if the goals of the LBO are achieved. 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.

Successful LBO Strategies

Finding cheap assets buying low and selling high (value arbitrage or multiple expansion)

Unlocking value through restructuring:

Financial restructuring of balance sheet

improved combination of debt and equity Operational restructuring improving operations to increase cash flows

Leverage Buyout: Ultimate Goal

Buy low, sell high! An equity investor expects that the Company will grow in value. How does Private Equity Firm create value?

Cost cutting (outsource ) Selecting operating executives and boards of directors Industry consolidation or acquisition strategies

Power of Leverage

Why borrow capital (debt) to fund buyout transaction?

Cash Purchase LBO

Transaction Structure: Purchase Price Today: Equity $s Invested:

$100 million $100 million

$100 million $30 million (30%)

Selling Price (1 year later):

$125 million

$125 million

Profit: Simple Return Calc:

$25 million $25 (profit) / $100 (invested amount) = 25%

$25 million $25 (profit) / $30 (invested amount) = 83%

Who are LBO Targets

Firms with large cash flows Firms in less risky industries with stable profits Firms with unutilized debt capacity

Management Buy outs:

A MBO is a special type of LBO where the management decides that it wants to take its publicly traded company or a division of the company to private. Since large sums are necessary for such transactions the management has to usually rely on borrowing to accomplish such objectives There should be a premium to be given above the MPS to convince the shareholders to sell their shares

The pros and cons of MBO

1. 2. 3.

1.

2.

The advantages of MBO The risks are high the potential rewards are also high MBOs are less risky than starting a new company altogether The firms bought out operate at a high level of efficiency as the shareholding employees takes the decision to benefit both The disadvantages: The MBOs are risky for the buying management as it may result in loss of personal wealth as well as established jobs The new problems may arise post MBO. For eg: there are chances of loosing the customers if they consider the existing firm to be too risky

Management Buy-ins
A Management buy-in occurs when a group of outside managers buys a controlling interest in a business MBI is effective when the existing management is 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 short term gains instead of the long term prosperity of the business

Going private
Going private refers to the transformation of a public company into a privately held company. 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 incumbent management) or LBO ( when bought by the third parties) or MBI

Master Limited Partnerships

MLPs are limited partnerships in which the units of partnerships are publicly traded
General partner

GP runs the business and bears Unlimited liability

Ltd partner 1

Ltd partner 2

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

Features of MLP
Unlimited life Unlimited liability to general partners and limited liability to limited partners and unit holders Centralized management MLPs do not have separate legal entity MLPs typically specify the limited liability of 100 years

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 in

exchange for general and limited partnership interests in the MLP

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 internal growth

Advantages of MLP

Best of Both:
It has the benefits of both a Corporation and a

partnership firm

Tax benefits
It is superior to Corporation as income is

distributed as cash distribution to the unit holders on a pro-rata basis and this is taxed at individual tax rates , not at corporate tax rates. Corporate tax rates are higher than the individual tax rates

Limited liability
The unit holders enjoy limited liability

Disadvantages

Non-suitability to all type of business :

Master Limited Partnerships are limited by US

Code to only apply to enterprises that engage in certain businesses, mostly pertaining to the use of natural resources, such as petroleum and natural 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 the charges of fraud

Employee Stock Ownership Plans (ESOP)

ESOPs are the right to buy the employers stock at a specified price It works on a theme of pension plan In case of restructuring exercise the ESOP is used as a financing vehicle in case on M&As or LBOs It can also be used as an anti takeover defense

Why ESOP?
ESOPs are used as a compensation tool To generate a sense of ownership Aligning employee goals with the organisation goals Encouraging initiatives & entrepreneurial drives Improving Corporate performance To transfer the profits to the employees