53 Restructuring

8/4/2019 53 Restructuring

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Corporate restructuring

Mergers & Amalgamations and Take overs

Term debt restructuring

Divestments

Demerger


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Corporate Reorganisations

To create long term holding structures

Cohesiveness in group structure and corporate objectives

Faster growth rate then an organic growth rate

To enter into a new market or grow beyond a saturated market

To capture forward and backward linkages in the value chain

To attain control on a larger fund / manufacturing base / Resources /Intellectual property rights / patents etc.

To attain or better utilise tax covers

To facilitate distribution of assets and family settlements

To exit non-core business Valuation of business


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Forms of Corporate Restructuring

Expansions

-Mergers & Acquisitions

- Tender offers / Take over

- JVs / Asset acquisition

Sell-offs

-Spin offs

- Divestitures / Demergers

Corporate Control

- Share buybacks

- Defence mechanisms

Changes in Ownership structure

- Swaps

-Going private


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Restructuring - key issues

COMMERCIAL

Scales of OperationIdentify markets

Prioritise resources allocated

LEGAL

Tax,RegulatoryDirect / Indirect

Cost of restructuring

FINANCIAL

Exsisting group networth

Promoter funding / resources

Future funding / internal reqt.

Operational

Managerial bandwidth

Stratergic alliances

Exsisting level of expertise


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Dilution Management

Rights Renounciation

Preferential allotment of shares to Promoters

Private placement to Promoter group

Issue of convertibles

Creeping acquisition

Share Buyback

Shares with differential rights

Delisting of shares


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Merger

Defined as the fusion or absorbtion of one Co into another.

It is an arrangement whereby assets of two or more

companies become vested in , or under the control of one

Co. One of the two existing Co merges its identity into another

existing Co or one or more existing Co may form another

Co.

Allotment of shares will be done in accordance with theshare exchange ratio incorporated in the scheme of merger.


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Amalgamation

Amalgamation is the process by which two or more

companies are joined together to form a new identity

It is an arrangement to bring assets of two companies

under the control of one which may or may not be one of

the original companies.

For the purpose s of companies act Mergers &

Amalgamations are synonymous.

The former loses its entity and is dissolved without

winding up.


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Rationale

Low promoter holdings

Market capitalisation lower than book value

Low book values vis-a vis high replacement value

Under performing businesses

Sectoral growth potential

Swift addition of facilities , personnel & processes

Tax efficiency / savings

Diversification

Access to inputs

Defensive considerations


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Operating or Financial Synergy

Greater pricing power

Combination of functional strengths

Higher growth in emerging markets

Debt capacity increase

Tax benefits

Value of control Reduced risk resulting in improvement of credit

rating


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Mergers

Types of merger :

1. Horizontal merger :

Merger of companies in same business segments.

2. Vertical mergers :

Merger of companies which would result in either

backward/forward integration.

3. Conglomerate merger :Unrelated business

4. Concentric merger


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Structuring an M & A transaction

- Evaluate options

- Finalise strategy

- Due diligence

- Valuation / Negotiations

- Preparation of a scheme of merger / Amalgamation

- Board meeting / Application to High court

- Notices and General body meeting

- Approval by court


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Steps in a Valuation

Calculate NOPAT and invested capital Calculate value drivers Develop an integrated historical perspective Analyze financial health

Understand strategic position Develop performance scenarios Forecast individual line items Check overall forecast for reasonableness

Develop target market value weights Estimate cost of non equity financing Estimate cost of equity financing

Select appropriate technique Select forecast horizon Estimate the parameters Discount continuing value to present

Calculate and test results Interpret results within decision context


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Methods of Valuation

Asset Based Market Based Earning based

Realisable

Value

Adjusted NAV

Replacement

cost

Price/Earning

Price /Book

Value

Current market

price

Discounted

Cash Flow

Earnings

capitalisation

Comparablemultiples


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Balance sheet approach

Based on NAV & book value

Establishes minimum / floor price at which seller may like

to sell

Method pertinent when value of intangibles is not

significant & business is recently set up

Takes into account amount historically spent & earned and

does not consider future earnings potential and hence is

seldomly used for a going concern


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Transaction multiples with comparables

Select comparable firms with operational and structural

similarities

Value paid for similar transactions in the industry with

benchmarks

EBITDA capitalised to get appropriate value

Sales / EPS / BV multiples

EV / EBITDA multiple Conversion of Equity to Debt will reduce EV thereby

improving the EV /EBIDTA multiple


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Discounted Free cash flows

Forecast free cash flows for the future

Establish discounting factor

Discount free cash flows

PV of future free cash flows would be the capitalised valueof equity


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Enterprise valuation

Using free cash flow discounting approach determinevalue of equity

Determine value of debt outstanding on date

Enterprise value = Equity valuation + Value of debt

EV / EBITDA Multiple measures the degree of dispersionin an inter firm analysis.( Lower the ratio the better )


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Ideal methodology for

Businesses which are a going concern

Businesses which posses intangibles such as brand ,technology,market leadership,goodwill,marketing &

distribution channels etc.

Substantial undisclosed assets


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It takes into account.

All available free cash flows to stake holders and it takes

into consideration the wacoc and associated risk factors.

Value of core assets gets captured while non-core assets

need to be added separately

Captures incremental capital cost for balancing /

modernisation / expansion with associated benefits.

Intangibles like market share, technological superiority etc

gets factored in while in the other methods of valuation

they are ignored.


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Shortcomings

The estimation of risk adjusted discount rate for base projects are

difficult to estimate.

The cost of equity is a difficult proposition even with the use of CAPMas the Beta used to value is an approximation at best.

The WACC for the company changes with time. Estimation of WACC,

which remains valid in the future, is difficult.

Many projects under taken by the company may have embedded realoptions.

The value of equity arrived at after the DCF process does not take intoconsideration the default option exercisable by the shareholders


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Asset based Valuation

Fair market value

Realiseable value

Adjusted book value

Replacement cost

Depreciated replacement cost (New price-WDV )

Ideal methodology in the event of liquidation / closure


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Impact of key variables on value creation

Example: Acquistion of two Thai telecommunications companies

Worst case Expected Case Best case

Net value to buyer

100

27

-50

Economic outlook GDP grows more slowly GDP grows as expected GDP grows faster than

than expected in the next in the next 5 years(3-4% expected in the next 5

5 years(0-1% in reals terms) in real terms) years (5-7% in real terms.

Demand is at low end of Demand meets base case Demand is at hig end

forecast forecast of forecast

Regulation Operational c onsolidation Operational c onsolidation Operational c onsolidation

prohibited allowed allowed

Many new licences issued New licences limited No new licences issued

Royalties to regulatory Royalties to rgulatory Royalties to regulatory

bodies remain bodies remain bodies diminish

Level of Many new entrants to the Few new entrants to the No new entrants to the

Competion market market market

market shares fall after Market shares rise Market shares rise steadily

2-3 years gradually, then stabilize over the next few years

Revenues per subscriber Revenues per subscriber Revenues per subscriber

fall faster than expected falls slowly fall after 2-3 years


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Exchange Ratios

EPS based

firms could follow different accounting policies

Book value based

historical value of assets may not account for current marketrealizations

NAV based

will have to necessitate revaluation of assets

Market price based

average price over a period of time.only applicable if both the firms are listed

It is based on the discounted value of future earnings incorporatingrisk


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Exchange ratios

Capitalisation rate based

used when firms are not listed or frequently traded

uses EPS as a base with an appropriate PE multiple

has element of judgment attached to it.

Composite based

frequently used methodology

combination of above methods with weights for each

multiple regression model

weights can be highly subjective


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Bid Range

Valuation range

- Return criteria

- Other bidders

- Vision of future value

- Other acquisition opportunities

- Defensive considerations

- Financing constrainst- Buyers long-term objectives

- Dilution


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Transaction structure

Upfront 100% Exit

Phased exit

Continual holding with minority rights

Continual holding with majority rights


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Shareholders agreement

Earn out mechanism for loss of value ROFR with tag / drag along

Asset stripping

White knight structuring of powers / rights / obligations

Board representation Voting arrangements / management control

Estoppel powers

Affirmative rights for specific items

Put / call options between inter-se holders Post closing adjustments

Raising of Capital


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Value drivers

Effects of regulatory framework

Market leadership

Synergies in capacity imbalances

Business fit

Brand acquisition / withdrawal

Backward / forward integration resulting in integration ofoperations

Prevent shake out effect

Barrier to entry

High replacement cost


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Value Discharge

Earn out mechanism

Profit from current year other revenues

Cash

Debt discharge

Liability guarantee take over

Issuance of shares of new company

Asset sale Sale of Brands


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Valuation of intangibles

Brandsincluding brands of goods and corporate names

Publishing rights

Intellectual propertypatents, copyrights, trademarks

Licensesdistribution rights, franchises


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Special valuation situations

Valuation of cyclical firms

Valuation of firms in financial distress

Valuation of thinly traded/illiquid shares


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M&A under Companies act

Provisions contained under sections 390 to 396A contain the following :

1. There should be a scheme of arrangement

2. Holding a meeting of shareholders in terms of

direction of the high court.

3. Scheme to be approved by 75% in value of creditors

and shareholders.

4. Application to Court for scantion of scheme.Courts order

binding on all but appeal able in a superior court.


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Scheme of Amalgamation

1. Effective date.

2. Capital structure of the transferor & transferee co.

3. Share exchange ratio

4. Transfer of undertaking and liabilities and continuance of legalproceedings by the transferee co.

5. Transfer of contracts , services of employees

6. Allotment date of transferee co shares

7. Dissolution of transferor co.

8. Conditions subject to which the scheme is to take effect.


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Statutory Approvals

Approval of board of directors

Approval of shareholders and creditors

Approval of Financial institutions

Approval of Land owners

Approval of the High court

Approval of RBI

Notice to Central Government

SEBI T k d


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SEBI Take over code

Acquirer must disclose to Company / stock exchange upon acquisition of5% of shares.

Public offer mandatory once acquirer acquires more than 15% of thecompanys shares

Public offer at 6 months average or 2 weeks which ever is higher.

Minimum 20% of the voting capital must be acquired from the public

Upward revisions in price /quantity can be made upto 7 days prior to theclosure of the offer.

In a PSU disinvestments a subsequent Put / call option will not trigger a

public offer if it is a part of SHA.


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SEBI Take over code

The date of opening of the offer shall be within 16 days of the public

announcement and shall remain open for a period of 30 days.

In a PSU disinvestments public offer will have to be at the offer price bySP to Govt. or last 6 months weekly average which ever is higher.

Counter offer within 21 days

Persons acting in Concertbroad definition

Maintaining of Escrow cover and security deposits with the Merchantbankers

Creeping acquisition upto 5% per annum will not trigger take over codefrom 15% to 75%.


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Taxation Aspects

Benefit u/s 72 A of carry forward & set off of accumulatedloss and unabsorbed depreciation allowed in the event thetransferee co holds for a minimum period of 5 years 75% ofthe value of the assets and continues the business of the

amalgamated co also for a period of 5 years.

Capital gains tax not applicable since it does not involve sale, relinquishment or exchange.

Amortisation of preliminary expenses allowed

Tax aspects on slump sale


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Asset purchase: Pros

- Enables acquisition of identified assets only

- Enables purchase of depreciable assets at high value, therby

getting future tax shields

- Enables keeping off undesirable liabilities

- Need not absorb all employees

- Less due diligence

- Buyer can create a suitable SPV, does not have to put up with

shareholders of the selling company.


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Asset purchase: cons

- Tax inefficient for the seller

- Capital gainslong term on non depreciable assets, could be

short term on depreciable assets

-Further taxation, when the proceeds are distributed to

shareholders as dividends (10% distribution tax)

- High transaction costs

- Stamp duty (conveyance)

- Sales tax, in certain cases

- Shareholder and lender consent required


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Share purchase: pros

- Immediate acquisition of an operating business

- Tax efficient for the seller (long term capital gains with

indexation)

- Lowest transaction costs (0.5% stamp duty, no sales tax)

- Quickerin terms of third party approvals

- Consideration flows to shareholders directly


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Share Purchase: cons

- Buyer inherits all liabilities (disclosed and contingent)

- Buyer inherits all manpower

- A stricter and detailed due diligence

- In case of purchase of shares in a listed entity, takeover code

will get triggered in case of acquisition.

- Buyer has to put up with other shareholders of the company


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Funding corporate acquisitions

Direct balance sheet financing by acquirer

Thru a SPV with cross holdings

Consortium of firms acting in concert as acquirers

Combination of all cash / all stock / hybrid

Objectives of share holders of acquiring firm differ fromthose of acquired firm


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Funding corporate acquisitions equity

stock financing route Acquirer issues stock of his firm

Cash outflows are prevented

Ideal for companies in the sunrise industry or for firms with highgrowth prospects who have yet to generate cash

Dilution of EPS and shareholding of the existing shareholders will takeplace

As compared to debt tangible, cost being dividend does not increasethe fixed cost

Synergetic benefits must pay for enhanced equity servicing as well as

the PE multiple of the merged entities must not fall which couldsignify value destruction

Risks as well as value from synergies will be shared by the shareholders of both the firms


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Equity stock financing

In the event acquiring firms shares are perceivably under valued then it

may be in efficient to the acquirer firm as its cost of acquisition will

increase

Will have an impact on the market perception of the acquirer firm and

could result in destruction of value as compared to a all cash

transaction

Provisions of NBFC not applicable for SPVs created for acquiring

PSU shares under the Disinvestment policy of GOI.


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Cash financing

Entail heavy out flow of cash upfront ( PSU divestment )

Synergetic benefit must pay for interest cost.

Long term / medium term instruments

Impact of dilution of earnings due to interest burden Impact on credit rating / debt appetite of acquirer

Use of warrants / debentures / convertible bonds

Sale of assets of not related business segment

In event of excessive liquidity short term sources could be deployed

Leveraging group companies through a SPV

May be in efficient to the share holders of the acquired firm due to tax

liabilities


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Transaction Methodology

PHASE 1 PHASE 2 PHASE 3 PHASE 4 PHASE 5

4 weeks 4 weeks 6 weeks 4 weeks 3 weeks

Receipt andevaluation ofbinding bids

Recommendation

Winning bidderselection

Preliminaryinterest bypotential partners

Review list ofpotential partners

Circulate

ConfidentialityUndertaking andInformationMemorandum

Define ObjectivesTransaction

StructuringValuationDocumentationOthersRelease of

Advertisement

Circulate duediligence visitrulesData room andsite visitsCirculate DraftShare

PurchaseAgreementPre-bidconference

AgreementSigning

StatutoryApprovals

Closure


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Transaction MethodologyPhase 1

Definition Valuation Documentation OthersTransactionstructuring

Restructuring, ifrequired

Objectives Maximise

proceedsAttract

funds/technology Mktg./Ops

expertise Transparency Employee Welfare

Size of stake tobe offered

Fundrequirements

Managementcontrol / otherstrategic issues

Employeeissues

Regulatoryissues

Discussions withmanagement andinfo collection

Business

valuation ofcompanies

Sensitivityanalysis fortransactionstructuring

Assess optimalcapital structure

Finalise Investment

Profile Confidentiality

Undertaking Information

Memorandum Draft Share

Purchase Agr.Assist inAgreements Regulatory

Prepare DataRoom

Finalisetechnical and

financial bidevaluationcriteria

Draft rulesfor site visitsand duediligence


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Transaction MethodologyPhase 3 Phase 4 Phase 5

Shortlist, ifrequired

CirculateConfidentialityUndertaking

Circulate IMsand duediligence ruleson receipt ofConfidentialityUndertaking

Co-ordinate duediligence

Manage dataroom, site visits

Circulate draftShare Purchase

Agreement Pre-bid

conference &supply of addl.information

Finalise SharePurchaseAgreement

Co-ordinate andreceive final

bids Evaluate bids Assist in

negotiations Choose the

partner(s)

Complete legalformalities suchas obtainapprovals andsign

Agreements Transfer of

funds Issue and / or

transfer sharesto partner(s)

Marketing Shortlisting Due-diligence Selection Signing

Releaseadvertisement

Follow up with

calls/mailers andone-to-onemeetings

Receivepreliminary bids

P i E i R ti


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Price Earning Ratio

Valuation Comparison with Management control

Sale of Shares Strategic Disinvestment

1991-99 2000 onwards1. IOC = 4.9 1. BALCO = 192. BPCL = 5.7 2. CMC = 12

3. HPCL = 5.9 3. HTL = 374. GAIL = 4.4 4. MFIL = very high *5. VSNL = 6.0 5. LJMC = - do -

(in monopoly days) 6. PPL = - do -7. JESSOP = - do -8. IBP = 639. VSNL = 11 **

10. HZL = 2611. MARUTI = 8912. IPCL = 58

* As earning per share was negative.** inclusive of income from dividend etc. (after the end of monopoly)

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53 Restructuring

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