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INTRODUCTION TO CORPORATE RESTRUCTURINGRESTRUCTURINGOrganic growth: When company increases the turnover of its existing business. This is done by enhanced customer base, higher sales and increased revenues.

Inorganic growth: rate of growth of business by increasing output and business reach by acquiring new business by way of mergers, acquisitions, takeovers and other restructuring strategies.

WHAT IS CORPORATE RESTRUCTURINGChange in the business capacity or portfolio carried out by an inorganic route expansion or contraction

Change in the capital structure of the company not in the ordinary course

Any change in the ownership of a company or control over its management.Restructuring hexagonOperating improvementIncentives management with VBMDivestiture activity, spin offsCurrent Market ValueValue status quoFinancial engineering: leverage, dual class stock, carve outs, tracking stock, employee ownership, debt restructuringValue with internal improvementsValue with improvementsand disposalsValue with financial restructuringOptimized firm valueInformation gapCorporate Restructuring The Conceptual FrameworkRestructuring ModelsSome models looked only at the internal factorsOthers at the external factorsSome combine these perspectivesOthers looked for congruence between various aspects of the organizationNo certainty on the factors that a company needs to study, one that would position the company effectively

Essentials of RestructuringEnsure the company has enough liquidity to operate during implementation of a complete restructuring

Produce accurate working capital forecasts

Provide open and clear lines of communication with creditors who mostly control the company's ability to raise financing

Update detailed business plan and considerations

Reasons for RestructuringChange in fiscal and government policies

Liberalization, Privatization, and Globalization (LPG)

Information Technology Revolution

Concept of Customer Focus

Cost Reduction

Divestment

Improving bottom-line

Core CompetenciesEnhancing shareholder value Incompatible company objectives Transfer of Corporate assetsEvolving appropriate capital structure Consistent growth and profitabilityMeeting investors expectationsResolving conflictBifurcation of businessBarriers to RestructuringInadequate commitment from the Top managementResistance to changePoor communicationAbsence of requisite skillsScepticism Failure to understand the benefits of restructuringAvailability of resourcesOrganizational workloadNon adherence to time scheduleLack of clear and visible leadership

Dimensions of restructurings-1Asset restructuringAcquisitions DivestituresSpin offsCorporate downsizing OutsourcingDimensions of restructuring-IIRestructuring ownership structure, leverage

Exchange offers

Share repurchases

LBOsRestructuring Equity ClaimsInside vs. outside equity ownershipMBOsESOPsIPOBuybackDimensions of restructuring-IIIOwnership vs. controlLimited partnershipsJoint venturesSecuritizationProject finance

Incentive restructuringValue based management programs (EVA, etc.)Dimensions of restructuring- IVCorporate controlTakeoversDual-class recapitalizationsShare repurchaseProxy contests

Distress related restructuringTroubled debt restructuring-CDR/SDRChapter 11 reorganizationsLiquidations15The last three weeks of the course are dedicated to distress related restructurings, which are the restructuring of the ownership and liability structure, and perhaps the asset structure, necessitated by financial distress of the corporation.The different channels of renegotiating terms, cancelling old contracts and writing new ones, are workouts (outside of a bankruptcy court), chapter 11 reorganizations and liquidations (in and outside of bankruptcy court).

Why Engage in Corporate Restructuring?

Sales enhancement and operating economiesImproved managementInformation effectWealth transfersTax reasonsLeverage gainsHubris hypothesisManagements personal agenda

Economies of Scale The benefits of size in which the average unit cost falls as volume increases.Horizontal merger: best chance for economiesVertical merger: may lead to economiesConglomerate merger: few operating economiesDivestiture: reverse synergy may occurFinancial RestructuringInvolves change in the capital structure and capital mix of the company to minimize its cost of capitalAlso involves infusion of financial resources to facilitate mergers, acquisitions, joint venture, strategic alliances, LBOs, and stock buy-backDepends on availability of free cash flows, takeover threats faced by the company and concentration of equity ownership.Changes in authorised and paid-up capitalPreferential allotment to promoters or joint venture partners as per SEBI guidelines.Buyback of sharesIssue of preference and non-voting sharesFIPB/RBI clearances, Companys Act, Income Tax Act

Purpose of Financial RestructuringGenerate cash for exploiting available investment opportunities

Ensure effective use of available financial resources

Change the existing financial structure, in order to reduce the cost of capital

Leveraging the firm

Preventing attempts of hostile takeover.Debt ReductionCompanies which had very high debt-to-equity ratio generally reap the most benefit in terms of higher ROCE and EVA Debt reduction below a certain level is not beneficial to the shareholders & to the company because of operational inefficiencies of the company, causing its EVA to also gradually decrease. Debt has one intrinsic benefit for corporates: by reducing the tax burden, it increases net profit for the company, thereby creating more value for shareholders.

Portfolio and Asset RestructuringInvolves divesting or acquiring a line of business perceived peripheral to the long term business strategy of the company.Represents the companys attempt to respond to the marketing needs without losing sight of its core competencies. Purpose-Restructuring as a result of some strategic alliance Responding to shareholders desire to downsize and refocus the companys operations Responding to outside boards suggestion to restructure

Portfolio and Asset RestructuringOrganic and inorganic growthMergers and Acquisitions: enhance market power, streamline core capabilities, pool resourcesDivestitures: hive off non-core areas, provide focus to individual businesses, simplify ownership structureInternal streamlining of operations.

Organizational RestructuringIs a response change in the business and related environments.Takes the form of divestiture and acquisitions.Restructuring strategy designed to increase the efficiency and effectiveness of personnel, through significant changes in the organizational structure.Internal streamlining: downsizing the numbers, closure of uneconomic units, Business Process Re-engineering-VRS schemes by banks, disposal of idle assets.

Restructuring options

Forms of Corporate Restructuring ExpansionMergers and AcquisitionsTender OffersAsset AcquisitionJoint Ventures

ContractionSpin offsSplit offsDivestituresEquity carve-outsAssets saleSplit-up

Corporate ControlTakeover defensesShare repurchasesExchange offersProxy contestsChanges in Ownership StructuresLeveraged buyoutGoing PrivateESOPs and MLPs

EXPANSIONMerger Combination of two or more companies into a single company by way of Amalgamation or Absorption.Amalgamation is the merger of one or more companies with another or the merger of two or more companies to form a new company, in such a way that all assets and liabilities of the amalgamating companies become assets and liabilities of the amalgamated company and shareholders not less than nine-tenths in value of the shares in the amalgamating company or companies become shareholders of the amalgamated company.Merger of Hindustan Computers Ltd, Hindustan Instruments Ltd, Indian Software Company Ltd and Indian Reprographics Ltd into an entirely new company called HCL Ltd

2. Tender Offer involves making a public offer for acquiring the shares of target company to acquire the management control in that company.3. Asset Acquisition involves buying tangible or intangibles assets like brands of a particular company. 4. Joint Ventures two companies entering into agreement to provide certain resources towards achievement of particular common business goal.

Mergers and AcquisitionsMERGERA + B = A, where company B is merged into company A (Absorption) Examples-Banks ( Bank Of America and Merrill lynch)A + B = C, where C is an entirely new company (Amalgamation or Consolidation)-Sandoz and Ciba Geigy formed Novartis, Arcelor-MittalACQUISITIONIt could be acquisition of control, leading to takeover of a company. A takeover, is the buying of one company (the target) by another. An acquisition can be friendly or hostile takeover. In a friendly takeover, the companies proceed through negotiations. In a hostile takeover, the takeover target is unwilling to be bought, or the targets board has no prior knowledge of the offerIt could be acquisition of tangible assets, intangible assets, rights and other kinds of obligations. Attempt by one firm to gain a majority interest in another firm.

Mergers Merger is defined as a combination of two or more companies into a single companyAmalgamation is the type of merger that involves fusion of two or more companies. After the amalgamation, the two companies loose their individual identity and a new company comes into existence. This form is generally applied to combinations of firms of equal size.

ABABBrooke Bond India LtdLipton India LtdBrooke Bond Lipton India LtdAcquisitionA corporate action where an acquiring company makes a bid for an acquiree. If the target company is publicly traded, the acquiring company will make an offer for the outstanding sharesAcquisition is an attempt by which a company or an individual or group of individuals acquires control over another company.Right to control is the right to control its management and policy decisions.In acquisitions the target companys identity remains intact. Purchasing a substantial percentage of the voting capitalAcquiring voting rights through proxy voting or power of attorneyAcquiring control over an investment or holding companyAcquiring management control over the target company by formal/informal means.

Acquisitions may lead toA subsequent mergerEstablishment of the Parent-subsidiary relationshipA strategy of breaking up the target firm and disposing off part or all of its assetsConversion of the target firm into a private firm.Types of acquisitions could be asset purchases and stock purchasesStrategic Acquisitions Involving Common StockStrategic Acquisition occurs when one company acquires another as part of its overall business strategy.When the acquisition is done for common stock, a ratio of exchange, which denotes the relative weighting of the two companies with regard to certain key variables, results.A financial acquisition occurs when a buyout firm is motivated to purchase the company (usually to sell assets, cut costs, and manage the remainder more efficiently), but keeps it as a stand-alone entity.Expansion is a form of restructuring, which results in an increase in the size of the firm. It can take place in the form of a merger, acquisition, tender offer, asset acquisition or a joint venture.

Factors driving Indian Companies to go in for M&A7. Changing scenario of restructuring capital structure from pure vanilla instruments to variants8. Enhancement of foreign equity in Indian companies9. Emergence of venture capitalists and PE firms10. Use of GDR, SPVs

Joint VentureAlternative to a merger or acquisition

A joint venture 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.

May allow the bidder to accomplish the goals it has in mind without incurring the costs of a complete acquisition of the target

These goals may be:

Enter a new marketLock up a source of supplyDevelop a new productPreempt competitors from achieving a certain goal

Strategic Alliance

Strategic Alliance An agreement between two or more independent firms to cooperate in order to achieve some specific commercial objective.Strategic alliances usually occur between (1) suppliers and their customers, (2) competitors in the same business, (3) non-competitors with complementary strengths.Why companies enter into Strategic Alliances?Internal reasons:

To spread costs and risksTo safeguard resources which cannot be obtained through the marketTo improve access to financial resourcesTo derive benefits of economies of scaleTo gain access to new technologies, customers and innovative managerial practices

Competitive Goals

To pre-empt competitors To create stronger competitive unitsTo influence structural evolution of the industryTo respond defensively to blurring industry boundaries and globalization To pre-empt competitors To create stronger competitive unitsTo influence structural evolution of the industryTo respond defensively to blurring industry boundaries and globalization

Types of Strategic AlliancesComplementary AlliancePartners combine their technologies to diversify their existing products/market portfolios

Market AllianceAims at combining the market knowledge of one partner with the production or product know-how of the other

Sales allianceProducer and a local partner cooperate in an arrangement that is a mixture of independent representation and own branch.

Concentration Alliance Competing partners cooperate to form larger and more economical units.

Research and Development alliance:Partners aim to create synergy by making joint use of research facilities, exploiting opportunities to specialize and standardize combining know-how and sharing risks.

Supply Alliance Competitors using similar inputs cooperate to safeguard supplies, reduce procurement costs, or to prevent the entry of new competitors.

Advantages and DisadvantagesAdvantages: May be more flexible than Joint VenturesThey come in wide varietiesMay enable companies to pursue goals without a large financial commitmentDisadvantages:Greater opportunities for opportunistic behavior by merger partnersCould lose valued know-how

Tender OfferA type of takeover bid. A public, open offer or invitation (usually announced in a newspaper advertisement) by a prospective acquirer to all stockholders of a publicly traded corporation (the target corporation) to tender their stock for sale at a specified price during a specified time, subject to the tendering of a minimum and To induce the shareholders of the target company to sell.The acquirer's offer price usually includes a premium over the current market price of the target company's shares maximum number of shares.

TENDER OFFERSTender Offer An offer to buy current shareholders stock at a specified price, often with the objective of gaining control of the company. The offer is often made by another company and usually for more than the present market price.Allows the acquiring company to bypass the management of the company it wishes to acquire.Two tier tender offerTwo-tier Tender Offer Occurs when the bidder offers a superior first-tier price (e.g., higher amount or all cash) for a specified maximum number (or percent) of shares and simultaneously offers to acquire the remaining shares at a second-tier price.Increases the likelihood of success in gaining control of the target firm.Benefits those who tender early.Asset AcquisitionA buyout strategy in which key assets of the target company are purchased, rather than its shares. These assets may be tangible assets like a manufacturing unit or intangible assets like brands. This is particularly popular in the case of bankrupt companies, who might otherwise have valuable assets which could be of use to other companies, but whose financing situation makes the company un-attractive for buyers.

Examples ---- Asset AcquistionThe acquisition of the cement division of Tata Steel by Laffarge of France. Laffarge acquired only the 1.7 million tonne cement plant and its related assets from Tata Steel.

The asset being purchased may also be intangible in nature. For example, Coca-Cola paid Rs.170 crore to Parle to acquire its soft drinks brands like Thums Up, Limca, Gold Spot etc.

Google acquired Motorola for its new open source operating system Android for the need of Motorolas 17000 patents out of which Google needs around 6000 patents.

M3M India acquired DLF 28- Acre Plot in Gurgaon as non core assets for Rs 440 Cr.

REASONS FOR DIVESTMENTSHive-off non profitable units/ divisionsManage internal operations more efficientlyAchieve focusAssets sale lead to improved realignment of resourcesReverse synergyRelease financial and managerial resources locked in non remunerative businessesImprove managerial efficiencyRespond to changing economic environmentTax considerationFacilitate valuation by stock marketSPIN OFFA corporate spin-off can be defined as the distribution of all, or substantially all, of the ownership interest of one firm (the parent) in another firm (the subsidiary) to the parents shareholders, so that following the spin-off, there are two separate publicly held companiesExample :Pepsi Spinoff of Pizza Hut and KFC, spin-off of EDS from GM. Lehman was an outcome of spin-off of American Express, L&T spun off its Cement division into a company Ultra tech, which was later acquired by Grasim. The stock distributed to the shareholders of the Parent is like a stock dividend, no cash is generated. The firm no longer has any control over the assets and operations of the subsidiary.Subsidiary becomes a separate legal entity with a distinct management and board. Decision to spin-off vs shut down

Spin-offA Company distributes all the shares it owns in a subsidiary to its own shareholders implying creation of two separate public companies with same proportional equity ownership. Sometimes, a division is set up as a separate company. Hence, the stockholders proportional ownership of shares is the same in the new legal subsidiary as well as the parent firm. The new entity has its own management and is run independently from the parent company. A spin-off does not result in an infusion of cash to parent company.Shareholders of Company AABSubsidiary Company of ABShareholders of Company A also has shares of Company BABSPLIT-UPIn a split-up, the existing corporation transfers all its assets to two or more new controlled subsidiaries, in exchange for subsidiary stockThe parent distributes all stock of each subsidiary to existing shareholders in exchange for all outstanding parent stock, and liquidates. In other words, a single company splits into two or more separately run companiesExample : Split Up of AT&T into four separate unitsAT&T Wireless, AT&T Broadband, AT&T Consumer and AT&T Business-US Telecom business, break-up of ITT Group, Reliance Group, Birla Group

Split-UPIn a split-up the entire firm is broken up in series of spin-offs, so that the parent company no longer exists and only the new off springs survive. A split-up involves the creation of a new class of stock for each of the parents operating subsidiaries, paying current shareholders a dividend of each new class of stock, and then dissolving the parent company.Shareholders of Company AABCDESubsidiary Companies of AAShareholders of Company A will get shares of EDCBSPLIT-OFFA split-off is a type of corporate reorganization whereby the stock of a subsidiary is exchanged for shares in the parent companyEx: Viacom announced a split-off of its interest in Blockbuster in 2004Split-offs are basically of two types. In the first type, a corporation transfers part of its assets to a new corporation in exchange for stock of the new corporationThe original corporation then distributes the same stock to its shareholders, who, in turn, surrender part of their stock in the original corporationIn the second type, a parent company transfers stock of a controlled corporation to its stockholders in redemption of a similar portion of their stockExample- Krafts Food split-off its Post cereal business

Split- offIn a split off, a new company is created to takeover the operations of an existing division or unit. A portion of existing shareholders receives stock in a subsidiary (new company) in exchange for parent company stock Hence the shareholding of the new entity does not reflect the shareholding of the parent firm. A split-off does not result in any cash inflow to the parent companyShareholders of Company AAOperations of Company AFEDCDShareholders of Company AShareholders of Company BShareholders of Company AAFECBDNew CompanyEquity Carve Out

Equity carve-outs (also known as partial public offering) are transactions in which a firm sells its minority interest in the common stock of a previously wholly-owned subsidiaryUsually this option is exercised by a parent when one of its subsidiaries is growing faster with valuations higher.Example: DuPonts IPO of Conoco in October 1998In a carve-out, the parent generally sells only minority interest in the subsidiary and maintains control over subsidiarys assets and operations. Its an IPO of a subsidiary which generates cash for the subsidiary

Equity Carve OutA parent has substantial holding in a subsidiary. It sells part of that holding to the public. "Public" does not necessarily mean a shareholder of the parent company. Thus the asset item "Subsidiary Investment" in the balance-sheet of the parent company is replaced with cash. Parent company keeps control of the subsidiary but gets cash.Issues IPO of B 20% Shares of BCCashA Investors20% Shares of Company BABSubsidiary Company of ATracking stocks, also known as letter or targeted stocks, are a class of parent company stock that track the earnings of a division or subsidiary. These are typically distributed as dividend to shareholders of the parent company. Unlike spin-off and carve-outs, control remains with the management of the parent company. Additionally, assets are also separated between the two entities. They dont have to report their earnings separately, no separate balance sheets. Tracking stocks are class B stocks, with no voting rights.Asset sell-off involves the sale of tangible or intangible assets of a company to generate cash. Normally, selloffs are done because the subsidiary does not fit into the parent companys core strategy

Divestiture

Divestiture The divestment of a portion of the enterprise or the firm as a whole.Liquidation The sale of assets of a firm, either voluntarily or in bankruptcy.Sell-off The sale of a division of a company, known as a partial sell-off, or the company as a whole, known as a voluntary liquidation.DivestituresA divestiture is a sale of a portion of the firm to an outside party, generally resulting in an infusion of cash to the parent. A firm may choose to sell an undervalued operation that it determines to be non-strategic or unrelated to the core business and to use the proceeds of the sale to fund investments in potentially higher return opportunities.Operations ASome Operations of ACash BOperations of AREASONS FOR DIVESTITUREUnprofitable divisionA Bad fitReverse SynergyFailure to generate hurdle rate of returnCapital market factorsIncreased cash flowsAbandoning core businessDivestiture and Spin off processDivestiture or Spinoff DecisionFormulation of a Restructuring PlanSelling the BusinessApproval of the Plan by ShareholdersRegistration of SharesCompletion of the DealFinancial Evaluation of Divestitures 1. Estimation of After-tax Cash Flows2. Determination of the Divisions Relevant Risk-Adjusted Discount Rates3. Present Value Calculations4. Deduction of the Market Value of the Divisions Liabilities5. Deduction of the Divestiture ProceedsIf DP> NOLV: sell divisionDP=NOLV: other factors will control decisionDP< NOLV: Keep divisionWhere DP is divestiture proceeds and NOLV is net off liability value

De MergersThe demerged company transfers one or more of its undertakings to the resulting company for an agreed consideration. The resulting company issues its shares at the agreed exchange ratio to the shareholders of the agreed merged company.Eg: Demerger of RelianceEg: Demerger of cement division at L&T.SLUMP SALEThe company sells or disposes off the whole or substantially the whole of its undertaking for a pre determined lump sum consideration. The acquiring company may not be interested in buying the whole company, but only one of its divisions or a running undertaking which maybe on a going concern basis. The sale is made for a lump sum price, without values being assigned to the assets and liabilities transferred. The business to be hived off is transferred from the transferor company to an existing or new company. Demerger and Slump Sale1.In a slump sale no value is assigned to the individual assets and liabilities, and the sale is for a lump sum consideration. In demergers, valuations of assets and liabilities are mandatory.2. In demergers, shareholders of demerged companies are issued shares of resulting company, while in case of slump sale, issue of shares does not take place.3. Demergers results in reorganization of capital while slump sales do not.4. In case of demerger, the resulting company has to continue the business of transferred undertaking while in slump sale it is not so.5.De merger is more tax efficient than slump sale.Corporate ControlShare BuybackDemergers: A demerger is a sensible option if negative synergies or diseconomies of scale exist, which can be eliminated by separating the firm.Debt Restructuring: Debt restructuring is a process that allows company facing cash flow problems and financial distress, to reduce and renegotiate its delinquent debts in order to improve or restore liquidity and rehabilitate so that it can continue its operations. Tracking Stock: A tracking stock is a special type of stock issued by a publicly held company to track the value of one segment of that company. The stock allows the different segments of the company to be valued differently by investors. Let's say a slow-growth company trading at a low price-earnings ratio (P/E ratio) happens to have a fast growing business unit. The company might issue a tracking stock so the market can value the new business separately from the old one and at a significantly higher P/E rating. Eg-General Motors tracking stock for its EDS divisionCORPORATE CONTROLTAKEOVER DEFENSES intends to change the corporate control position of the promoter. This includes pre-bid & post-bid defenses.SHARE REPURCHASES leads to reduction in the equity capital of the company thereby increasing the promoters stake.EXCHANGE OFFERS involves exchanging common stock for debt or vice versa for changing the capital structure &keeping the investment policy unchanged. PROXY CONTESTS is an attempt by a single shareholder or a group of dissident shareholder to take control or seek membership of the Board , to influence the management decision-making process of the firm. Even if the dissident group obtains a minority position on the Board, it can have positive impact on the share prices by virtue of pressures they can exert on various corporate and functional policies.TENDER OFFER involves making a public offer for acquiring the shares of target company to acquire the management control in that company.6. DUAL CLASS STOCK RECAPITALISATION: Those with non-voting rights/ limited voting rights but preferential claim on the companys cash flows, and those with voting rights ( Ford Company). Usually common in closely-held companies.

CHANGES IN OWNERSHIP STRUCTURELEVERAGE BUYOUTS is a financing technique where debt is used to acquire a company.GOING PRIVATE converting public corporation into privately held firm by purchasing entire equity interest by a small group of investors.ESOP is a mechanism whereby a corporation can make tax deductible contributions of cash or stock into a trust. The assets are allocated to the employees and are not taxed until withdrawn by them.MLPs Master Limited Partnership is a type of limited partnership whose shares are publicly traded. Reduction of capital for Extinguishing or reducing liability in respect of share capital not paid-upWriting-off capital that is lostPaying off or returning excess capital that is not required by the companyMOTIVATIONS FOR GOING PRIVATEElimination of costs associated with being a publicly held firm (e.g., registration, servicing of shareholders, and legal and administrative costs related to SEC regulations and reports).Reduces the focus of management on short-term numbers to long-term wealth building.Allows the realignment and improvement of management incentives to enhance wealth building by directly linking compensation to performance without having to answer to the public.ESOPsA trust fund that invests in the securities of the firm sponsoring the plan.ESOPs are tax deductibleESOPs are used to restructure firmsESOPs may be used by employees in LBOs and MBOsThey are an effective antitakeover defenseTYPES OF MERGERSHorizontal mergers- Mergers between two firms operating & competing in the same kind of business activity;- Main purpose is economies of scale by elimination of duplication of facilities and operations broadening the product line reduction in investment in working capital elimination of competition in a product reduction in advertising costs increase in market share etc.;- Decrease in no. of firms in an industry;- Potential to create monopoly.- Timing is the keyExxon-Mobil,

Vertical mergers- Involves merger between firms that are in different stages of production or value chain;- Combination of companies that usually have buyer seller relationships;- Backward & Forward integration;Motive is to reduce inventories of raw materials and finished goods-better competitive power through controlling input prices implements its production plans as per the schedules better working capital management elimination of transaction costs etc.Eg-RIL-RPL MERGER, Acquisition by Pepsico acquisition of bottlers of Pizzahut and KFC AOLs purchase of media and content provider Time WarnerMerck and Medco containment Services (forward) Ford buying Hertz (forward)Auto Car Rental Acquisitions: Chrysler, GM, Ford Sales to car rental companies add to market share but not profitability

3. Conglomerate mergers- Merger between the firms engaged in unrelated types of business activity; example- GE- Motive is to utilize financial resources, enhance the stability of acquirer company by creating balance in the companys total portfolio of diverse products production processes. Philip Morris, a tobacco company, acquired General Foods in 1985 for $5.6 billionTypes of Conglomerate mergers:- Product extension mergers or Concentric mergers- Geographic market extension merger- Pure conglomerate merger- Financial conglomerate-TDPL merged with Sun Pharma for funds- Managerial conglomerate

TYPES OF MERGERSCOGENERIC MERGERS Type of merger when two merging firms are in the same industry but have no mutual buyer-customer or supplier relationship, such as a bank and a leasing company. For Example-Prudentials acquisition of Bache and Company.Example: American Express acquisition of Shearson HamilREVERSE MERGERIn a reverse merger, a private company may go public by merging with an already existing public company that is often inactive. The publicly traded company is often known as a shell corporation. Which is almost in bankruptcy and the private company acquires such a company because it has viable business.In India, companies go for reverse mergers to take advantage of the tax savings. Example-Kirloskar Pneumatics merged with Kirloskar Tractors, a sick unit.Reverse merger may also arise on account of regulatory requirements. For example- reverse merger of ICIC in to ICICI Bank. ICICI could become a universal bank only through a reverse merger with its banking subsidiary.Reverse mergers-a healthy unit is merged with a sick company as a result of which the former loses its identity. However, following a lapse of sometime, the name of the sick unit is usually changed to that of the healthy unit . As a result of this, under Section 72 A of the Indian Income Tax Act, the healthy company can take advantage of sick companys carry forward losses. Example-Ahmedabad Laxmi Mills and Arvind Mills.Holding Company: An acquiring company becomes a holding company when it chooses to purchase only a portion of the targets stock. The holding company that holds sufficient stock has a controlling interest in the target. The advantages areLower costNo control premiumControl with fractional ownership

Accretive mergers: The acquiring companys EPS increase or a company with a high P/E acquires a company with a low P/E.Dilutive mergers: A company with a low P/E acquires a company with a high P/E.: Daimler merger of equals with Chrysler (1998)Merger of Equals two companies of equal sizeUsually one company ends up being the dominant oneExample Daimler merger of equals with Chrysler (1998) Statutory merger Specifically means that it is a merger pursuant to state laws in which the acquirer is incorporated. The acquiring company assumes the assets and liabilities of the target in accordance with the statutes of the state where combined companies will be incorporated Subsidiary merger a merger of two companies in which the target becomes a subsidiary. The target may be operated under its brand name but it will be owned and controlled by the acquirer.Example: GM acquired EDS and made it a subsidiary and issued Class E shares

Earn-outsEarn-outs is an arrangement whereby a part of the purchase price is calculated by reference to the future performance of the target company. The deal describes a payment to shareholders selling their shares in the target company and the payment made by the acquirer is based on the companys profits in a specified period, usually after the closing of the sale. The acquirer typically pays 60-80%of the purchase price up front and the remaining 20-40% structured as an earn-out and paid over time as the acquired company achieves certain levels of sales or profitability.The Acquisition ProcessPre-Purchase Decision Activities

Post-Purchase Decision ActivitiesPhase 1: Business PlanPhase 2: Acquisition PlanPhase 3: SearchPhase 4: ScreenPhase 5: First ContactPhase 6: NegotiationPhase 7: Integration PlanPhase 8: ClosingPhase 9: IntegrationPhase 10: EvaluationMotivations for M&AStrategic realignmentTechnological changeDeregulationSynergyEconomies of scale/scopeCross-sellingDiversification (Related/Unrelated)Financial considerationsAcquirer believes target is undervaluedBooming stock marketFalling interest ratesMarket powerEgo/HubrisTax considerations

Primary Reasons Some M&As Fail to Meet ExpectationsOverpayment due to over-estimating synergySlow pace of integrationPoor strategy

Merger Waves (Boom Periods)Horizontal Consolidation (1897-1904)Efficiency, enforcement of Sherman Anti-trust ActMetals, transportation, mining. JP Morgan created US SteelIncreasing Concentration (1916-1929)Industry concentrationThe Conglomerate Era (1965-1969)Rising stock marketHigh P/E ratiosIncreasing leverageHigh prices paid for targets

The Retrenchment Era (1981-1989)Rise of corporate raidersProliferation of LBOs and hostile takeoversDivestment of unrelated acquisitions by conglomeratesEra concluded with junk bonds, LBO bankruptciesAge of Strategic Megamerger (1992-2000)M&As declined during 1990sIT revolutionDeregulationReduction in trade barriersTrends towards privatisationAge of Cross Border and Horizontal Megamergers (2003-2007)Syndicated debtPrivate Equity InvestmentsCDOsMajor Components of Deal Structuring ProcessAcquisition vehiclePost-closing organizationForm of paymentForm of acquisitionLegal form of selling entityAccounting ConsiderationsTax considerationsWhen the acquisition is done for common stock, a ratio of exchange, which denotes the relative weighting of the two companies with regard to certain key variables, results.A financial acquisition occurs when a buyout firm is motivated to purchase the company (usually to sell assets, cut costs, and manage the remainder more efficiently), but keeps it as a stand-alone entity.Strategic Acquisition Occurs when one company acquires another as part of its overall business strategy.Strategic Acquisitions Involving Common StockExample Company A will acquire Company B with shares of common stock.Present earnings$20,000,000$5,000,000Shares outstanding 5,000,000 2,000,000Earnings per share$4.00 $2.50Price per share $64.00 $30.00Price / earnings ratio 16 12Company A Company BStrategic Acquisitions Involving Common StockExample Company B has agreed on an offer of $35 in common stock of Company A.Total earnings$25,000,000Shares outstanding* 6,093,750Earnings per share$4.10Surviving Company AExchange ratio = $35 / $64 = 0.546875* New shares from exchange = 0.546875 x 2,000,000 = 1,093,750Strategic Acquisitions Involving Common StockThe shareholders of Company A will experience an increase in earnings per share because of the acquisition [$4.10 post-merger EPS versus $4.00 pre-merger EPS].The shareholders of Company B will experience a decrease in earnings per share because of the acquisition [.546875 x $4.10 = $2.24 post-merger EPS versus $2.50 pre-merger EPS].Strategic Acquisitions Involving Common StockSurviving firm EPS will increase any time the P/E ratio paid for a firm is less than the pre-merger P/E ratio of the firm doing the acquiring. [Note: P/E ratio paid for Company B is $35/$2.50 = 14 versus pre-merger P/E ratio of 16 for Company A.]Strategic Acquisitions Involving Common StockExample Company B has agreed on an offer of $45 in common stock of Company A.Total earnings$25,000,000Shares outstanding* 6,406,250Earnings per share$3.90Surviving Company AExchange ratio = $45 / $64 = 0.703125* New shares from exchange = 0.703125 x 2,000,000 = 1,406,250 Strategic Acquisitions Involving Common StockThe shareholders of Company A will experience a decrease in earnings per share because of the acquisition [$3.90 post-merger EPS versus $4.00 pre-merger EPS].The shareholders of Company B will experience an increase in earnings per share because of the acquisition [0.703125 x $4.10 = $2.88 post-merger EPS versus $2.50 pre-merger EPS].Strategic Acquisitions Involving Common StockSurviving firm EPS will decrease any time the P/E ratio paid for a firm is greater than the pre-merger P/E ratio of the firm doing the acquiring. [Note: P/E ratio paid for Company B is $45/$2.50 = 18 versus pre-merger P/E ratio of 16 for Company A.]Strategic Acquisitions Involving Common StockMerger decisions should not be made without considering the long-term consequences.The possibility of future earnings growth may outweigh the immediate dilution of earnings.With themergerWithout themergerTime in the Future (years)Expected EPS ($)Initially, EPS is less with the merger.Eventually, EPS is greater with the merger.EqualWhat About Earnings Per Share (EPS)?The above formula is the ratio of exchange of market price.If the ratio is less than or nearly equal to 1, the shareholders of the acquired firm are not likely to have a monetary incentive to accept the merger offer from the acquiring firm.Market price per shareof the acquiring companyNumber of shares offered bythe acquiring company for eachshare of the acquired companyMarket price per share of the acquired companyXMarket Value ImpactExample Acquiring Company offers to acquire Bought Company with shares of common stock at an exchange price of $40.Present earnings$20,000,000$6,000,000Shares outstanding 6,000,000 2,000,000Earnings per share$3.33 $3.00Price per share $60.00 $30.00Price / earnings ratio 18 10Acquiring BoughtCompany Company Market Value ImpactExchange ratio = $40 / $60 = .667Market price exchange ratio = $60 x .667 / $30 = 1.33Total earnings$26,000,000Shares outstanding* 7,333,333Earnings per share$3.55Price / earnings ratio 18Market price per share $63.90Surviving Company* New shares from exchange = 0.666667 x 2,000,000 = 1,333,333 Market Value ImpactNotice that both earnings per share and market price per share have risen because of the acquisition. This is known as bootstrapping.The market price per share = (P/E) x (Earnings).Therefore, the increase in the market price per share is a function of an expected increase in earnings per share and the P/E ratio NOT declining.The apparent increase in the market price is driven by the assumption that the P/E ratio will not change and that each dollar of earnings from the acquired firm will be priced the same as the acquiring firm before the acquisition (a P/E ratio of 18).Market Value ImpactTarget firms in a takeover receive an average premium of 30%.Evidence on buying firms is mixed. It is not clear that acquiring firm shareholders gain. Some mergers do have synergistic benefits.BuyingcompaniesSellingcompaniesTIME AROUND ANNOUNCEMENT(days)Announcement date0+CUMULATIVE AVERAGEABNORMAL RETURN (%)Empirical Evidence on MergersIdea is to rapidly build a larger and more valuable firm with the acquisition of small- and medium-sized firms (economies of scale).Provide sellers cash, stock, or cash and stock.Owners of small firms likely stay on as managers.If privately owned, a way to more rapidly grow towards going through an initial public offering (see Slide 24).Roll-Up Transactions The combining of multiple small companies in the same industry to create one larger company.Developments in Mergers and AcquisitionsIPO funds are used to finance the acquisitions.IPO Roll-Up An IPO of independent companies in the same industry that merge into a single company concurrent with the stock offering.An Initial Public Offering (IPO) is a companys first offering of common stock to the general public.Developments in Mergers and AcquisitionsTarget is evaluated by the acquirerTerms are agreed uponRatified by the respective boardsApproved by a majority (usually two-thirds) of shareholders from both firmsAppropriate filing of paperworkPossible consideration by The Antitrust Division of the Department of Justice or the Federal Trade CommissionConsolidation The combination of two or more firms into an entirely new firm. The old firms cease to exist.Closing the DealFactors Affecting Alternative Forms of Legal EntitiesControl by ownersManagement autonomyContinuity of ownership Duration or life of entityEase of transferring ownership Limitation on ownership liabilityEase of raising capitalTax Status