Corporate Restructuring
Restructuring ◦ To give a new structure ◦ To rebuild or rearrange
Corporate restructuring ◦ Consolidate business operations ◦ Strengthen its position in the market◦ To achieve corporate objectives
Corporate restructuring
India – highly regulated economy Government participation and intervention Closed economy
◦ Demand supply not allowed to rule the market Restrictive government policies Rigid regulatory framework
Not much scope for corporate restructuring
Historical background
To achieve faster economic growth
Industrial policy, 1991 Opening up of the economy Industrial licensing relaxed Foreign investment encouraged Transfer of foreign technology
Indian corporate sector started restructuring to meet the opportunities and challenges of competition
Liberalization
Market oriented globalized economy Easy and free flow of technology, capital
and expertise
Restructuring ◦ Tata Steel – Corus group◦ Hindalco – Novelis ◦ Mittal Steel – Arcelor◦ Vodafone – Hutch-Essar
Current scenario
Redirection of firm’s activities Deploy surplus cash from one business to
finance growth in another Exploit interdependence among businesses
within the corporate structure Risk reduction Develop core competencies
Cost cutting and Value addition – key to succeed in a competitive environment
Need and scope
Organic growth ◦ The growth rate that a company can achieve by
increasing output and enhancing sales.
Inorganic growth ◦ Arises from mergers or takeovers, rather than an
increase in the companies own business activity. gain access to new markets fresh ideas available through successful mergers and
acquisitions
Organic vs. Inorganic growth
Developing new business areas ◦ May or may not be connected with its traditional
business areas
Exploiting some competitive advantage it has
Business growth
Three alternatives:1. Formation of a new company2. Acquisition of an existing company 3. Merger with an existing company
Decision would depend on:◦ Cost ◦ Likelihood of success◦ Degree of managerial control
Enter new business area
Growth of mergers, acquisitions and corporate restructuring ◦ 2004 - $ 4.5 Billion◦ 2010 - $ 62 Billion (971 deals)◦ 2012 (first 4 months) $ 23 Billion (396 deals)
2005 – year of mergers and acquisitions ◦ India - $ 13 billion
M & A Activity
Merger – unification of 2 entities into one
Amalgamation – by merger of companies under Companies Act
Acquisition ◦ One entity buying out another and absorbing the
same. ◦ Acquisition through take over - regulated by SEBI
Definitions
Acquisition ◦ Both acquiring and acquired companies are still
left standing as separate entities
Merger ◦ Legal dissolution of one of the companies
Consolidation ◦ Dissolves both parties and creates a new one
Legal identity
Started by Lord Swaraj Paul◦ Takeover of Escorts
Some major takeovers◦ Ashok Leyland by Hindujas◦ Ceat Tyre by Goenkas◦ Consolidated Coffee by Tata Tea
Corporate takeovers - India
Interest of general public
Promotion of industry and trade
Government - Safeguard interest of citizens, consumers, investors and shareholders, creditors, workers.
Rationale
Reconstruction / Compromise / Arrangement ◦ Sec. 391 – 394 of the Companies Act
Acquisition ◦ Sec. 395
Amalgamation ◦ Sec. 396
Reconstruction of sick industrial company ◦ Sec. 17, 18 of the Sick Industries (Special Provisions) Act.
Revival of financially unviable companies ◦ Sec. 72A of Income Tax Act, 1961
Control / Governance
Relevant provisions of:
FEMA, 2000 Income Tax Act, 1961 Industries (Development and Regulation)
Act, 1973 The Competition Act, 2002 SEBI Act, 1992 Restrictions imposed by any other relevant
Act
Control…
One company involved – rights of shareholder and creditors are varied◦ Reconstruction◦ Reorganization◦ Scheme of arrangement
Two or more existing companies – fused into one by merger or one company taking over another ◦ Amalgamation ◦ Shareholders of each blending company become
substantially the shareholders of the company which is to carry on the blended undertaking
Companies involved
Fusion of two companies
Dissolution of one or more companies / firms / proprietorships◦ Form or get absorbed into another company
Merger increases the size of the undertaking
Types of mergers
Two companies in the same industry
Market share of new consolidated company would be larger
Closer to being a monopoly / near monopoly - to avoid competition
Economies of scale / economies of scope
Eg.
1. Horizontal merger
Two companies – different stages of industrial or production process
A (potential) ‘buyer – seller’ relationship
Lower transaction costs
Demand – supply synchronization
Independence and self sufficiency
Eg.
2. Vertical merger
Firms engaged in unrelated type of business operations ◦ Business activities not related either horizontally, or
vertically
No important common factors◦ Production / marketing / research and development
Unification of different kinds of businesses ◦ One flagship company
Foray into varied businesses ◦ Without having to incur large start-up costs
3. Conglomerate merger
Purpose ◦ Utilization of financial resources◦ Enlarged debt capacity◦ Synergy of managerial functions
Leads to increase in the value of outstanding shares by ◦ increased leverage and earnings per share, and ◦ lowering the average cost of capital
Eg.
Acquirer and target companies are related through ◦ Basic technologies ◦ Productions processes◦ Markets
Acquired company represents an extension of ◦ Product line◦ Market participants ◦ Technologies
4. Congeneric merger
Outward movement by acquirer ◦ from its current business scenario ◦ to other related business activities
Eg.
Also known as a ‘cash-out merger’
The shareholders of one entity receive cash in place of shares in the merged entity.
Common practice in cases where the shareholders of one of the merging entities do not want to be a part of the merged entity.
5. Cash merger
For regulatory and tax reasons.
A tripartite arrangement ◦ the target merges with a subsidiary of the acquirer.
Based on which entity is the survivor after such merger, a triangular merger may be ◦ forward (when the target merges into the
subsidiary and the subsidiary survives), or ◦ reverse (when the subsidiary merges into the
target and the target survives).
6. Triangular merger
Involves acquisition of a public (shell) company by a private company ◦ Public company may have little or no assets ◦ Only the internal structure and shareholders exist
Also called ‘back door listing’◦ Helps the private company to by pass lengthy and
complex process in order to go pubic ◦ Without incurring huge expenses
7. Reverse merger
Easy access to capital market
Increase in visibility of company
Tax benefits on carry forward losses (of the acquired public company)
Cheaper and easier route to become a public company
Benefits of Reverse Merger
Downstream merger ◦ Merger of parent company into its subsidiary
Upstream merger ◦ Merger of subsidiary company into its parent
company
Other forms
Rationale for M&A
Synergistic operating economics
Growth
Diversification
Taxation
Consolidation of production capacities
Increasing market power
Rationale…
Synergy defined as◦ V (AB) > V(A) + V(B)
Combined value of 2 entities > addition of their individual values
Increase in performance of the combined firm◦ Result of complimentary services
And / Or ◦ Economies of scale
1. Synergistic operating economics
Complimentary activities ◦ One company with an efficient production system◦ Other with a good networking of branches
Economies of scale ◦ Lower average cost of production – reduction in overhead
costs
Real economies ◦ Reduction in factor input per unit of output
Pecuniary economies ◦ Lower prices for factor inputs due to bulk transactions
Synergy…
Enables firm to grow at a faster rate than organic growth
Shortening of ‘Time to Market’ - Avoid delays associated with ◦ Purchasing of building◦ Site preparation ◦ Setting up of plant ◦ Hiring personnel ◦ Supply chain
2. Growth
Merger between 2 unrelated companies ◦ Reduction in business risk ◦ Increase market value
Combination of independent or negatively correlated income streams of merged companies ◦ Higher reduction in business risk
3. Diversification
Set off and carry forward of business losses as per Income Tax Act, 1961
Tax saving or tax reduction of merged entity
4. Taxation
Increase in production capacity ◦ By combining 2 or more plants
Reduced competition◦ Leads to increase in marketing power
5. Consolidation of production capacities
Increase in financial strength
Advantage of brand equity
Competitive advantage
Eliminate / weaken competition
Revival of sick company
Survival
Other reasons for mergers / amalgamations
Underlying objectives and benefits of Mergers
Enhance value for shareholders for both companies◦ Greater access to market resources
Increased market share ◦ Higher control on price ◦ Increase in profitability
Increased bargaining power◦ Labour, suppliers,
Market leadership
Increase in volume of production◦ Ratio of output – input improves◦ Lower cost of production per unit◦ No increase in fixed costs
Optimum utilization of management resources
Competitive advantage◦ Reduce price – increase market share◦ Maintain price – higher profits
Economies of scale
Avoid overlapping functions
Eliminate duplicate channels ◦ Integrated planning and control system
Common R&D facilities
Operating economies
Deployment of surplus cash
Enhanced debt capacity
Low cost of financing
Stability of cash flows
Borrow at lower interest rates
Financial benefits
Exploit existing brand name ◦ Buy existing manufacturing unit ◦ Higher market share
Takeover company with a strong brand name ◦ Increase market share for own products
Acquiring a new product / brand name
Diversify into various segments
Growth through combination of unrelated companies / products
Widen growth opportunities
Smoothen ups and downs of product life cycles
Diversifying the portfolio
Complementary nature of companies ◦ Commercial strength◦ Geographical profiles
Increase cost effectiveness and efficiency
Optimal utilization ◦ Infrastructural and manufacturing assets◦ Utilities and other resources
Strategic integration
Substantial cost saving
Standardization and simplification of business processes
Elimination of duplication
Eliminate disadvantage of each company
Synergies
Loss making company – carry forward losses◦ Merged with another company◦ Absorbs tax liability of the latter
Company – modernizing or investing in P&M – investment incentives ◦ Not much taxable profits◦ Merge with profit making company to utilise the
investment incentives
Taxation / Investment incentives
Mergers limit or restrict competition
Company becomes a monopoly / near monopoly◦ Price benefits◦ Market share
Limiting competition