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Chapter 7Corporate Restructuring

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A. Corporate Restructuring Activities

a) Expansions and take over• Mergers ：

A combination of two firms such that only one survives Horizontal merger Vertical merger Conglomerate merger

• Consolidations ： A creation of an altogether new firm owning the assets of both

of the first two firm and neither of the first two survives• Tender offers ：

A party takes the initiative in making a monetary offer directly to the shareholder of the target firm, with or without the approval of the board of directors

＊ Friendly takeover ＊ Hostile takeover• Joint venture ：

Two separate firms pool some of their resource in a company for limited duration of 10 to 15 years or less

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b) Corporate Control and defenses• Premium buybacks

The repurchase of a substantial stockholder’s ownership interest at a premium

above the market price Green mail Standstill agreement

• Antitakeover amendments Change in the corporate bylaws to make an acquisition of the company more difficult or more expensive

Super-majority voting provisions Staggered terms for directors Golden parachutes Poison pills Leverage cash-out (LCO)

@ Decrease attractiveness by increasing leverage @ Concentrates insiders stock

• Management Buy-out (MBO) A white knight Leverage buy out

• Proxy contestsAn outside group seeks to obtain representation on the firm’s board of director

s

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c) Contraction• Spinoffs

The parent company transfers some of its assets and liabilities to a

new firm created for that purpose Spilt-off Spilt-up

• Divestitures A divestiture involves the sale of a portion of the firm to an outsid

e third party with a cash consideration

• Equity Carve-outs An equity carve-out involves the sale of a portion of the firm via a

n equity offering to outsiders

Original firm forms a new firm Original firm transfers some of the original firm’s assets to the n

ew firm New shares of equity are sold to outsiders with a cash surrender

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d) Changes in ownership structure• Exchange offers

The exchange of debt or preferred stock for common stock, or

conversely, of common stock for the more senior claim

• Share repurchases or self-tender offers A corporation buys back some fraction of its outstanding shares of common stock

• Going private The entire equity interest in a previously public corporation

is purchased by a small group of investors

• Leverage Buy Out (LBO)

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B. The motives of Corporate Restructuring

a) Tax Benefit• Interest expense is tax deductible while dividend

payments are not• Debt-equity swap increase a company’s intrinsic value

because of tax shelter

b) Strengthening incentives• Raising to retire equity Concentrating the remaining common shares in fewer

hands increasing the incentive for shareholders to monitor their investment• Re-capitalizing the company Management employees receive an equity stake No Guts – No Glory

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• Introduction of ESOPs Employee stock Ownership plan

Providing employees with an opportunity to share profits

Common stock represents a share in current and future profits

ESOP incentives accumulate ESOPs build up a company’s debt capacity

more effectively (Free cash Agency cost)

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c) Cash disgorgement• Management return control of discretionary

cash-flow to the capital market to eliminate the discount on value by the markets perception of reinvestment risk

Repurchase shares Leveraged shares repurchases House assets in a partnership to avoid double

taxation of earnings Leverage acquisitions Pay dividend

B. The motives of Corporate Restructuring

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d) Achieving a better business fit• Management team• Divestitures• Sharpening management focus

e) Organization imperative Soft hard

Equity is forgiving, debt insistent a pillow a sword

B. The motives of Corporate Restructuring

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f) Bifurcation Splitting of a business into two or more unit which

sum to a value greater than the original whole

• Improve management focus• Sharpen incentives• Create pure-plays that have a unique investment

appeal• Increase debt capacity

g) Eliminate cross subsidies• An operating cross subsidy• A strategic cross subsidy• An economic cross subsidy

B. The motives of Corporate Restructuring

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C. Take over

a) Motives• Create operating synergies• Build corporate portfolio• Acquire undervalue asset• Improve efficiency by restructuring• Maintain independence• Tax motives• Free cash-flow theory

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b) Approaches1. Friendly takeovers

• Mostly are for build corporate portfolio• Financing with high risk debt• Increase investment• Less redistribution than hostile• Less divestiture than hostile• No significant management change

2. Hostile takeovers• Do not lead to dangerous permanent increases in financial risk• Did not sacrifice long-term investment• Were usually followed by divestitures• Did not lead to substantial job losses• Do not appear to have displeased good

managers

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D. Leverage Buy Out (LBO)

a) Background• The average q ratio, which is the ratio of market value to replacement assets, declined from about 1.3 to 0.5

during the period of 1965-81• The inflation effect reduce the average corporation’s real leverage• Tax effect of Economic Recovery Tax Act (ERTA) of 1981 encourage banks to make ESOP loans• Government favors horizontal and vertical business

combinations• Steady economic and earnings growth in 1980s

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b) The LBO process LBO buyers

Individual buyers Persons with self-ego

Larger corporations Increase short-term EPS

Smaller private companies Cash flow

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b) The LBO process LBO sellers

Privately held firms Divestitures

Difficulty in deals Profitable

Publicly held firms Easy access data Too many parties involved

SEC Board of directors management

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b) The LBO process Finding the deal

Start with agents Insurance agents Stock brokers Individual portfolio

Search divisional sell-offs or spin-offs Networking with seasoned LBO buyers Other sources

S&P

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b) The LBO process Preparing the ideal business plan

The overall strategy Operating tactics

Redeployment of assets Improved turn of current assets

Managerial structure Marketing approach Financial data Contingency plan and corrective action plan

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b) The LBO process

Financing LBO1. Junk bonds

• Pioneered by Drexel Burnhom Lambert (DBL)• ＄ 200 billion Junk bond market in 1989

2. Mezzanine Financing• Private placement to a small group of institutions, such as

pension funds of insurance companies• Inexpensive and quick issue

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3. Bridge financing• Investment bank make a loan to the buyout group as

interim financing until permanent financing can be arranged

• Target for M＆ A advisory fee and underwriting fees • Quick and greater possibility of success

4. Venture capital • Take an hold a portion of the privately placement debt• Joint the buyout group

5. Merchant banking• Take a portion of the target firm’s equity on its own

book• A high-stakes games

c) LBO structure Stock acquisitions

Stock purchases of subsidiary corporations

Lender Holding

Target ShareholdersOf Target

Step 1:unsecured loan

Step 3:mergerStep 4:Secured

loan aftermerger

Step2:loan

purchase

c) LBO structure

Lender Holding

Target ShareholdersOf Target

Step 3:transfer lo

anStep 2:Secured

loan

Step1:Issuenote

Step 4:demand

note

c) LBO structure Cash Merger

Lender Holding

Target ShareholdersOf Target

Step

5:tr

ansf

er lo

an

Step 3:Secured

loan

Step1:share

exchangeStep 2:merger

AcquisitionSub

Step 4:share purchase

c) LBO structure Redemption

Lender Holding

Target ShareholdersOf Target

Step 1:Secured

loan

Step 2:redeem stock

c) LBO structure Leveraged Tender Offers

Lender Holding

Target ShareholdersOf Target

Step 2:Secured

loan Step 1:public tender offer

AcquisitionSub

Step 3:share purchase

form

c) LBO structure Asset acquisitions

Lender

Target

NewCompany

Step 2: Asset transfer

Step 3: purchase price

Step 1: Secured loan

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d) Financial Synergies of LBO1. Leveraged Buyout create value

• Acquiring group in non-management LBO or MBO may continues to operate or go public again to gain personal wealth

2. Stock bidding price boom up at a premiums about 50 due to ﹪Market efficiency

• Agency problem• Efficient in decision making, publication of

sensitive information, production, portfolio• Tax benefit from saving of interest

depreciation and ESOP

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e) Investment Banking in the LBO1. Preliminary analysis of the targets cash

flow• Reduce debt• Acquire asset• Pay cash dividend

2. Sensitivity analysis• Underlying assumption (sales)

3. ROI4. Debt Sources adequacy5. ESOP6. When to cash out