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Corporate Restructuring

©2006 Thomson/South-Western

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Introduction

This chapter focuses on forms of corporate restructuring, including external expansion (mergers) and business failure (bankruptcy).

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CorporateRestructuring

ExternalExpansion

Failure

MergerAcquisition

Bankruptcy

Corporate Restructuring

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Types of Combinations

Merger Vertical Horizontal Conglomerate

Geographic market Product extension Pure

Consolidation Holding company Joint venture

Acquisition Synonymous with merger

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Leveraged Buyout (LBO)

Buyer borrows most of the purchase price. Purchased assets used as collateral. Buyers frequently are the managers. Anticipate CFs sufficient to service debt Reasonable ROI Sell assets to pay off debt Employee Stock Ownership Plan (ESOP)

Tax advantage

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Types of mergers

Stock Purchase Acquiring company buys the stock of the target

company. Assumes liabilities

Asset Purchase Acquiring company buys assets of target company. NO assumption of liabilities

Tender Offer/Hostile Takeover Purchase the C/S of the merger candidate Offering price is greater than the market price

Induce shareholders to sell

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What Happens After a Merger? Divestitures

Part of the company sold for cash Spin-off Equity carve-out

Restructurings Operational Financial

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Why Has Restructuring Been Increasing? Failure of internal control mechanisms

Unproductive investment Organizational inefficiencies

Large active investors Available financing High Yield Bonds

Long economic expansion Increased revenues Increased asset values

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Anti-Takeover Measures

Staggering board

Golden parachutes

Supermajority rule

Poison pills

White knight

Standstill agreement

“Pacman” defense

Litigation

Asset/Liability

restructuring

• Greenmail

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Boardmail

Institutional investors use it to fight anti-takeover devices.

Requires the board of directors to adopt weaker anti-takeover measures…

…in exchange for voting support from institutional owners

Vote in sympathetic board members

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Why Do Companies Seek External Growth? Less Expensive

Economies of scale

Vertical merger Availability

Rapid growth

Diversification

Tax-loss carryforward

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Taxes on Mergers

Cash or nonvoting securities Gains are taxable at the time of the merger

Voting equity securities Tax-free

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Accounting for Mergers

Purchase method Total value paid recorded on books. Tangible assets at fair market value Excess as good will Not a tax-deductible

expense Must be amortized Deducted from NI after taxes

Pooling-of-interest Assets recorded at book value. No good will Higher NI No deduction for good will

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Valuation of a Merger Candidate Comparative P/E Ratio Method

Examines prices and P/E ratios of similar companies

Adjusted book value method Determine market value of the company’s

assets Discounted C/F method

Capital budgeting techniquesFuture free C/Fs

Risk-adjusted rate

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Terms of a Merger

Cash

Stock

Other FinancialInstruments

Terms

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EPS of the Surviving Company

Determinedin the

marketplace

E1 + E2 + E1,2

NS1 + NS2(ER)• EPSc =

Post-merger price of C/S

Post-merger P/E

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Failures

Technically insolvent Unable to meet current obligations

Legally insolvent Assets are less than liabilities

Bankrupt Unable to pay debts Files bankruptcy Federal bankruptcy laws

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Why Do Businesses Fail ?

Business risk Symptoms Industry downturns

Over expansion Inadequate sales Increased competition Technological change

Financial risk Symptoms Leverage Too much S-T debt Poor management of

A/R A/P

Incompetent management

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FailingFirm

Resolve itsDifficulties

DeclareBankruptcy

Alternatives for Failing Businesses

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Reorganization Vs Liquidation Reorganize if going-concern value

exceeds its liquidation value Going-concern Liquidation

Liquidate if liquidation value is more than its going-concern value

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Corporate Restructuring in Japan

Explore the social changes of corporate restructuring in Japan at this Web site:http://www.jinjapan.org/insight/html/

in_persctive/corporate/index.html

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Alternatives for C/F Problems

Stretch A/P: Buy a few weeks time

Debt restructuring: Voluntary Extension Composition Suppliers make concessions

Sell off assets Real estate/operating divisions

Sale and leaseback Creditors’ committee Assignment: Liquidation outside bankruptcy

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U. S. Bankruptcy

Chapter 11

Chapter 7

Bankruptcy Alternatives

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Information on Bankruptcy Check out this SEC Web site to find out

what happens when a public company files for bankruptcy:http://www.sec.gov/answers/bankrup.htm

Check out the American Bankruptcy Institute Web site to find additional information on Chapter 7 Bankruptcy and Chapter 11 Reorganization.http://www.abiworld.org/media/chapters.html

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Chapter 11

Seek protection from creditors Attempt to work out a plan of reorganization Court may appoint trustee. to run the business

Reorganization plan must be approved. Court Creditors SEC Review for fairness and feasibility Company’s security holders

2/3 debt holders Majority of stockholders

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Chapter 7

Court selects a referee. Handles the administrative procedures Arranges a meeting of the creditors

Creditors select a trustee. To liquidate the business Distribute the proceeds

According to Chapter 7 priorities

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Priorities

Debts satisfied from sale of secured assets. Administration expenses Business expenses After petition before trustee

Wages owed three months prior Contributions to employee benefit plans Customer lay-away deposits Taxes owed General/unsecured claims Creditors

P/S C/S holders