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Chapter 7. Corporate Restructuring. Corporate Restructuring Activities. Expansions and take over Mergers : A combination of two firms such that only one survives Horizontal merger Vertical merger Conglomerate merger Consolidations :

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chapter 7
Chapter 7

Corporate Restructuring

corporate restructuring activities
Corporate Restructuring Activities
  • 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

slide3
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 contests

An outside group seeks to obtain representation on the firm’s board of directors

slide4
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 outside

third party with a cash consideration

    • Equity Carve-outs

An equity carve-out involves the sale of a portion of the firm via an

equity offering to outsiders

        • Original firm forms a new firm
        • Original firm transfers some of the original firm’s assets to the new firm
        • New shares of equity are sold to outsiders with a cash surrender
slide5
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)
the motives of corporate restructuring
The motives of Corporate Restructuring
  • 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
  • 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

slide7
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)
the motives of corporate restructuring1
The motives of Corporate Restructuring
  • 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
the motives of corporate restructuring2
The motives of Corporate Restructuring
  • Achieving a better business fit
      • Management team
      • Divestitures
      • Sharpening management focus
  • Organization imperative

Soft hard

Equity is forgiving, debt insistent

a pillow a sword

the motives of corporate restructuring3
The motives of Corporate Restructuring
  • 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
  • Eliminate cross subsidies
      • An operating cross subsidy
      • A strategic cross subsidy
      • An economic cross subsidy
take over
Take over
  • Motives
    • Create operating synergies
    • Build corporate portfolio
    • Acquire undervalue asset
    • Improve efficiency by restructuring
    • Maintain independence
    • Tax motives
    • Free cash-flow theory
slide12
Approaches
    • 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
    • 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
leverage buy out lbo
Leverage Buy Out (LBO)
  • 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
b the lbo process
b) The LBO process
  • LBO buyers
    • Individual buyers
      • Persons with self-ego
    • Larger corporations
      • Increase short-term EPS
    • Smaller private companies
      • Cash flow
b the lbo process1
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
b the lbo process2
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
b the lbo process3
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
slide18
b) The LBO process

Financing LBO

  • Junk bonds
    • Pioneered by Drexel Burnhom Lambert (DBL)
    • $200 billion Junk bond market in 1989
  • Mezzanine Financing
    • Private placement to a small group of institutions, such as pension funds of insurance companies
    • Inexpensive and quick issue
slide19
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
  • Venture capital
    • Take an hold a portion of the privately placement debt
    • Joint the buyout group
  • Merchant banking
    • Take a portion of the target firm’s equity on its own book
    • A high-stakes games
c lbo structure
c) LBO structure
  • Stock acquisitions

Stock purchases of subsidiary corporations

Lender

Holding

Step 1:unsecured loan

Step 4:

Secured

loan after

merger

Step2:

loan

purchase

Step 3:merger

Target

Shareholders

Of Target

c lbo structure1
c) LBO structure

Lender

Holding

Step1:

Issue

note

Step 2:

Secured

loan

Step 4:

demand

note

Step 3:transfer loan

Target

Shareholders

Of Target

c lbo structure2
c) LBO structure
  • Cash Merger

Lender

Holding

Acquisition

Sub

Step 3:

Secured

loan

Step1:

share

exchange

Step 5:transfer loan

Step 2:merger

Target

Shareholders

Of Target

Step 4:share purchase

c lbo structure3
c) LBO structure
  • Redemption

Lender

Holding

Step 1:

Secured

loan

Target

Shareholders

Of Target

Step 2:redeem stock

c lbo structure4
c) LBO structure
  • Leveraged Tender Offers

form

Lender

Holding

Acquisition

Sub

Step 2:

Secured

loan

Step 1:public tender offer

Target

Shareholders

Of Target

Step 3:share purchase

c lbo structure5
c) LBO structure
  • Asset acquisitions

Lender

Step 1: Secured loan

New

Company

Step 2: Asset transfer

Target

Step 3: purchase price

slide26
d) Financial Synergies of LBO
  • Leveraged Buyout create value
    • Acquiring group in non-management LBO or MBO may continues to operate or go public again to gain personal wealth
  • 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
slide27
Investment Banking in the LBO
    • Preliminary analysis of the targets cash flow
      • Reduce debt
      • Acquire asset
      • Pay cash dividend
    • Sensitivity analysis
      • Underlying assumption (sales)
    • ROI
    • Debt Sources adequacy
    • ESOP
    • When to cash out
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