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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

  • Chapter 7

    • 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

  • Chapter 7

    • 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

  • Chapter 7

    • 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


      • Re-capitalizing the company

         Management employees receive an equity stake

         No Guts – No Glory

    Chapter 7

    • 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

    Chapter 7

    • 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


      • 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

    Chapter 7

    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

    Chapter 7

    • 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



    Step 1:unsecured loan

    Step 4:


    loan after





    Step 3:merger



    Of Target

    C lbo structure1
    c) LBO structure






    Step 2:



    Step 4:



    Step 3:transfer loan



    Of Target

    C lbo structure2
    c) LBO structure

    • Cash Merger





    Step 3:






    Step 5:transfer loan

    Step 2:merger



    Of Target

    Step 4:share purchase

    C lbo structure3
    c) LBO structure

    • Redemption



    Step 1:





    Of Target

    Step 2:redeem stock

    C lbo structure4
    c) LBO structure

    • Leveraged Tender Offers






    Step 2:



    Step 1:public tender offer



    Of Target

    Step 3:share purchase

    C lbo structure5
    c) LBO structure

    • Asset acquisitions


    Step 1: Secured loan



    Step 2: Asset transfer


    Step 3: purchase price

    Chapter 7

    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

    Chapter 7

    • 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