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Chapter 7

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

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  1. Chapter 7 Corporate Restructuring

  2. 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

  3. 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

  4. 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

  5. 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)

  6. 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

  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)

  8. 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

  9. 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

  10. 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

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

  12. 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

  13. 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

  14. b) The LBO process • LBO buyers • Individual buyers • Persons with self-ego • Larger corporations • Increase short-term EPS • Smaller private companies • Cash flow

  15. 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

  16. 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

  17. 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

  18. 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

  19. 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

  20. 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

  21. c) LBO structure Lender Holding Step1: Issue note Step 2: Secured loan Step 4: demand note Step 3:transfer loan Target Shareholders Of Target

  22. 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

  23. c) LBO structure • Redemption Lender Holding Step 1: Secured loan Target Shareholders Of Target Step 2:redeem stock

  24. 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

  25. c) LBO structure • Asset acquisitions Lender Step 1: Secured loan New Company Step 2: Asset transfer Target Step 3: purchase price

  26. 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

  27. 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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