Chapter 7
Corporate Restructuring
1
A.
Corporate Restructuring Activities
Expansions and take over
a)
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Mergers：
A combination of two firms such that only one survives
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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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Corporate Control and defenses
b)
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Premium buybacks
The repurchase of a substantial stockholder’s ownership interest at a premium
above the market price
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Green mail
Standstill agreement
Antitakeover amendments
Change in the corporate bylaws to make an acquisition of the company more
difficult or more expensive
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Management Buy-out (MBO)
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Super-majority voting provisions
Staggered terms for directors
Golden parachutes
Poison pills
Leverage cash-out (LCO)
@ Decrease attractiveness by increasing leverage
@ Concentrates insiders stock
A white knight
Leverage buy out
Proxy contests
An outside group seeks to obtain representation on the firm’s board of directors
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Contraction
c)
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Spinoffs
The parent company transfers some of its assets and liabilities to a
new firm created for that purpose
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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
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Equity Carve-outs
An equity carve-out involves the sale of a portion of the firm via an
equity offering to outsiders
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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
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Changes in ownership structure
d)
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Exchange offers
The exchange of debt or preferred stock for common stock, or
conversely, of common stock for the more senior claim
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•
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
Tax Benefit
a)
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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
b)
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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
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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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B.
The motives of Corporate Restructuring
Cash disgorgement
c)
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Management return control of discretionary cashflow to the capital market to eliminate the discount
on value by the markets perception of reinvestment
risk
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Repurchase shares
Leveraged shares repurchases
House assets in a partnership to avoid double taxation of
earnings
Leverage acquisitions
Pay dividend
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B.
d)
The motives of Corporate Restructuring
Achieving a better business fit
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e)
Management team
Divestitures
Sharpening management focus
Organization imperative
Soft
hard
Equity is forgiving, debt insistent
a pillow
a sword
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B.
f)
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
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g)
Improve management focus
Sharpen incentives
Create pure-plays that have a unique investment appeal
Increase debt capacity
Eliminate cross subsidies
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An operating cross subsidy
A strategic cross subsidy
An economic cross subsidy
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C.
Take over
Motives
a)
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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)
Approaches
Friendly takeovers
1.
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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
2.
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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)
Background
a)
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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
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Individual buyers
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Larger corporations
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Persons with self-ego
Increase short-term EPS
Smaller private companies
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Cash flow
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b) The LBO process
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LBO sellers
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Privately held firms
Divestitures
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Difficulty in deals
Profitable
Publicly held firms
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Easy access data
Too many parties involved
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SEC
Board of directors
management
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b) The LBO process

Finding the deal
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Start with agents
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Insurance agents
Stock brokers
Individual portfolio
Search divisional sell-offs or spin-offs
Networking with seasoned LBO buyers
Other sources
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S&P
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b) The LBO process
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Preparing the ideal business plan
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The overall strategy
Operating tactics
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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 LBO
Junk bonds
1.
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Pioneered by Drexel Burnhom Lambert (DBL)
＄200 billion Junk bond market in 1989
Mezzanine Financing
2.
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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
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4.
Venture capital
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5.
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
Take an hold a portion of the privately placement debt
Joint the buyout group
Merchant banking
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Take a portion of the target firm’s equity on its own book
A high-stakes games
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c) LBO structure

Stock acquisitions
Stock purchases of subsidiary corporations
Lender
Step 4:
Secured
loan after
merger
Target
Step 1:unsecured loan
Holding
Step2:
loan
purchase
Shareholders
Of Target
c) LBO structure
Lender
Step 2:
Secured
loan
Target
Holding
Step 4:
demand
note
Step1:
Issue
note
Shareholders
Of Target
c) LBO structure

Cash Merger
Lender
Holding
Step 3:
Secured
loan
Acquisition
Sub
Step1:
share
exchange
Target
Step 4:share purchase
Shareholders
Of Target
c) LBO structure

Redemption
Lender
Holding
Step 1:
Secured
loan
Target
Step 2:redeem stock
Shareholders
Of Target
c) LBO structure

Leveraged Tender Offers
Lender
Holding
form
Acquisition
Sub
Step 2:
Secured
loan
Target
Step 3:share purchase
Shareholders
Of Target
c) LBO structure

Asset acquisitions
Lender
New
Company
Target
d) Financial Synergies of LBO
Leveraged Buyout create value
1.
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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
2.
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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 LBO
Preliminary analysis of the targets cash flow
1.
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Sensitivity analysis
2.
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3.
4.
5.
6.
Reduce debt
Acquire asset
Pay cash dividend
Underlying assumption (sales)
ROI
Debt Sources adequacy
ESOP
When to cash out
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