INTRODUCTION TO CORPORATE RESTRUCTURING

RESTRUCTURING

Organic growth: When company increases the turnover of its

existing business. This is done by enhanced customer base,
higher sales and increased revenues.

Inorganic growth: rate of growth of business by increasing

output and business reach by acquiring new business by way
of mergers, acquisitions, takeovers and other restructuring
strategies.

WHAT IS CORPORATE RESTRUCTURING

Change in the business capacity or portfolio carried out by an

inorganic route expansion or contraction

Change in the capital structure of the company not in the

ordinary course

Any change in the ownership of a company or control over its

management.

Restructuring hexagon

Information gap
Current Market Value
Optimized firm value

Value status quo

Operating
improvement
Incentives Value with internal improvements
management
with VBM

Value with financial

restructuring

Value with improvements

Divestiture
activity, spin
offs

and disposals

Financial engineering:
leverage, dual class
stock, carve outs,
tracking stock,
employee ownership,
debt restructuring

Corporate Restructuring The Conceptual Framework

Restructuring Models

Some models looked only at the internal factors

Others at the external factors

Some combine these perspectives

Others looked for congruence between various aspects of the

organization

No certainty on the factors that a company needs to study, one

that would position the company effectively

Essentials of Restructuring

Ensure the company has enough liquidity to operate during

implementation of a complete restructuring

Produce accurate working capital forecasts

Provide open and clear lines of communication with creditors

who mostly control the company's ability to raise financing

Update detailed business plan and considerations

Reasons for Restructuring

Change in fiscal and government policies

Liberalization, Privatization, and Globalization (LPG)

Information Technology Revolution

Concept of Customer Focus

Cost Reduction

Divestment

Improving bottom-line

Core Competencies

Enhancing shareholder value

Incompatible company objectives

Transfer of Corporate assets

Evolving appropriate capital structure

Consistent growth and profitability

Meeting investors expectations

Resolving conflict

Bifurcation of business

Barriers to Restructuring

Inadequate commitment from the Top management

Resistance to change

Poor communication

Absence of requisite skills

Scepticism

Failure to understand the benefits of restructuring

Availability of resources

Organizational workload

Non adherence to time schedule

Lack of clear and visible leadership

Dimensions of restructurings-1
Asset restructuring

Acquisitions

Divestitures

Spin offs

Corporate downsizing

Outsourcing

Dimensions of restructuring-II
Restructuring ownership structure, leverage

Exchange offers

Share repurchases

LBOs

Restructuring Equity Claims

Inside vs. outside equity ownership

MBOs

ESOPs

IPO

Buyback

Dimensions of restructuring-III
Ownership vs. control

Limited partnerships

Joint ventures

Securitization

Project finance

Incentive restructuring

Value based management programs (EVA, etc.)

Dimensions of restructuring- IV
Corporate control

Takeovers

Dual-class recapitalizations

Share repurchase

Proxy contests

Distress related restructuring

Troubled debt restructuring-CDR/SDR

Chapter 11 reorganizations

Liquidations

Why Engage in Corporate Restructuring?

Sales enhancement and operating economies

Improved management

Information effect

Wealth transfers

Tax reasons

Leverage gains

Hubris hypothesis

Managements personal agenda

 Economies

of Scale The benefits of size in which

the average unit cost falls as volume increases.

Horizontal merger: best chance for economies

Vertical merger: may lead to economies
Conglomerate merger: few operating economies
Divestiture: reverse synergy may occur

Financial Restructuring

Involves change in the capital structure and capital mix of

the company to minimize its cost of capital

Also involves infusion of financial resources to facilitate

mergers, acquisitions, joint venture, strategic alliances, LBOs,
and stock buy-back

Depends on availability of free cash flows, takeover threats

faced by the company and concentration of equity ownership.

Changes in authorised and paid-up capital

Preferential allotment to promoters or joint venture partners

as per SEBI guidelines.

Buyback of shares

Issue of preference and non-voting shares

FIPB/RBI clearances, Companys Act, Income Tax Act

Purpose of Financial Restructuring

Generate cash for exploiting available investment opportunities

Ensure effective use of available financial resources

Change the existing financial structure, in order to reduce the

cost of capital

Leveraging the firm

Preventing attempts of hostile takeover.

Debt Reduction

Companies which had very high debt-to-equity ratio generally

reap the most benefit in terms of higher ROCE and EVA

Debt reduction below a certain level is not beneficial to the

shareholders & to the company because of operational
inefficiencies of the company, causing its EVA to also
gradually decrease.

Debt has one intrinsic benefit for corporates: by reducing the

tax burden, it increases net profit for the company, thereby
creating more value for shareholders.

Portfolio and Asset Restructuring

Involves divesting or acquiring a line of business

perceived peripheral to the long term business strategy of
the company.

Represents the companys attempt to respond to the

marketing needs without losing sight of its core
competencies.

Purpose

Restructuring as a result of some strategic alliance

Responding to shareholders desire to downsize and

refocus the companys operations

Responding to outside boards suggestion to

restructure

Portfolio and Asset Restructuring

Organic and inorganic growth

Mergers and Acquisitions: enhance market power, streamline

core capabilities, pool resources

Divestitures: hive off non-core areas, provide focus to

individual businesses, simplify ownership structure

Internal streamlining of operations.

Organizational Restructuring

Is a response change in the business and related environments.

Takes the form of divestiture and acquisitions.

Restructuring strategy designed to increase the efficiency and

effectiveness of personnel, through significant changes in the
organizational structure.

Internal streamlining: downsizing the numbers, closure of

uneconomic units, Business Process Re-engineering-VRS
schemes by banks, disposal of idle assets.

Restructuring options

Forms of Corporate Restructuring

Expansion

Contraction

Mergers and Acquisitions

Tender Offers
Asset Acquisition
Joint Ventures

Spin offs
Split offs
Divestitures
Equity carve-outs
Assets sale
Split-up

Corporate Control

Takeover defenses
Share repurchases
Exchange offers
Proxy contests

Changes in Ownership Structures

Leveraged buyout
Going Private
ESOPs and MLPs

EXPANSION
1. Merger Combination of two or more companies into a single
company by way of Amalgamation or Absorption.
Amalgamation is the merger of one or more companies with another or
the merger of two or more companies to form a new company, in
such a way that all assets and liabilities of the amalgamating
companies become assets and liabilities of the amalgamated
company and shareholders not less than nine-tenths in value of the
shares in the amalgamating company or companies become
shareholders of the amalgamated company.
Merger of Hindustan Computers Ltd, Hindustan Instruments Ltd, Indian
Software Company Ltd and Indian Reprographics Ltd into an entirely new
company called HCL Ltd

2. Tender Offer involves making a public offer for acquiring

the shares of target company to acquire the management
control in that company.
3. Asset Acquisition involves buying tangible or intangibles
assets like brands of a particular company.
4. Joint Ventures two companies entering into agreement to
provide certain resources towards achievement of particular
common business goal.

Mergers and Acquisitions

MERGER

A + B = A, where company B is merged into company A (Absorption)

Examples-Banks ( Bank Of America and Merrill lynch)

A + B = C, where C is an entirely new company (Amalgamation or

Consolidation)-Sandoz and Ciba Geigy formed Novartis, Arcelor-Mittal

ACQUISITION

It could be acquisition of control, leading to takeover of a company. A

takeover, is the buying of one company (the target) by another. An
acquisition can be friendly or hostile takeover. In a friendly takeover,
the companies proceed through negotiations. In a hostile takeover, the
takeover target is unwilling to be bought, or the targets board has no
prior knowledge of the offer

It could be acquisition of tangible assets, intangible assets, rights and

other kinds of obligations. Attempt by one firm to gain a majority
interest in another firm.

Mergers

Merger is defined as a combination of two or more companies into

a single company
Amalgamation

is the type of merger that involves fusion of two

or more companies. After the amalgamation, the two
companies loose their individual identity and a new company
comes into existence. This form is generally applied to
combinations of firms of equal size.

A
Brooke Bond
India Ltd

B
Lipton
India Ltd

A
B

Brooke Bond Lipton

India Ltd

Acquisition

A corporate action where an acquiring company makes a bid for an

acquiree. If the target company is publicly traded, the acquiring
company will make an offer for the outstanding shares

Acquisition is an attempt by which a company or an individual or

group of individuals acquires control over another company.

Right to control is the right to control its management and

policy decisions.

In acquisitions the target companys identity remains intact.

Purchasing a substantial percentage of the voting capital

Acquiring voting rights through proxy voting or power of attorney

Acquiring control over an investment or holding company

Acquiring management control over the target company by

formal/informal means.

Acquisitions may lead to

A subsequent merger

Establishment of the Parent-subsidiary relationship

A strategy of breaking up the target firm and disposing off

part or all of its assets

Conversion of the target firm into a private firm.

Types of acquisitions could be asset purchases and stock

purchases

Strategic Acquisitions Involving Common Stock

Strategic Acquisition occurs when one company acquires another

as part of its overall business strategy.
When the acquisition is done for common stock, a ratio of
exchange, which denotes the relative weighting of the two
companies with regard to certain key variables, results.
A financial acquisition occurs when a buyout firm is
motivated to purchase the company (usually to sell assets, cut
costs, and manage the remainder more efficiently), but keeps
it as a stand-alone entity.
Expansion is a form of restructuring, which results in an
increase in the size of the firm. It can take place in the form
of a merger, acquisition, tender offer, asset acquisition or a
joint venture.

Factors driving Indian Companies to go in for M&A

1.The only way for companies with sick subsidiaries to seek
a credible rehabilitation package is to amalgamate the sick
subsidiary with the parent company
2.Companies are seeking to consolidate the core business
activities of the group firms to attain balance sheet size and
net worth to mount strategic takeovers of companies in
similar business activities
3.In the third category of companies, promoters have
proposed to merge investment subsidiaries with the parent
to streamline their shareholding in other group
4.
Many mergers and takeovers have happened for tax
companies
advantage
5. Another important factor driving M&A activity is the
changing role of financial institutions
6. The presence of intermediaries, like investment bankers,
has facilitated M&A activity by negotiating with buyers and
sellers

7.

Changing scenario of restructuring capital structure

from pure vanilla instruments to variants

8. Enhancement of foreign equity in Indian companies

9. Emergence of venture capitalists and PE firms
10. Use of GDR, SPVs

Joint Venture

Alternative to a merger or acquisition

A joint venture is a business jointly owned and controlled by two or more

independent firms. Each venture partner continues to exist as a separate
firm, and the joint venture represents a new business enterprise.

May allow the bidder to accomplish the goals it has

in mind without incurring the costs of a complete
acquisition of the target

These goals may be:

1.
2.
3.
4.

Enter a new market

Lock up a source of supply
Develop a new product
Preempt competitors from achieving a certain goal

Strategic Alliance

Strategic Alliance An agreement between two or more

independent firms to cooperate in order to achieve some
specific commercial objective.

Strategic alliances usually occur between (1) suppliers

and their customers, (2) competitors in the same
business, (3) non-competitors with complementary
strengths.

Why companies enter into Strategic Alliances?

Internal reasons:

To spread costs and risks

To safeguard resources which cannot be obtained through the

market

To improve access to financial resources

To derive benefits of economies of scale

To gain access to new technologies, customers and innovative

managerial practices

Competitive Goals

To pre-empt competitors

To create stronger competitive units

To influence structural evolution of the industry

To respond defensively to blurring industry boundaries and globalization

To pre-empt competitors

To create stronger competitive units

To influence structural evolution of the industry

To respond defensively to blurring industry boundaries and globalization

Types of Strategic Alliances

Complementary Alliance

Partners combine their technologies to diversify their existing

products/market portfolios

Market Alliance

Aims at combining the market knowledge of one partner with

the production or product know-how of the other

Sales alliance

Producer and a local partner cooperate in an arrangement that

is a mixture of independent representation and own branch.

Concentration Alliance

Competing partners cooperate to form larger and more

economical units.

Research and Development alliance:

Partners aim to create synergy by making joint use of research

facilities, exploiting opportunities to specialize and standardize
combining know-how and sharing risks.

Supply Alliance

Competitors using similar inputs cooperate to safeguard

supplies, reduce procurement costs, or to prevent the entry of
new competitors.

Advantages and Disadvantages

Advantages:

May be more flexible than Joint Ventures

They come in wide varieties

May enable companies to pursue goals without a large

financial commitment

Disadvantages:

Greater opportunities for opportunistic behavior by

merger partners

Could lose valued know-how

Tender Offer

A type of takeover bid.

A public, open offer or invitation (usually announced in a

newspaper advertisement) by a prospective acquirer to all
stockholders of a publicly traded corporation (the target
corporation) to tender their stock for sale at a specified price
during a specified time, subject to the tendering of a minimum
and

To induce the shareholders of the target company to sell.

The acquirer's offer price usually includes a premium over the

current market price of the target company's shares maximum
number of shares.

TENDER OFFERS
Tender Offer An offer to buy current shareholders stock at a
specified price, often with the objective of gaining control of the
company. The offer is often made by another company and
usually for more than the present market price.

Allows the acquiring company to bypass the management of the

company it wishes to acquire.

Two tier tender offer

Two-tier

Tender Offer Occurs when the bidder offers

a superior first-tier price (e.g., higher amount or all
cash) for a specified maximum number (or percent) of
shares and simultaneously offers to acquire the
remaining shares at a second-tier price.

Increases the likelihood of success in gaining control of

the target firm.
Benefits those who tender early.

Asset Acquisition

A buyout strategy in which key assets of the target company

are purchased, rather than its shares. These assets may be
tangible assets like a manufacturing unit or intangible assets
like brands. This is particularly popular in the case of bankrupt
companies, who might otherwise have valuable assets which
could be of use to other companies, but whose financing
situation makes the company un-attractive for buyers.

Examples ---- Asset Acquistion

The acquisition of the cement division of Tata Steel by Laffarge of

France. Laffarge acquired only the 1.7 million tonne cement plant
and its related assets from Tata Steel.

The asset being purchased may also be intangible in nature. For

example, Coca-Cola paid Rs.170 crore to Parle to acquire its soft
drinks brands like Thums Up, Limca, Gold Spot etc.

Google acquired Motorola for its new open source operating

system Android for the need of Motorolas 17000 patents out of
which Google needs around 6000 patents.

M3M India acquired DLF 28- Acre Plot in Gurgaon as non core
assets for Rs 440 Cr.

REASONS FOR DIVESTMENTS

Hive-off non profitable units/ divisions

Manage internal operations more efficiently

Achieve focus

Assets sale lead to improved realignment of resources

Reverse synergy

Release financial and managerial resources locked in non

remunerative businesses

Improve managerial efficiency

Respond to changing economic environment

Tax consideration

Facilitate valuation by stock market

SPIN OFF

A corporate spin-off can be defined as the distribution of all, or

substantially all, of the ownership interest of one firm (the parent) in
another firm (the subsidiary) to the parents shareholders, so that
following the spin-off, there are two separate publicly held companies

Example :Pepsi Spinoff of Pizza Hut and KFC, spin-off of EDS from
GM. Lehman was an outcome of spin-off of American Express, L&T
spun off its Cement division into a company Ultra tech, which was later
acquired by Grasim.

The stock distributed to the shareholders of the Parent is like a stock

dividend, no cash is generated. The firm no longer has any control over
the assets and operations of the subsidiary.

Subsidiary becomes a separate legal entity with a distinct management

and board. Decision to spin-off vs shut down

Spin-off

A Company distributes all the shares it owns in a subsidiary to its

own shareholders implying creation of two separate public
companies with same proportional equity ownership. Sometimes,
a division is set up as a separate company. Hence, the stockholders
proportional ownership of shares is the same in the new legal
subsidiary as well as the parent firm. The new entity has its own
management and is run independently from the parent company. A
spin-off does not result in an infusion of cash to parent company.
Shareholders of
Company A also has
shares of Company B

Shareholders of
Company A

A
Subsidiary
Company
of A

SPLIT-UP

In a split-up, the existing corporation transfers all its assets

to two or more new controlled subsidiaries, in exchange
for subsidiary stock

The parent distributes all stock of each subsidiary to

existing shareholders in exchange for all outstanding
parent stock, and liquidates. In other words, a single
company splits into two or more separately run companies

Example : Split Up of AT&T into four separate units

AT&T Wireless, AT&T Broadband, AT&T Consumer and
AT&T Business-US Telecom business, break-up of ITT
Group, Reliance Group, Birla Group

Split-UP

In a split-up the entire firm is broken up in series of spin-offs, so that

the parent company no longer exists and only the new off springs
survive. A split-up involves the creation of a new class of stock for
each of the parents operating subsidiaries, paying current
shareholders a dividend of each new class of stock, and then dissolving
the parent company.
Shareholders of
Company A will get
shares of

Shareholders of
Company A

A
B

Subsidiary

SPLIT-OFF

A split-off is a type of corporate reorganization whereby the

stock of a subsidiary is exchanged for shares in the parent
company

Ex: Viacom announced a split-off of its interest in Blockbuster

in 2004

Split-offs are basically of two types. In the first type, a

corporation transfers part of its assets to a new corporation in
exchange for stock of the new corporation

The original corporation then distributes the same stock to its

shareholders, who, in turn, surrender part of their stock in the
original corporation

In the second type, a parent company transfers stock of a

controlled corporation to its stockholders in redemption of a
similar portion of their stock

Example- Krafts Food split-off its Post cereal business

Split- off
In a split off, a new company is created to takeover the operations
of an existing division or unit. A portion of existing shareholders
receives stock in a subsidiary (new company) in exchange for
parent company stock Hence the shareholding of the new entity
does not reflect the shareholding of the parent firm. A split-off
does not result in any cash inflow to the parent company
Shareholders of
Company A

Shareholders of
Company A

A
C

Shareholder
s of
Company A

New Compan

A
E

Operations of

Shareholder
s of
Company B

Equity Carve Out

Equity carve-outs (also known as partial public offering)

are transactions in which a firm sells its minority interest
in the common stock of a previously wholly-owned
subsidiary

Usually this option is exercised by a parent when one of its

subsidiaries is growing faster with valuations higher.

Example: DuPonts IPO of Conoco in October 1998

In a carve-out, the parent generally sells only minority

interest in the subsidiary and maintains control over
subsidiarys assets and operations. Its an IPO of a
subsidiary which generates cash for the subsidiary

Equity Carve Out

A parent has substantial holding in a subsidiary. It sells part of that

holding to the public. "Public" does not necessarily mean a
shareholder of the parent company. Thus the asset item
"Subsidiary Investment" in the balance-sheet of the parent
company is replaced with cash. Parent company keeps control of
the subsidiary but gets cash.
A

Issues IPO of B 20%

Shares of B
CCashA

B
Subsidiary
Company
of A

Investors

20%
Shares
of
Compan
yB

Tracking stocks, also known as letter or targeted stocks, are a

class of parent company stock that track the earnings of a division or
subsidiary. These are typically

distributed as dividend to

shareholders of the parent company. Unlike spin-off and carve-outs,

control remains with the management of the parent company.
Additionally, assets are also separated between the two entities. They
dont have to report their earnings separately, no separate balance
sheets. Tracking stocks are class B stocks, with no voting rights.

Asset sell-off involves the sale of tangible or intangible assets of a

company to generate cash. Normally, selloffs are done because the
subsidiary does not fit into the parent companys core strategy

Divestiture

Divestiture The divestment of a portion of the enterprise or

the firm as a whole.

Liquidation The sale of assets of a firm, either

voluntarily or in bankruptcy.
Sell-off The sale of a division of a company, known as a
partial sell-off, or the company as a whole, known as a
voluntary liquidation.

Divestitures

A divestiture is a sale of a portion of the firm to an outside party,

generally resulting in an infusion of cash to the parent. A firm may
choose to sell an undervalued operation that it determines to be
non-strategic or unrelated to the core business and to use the
proceeds of the sale to fund investments in potentially higher
return opportunities.

Shares

A
A
Oper
ation
s

Shares

Some Operations
of A
Cash

Patent
s

B
B

Assets
Assets

Oper
ation
s of
A

REASONS FOR DIVESTITURE

Unprofitable division

A Bad fit

Reverse Synergy

Failure to generate hurdle rate of return

Capital market factors

Increased cash flows

Abandoning core business

Divestiture and Spin off process

1.

Divestiture or Spinoff Decision

2.

Formulation of a Restructuring Plan

3.

Selling the Business

4.

Approval of the Plan by Shareholders

5.

Registration of Shares

6.

Completion of the Deal

Financial Evaluation of Divestitures

1. Estimation of After-tax Cash Flows
2. Determination of the Divisions Relevant Risk-Adjusted Discount
Rates
3. Present Value Calculations
4. Deduction of the Market Value of the Divisions Liabilities
5. Deduction of the Divestiture Proceeds
If DP> NOLV: sell division
DP=NOLV: other factors will control decision
DP< NOLV: Keep division
Where DP is divestiture proceeds and NOLV is net off liability value

De Mergers

The demerged company transfers one or more of its

undertakings to the resulting company for an agreed
consideration. The resulting company issues its shares at the
agreed exchange ratio to the shareholders of the agreed
merged company.

Eg: Demerger of Reliance

Eg: Demerger of cement division at L&T.

SLUMP SALE

The company sells or disposes off the whole or substantially

the whole of its undertaking for a pre determined lump sum
consideration.

The acquiring company may not be interested in buying the

whole company, but only one of its divisions or a running
undertaking which maybe on a going concern basis.

The sale is made for a lump sum price, without values being
assigned to the assets and liabilities transferred.

The business to be hived off is transferred from the transferor

company to an existing or new company.

Demerger and Slump Sale

1.In a slump sale no value is assigned to the individual assets and
liabilities, and the sale is for a lump sum consideration. In
demergers, valuations of assets and liabilities are mandatory.
2. In demergers, shareholders of demerged companies are issued
shares of resulting company, while in case of slump sale,
issue of shares does not take place.
3. Demergers results in reorganization of capital while slump
sales do not.
4. In case of demerger, the resulting company has to continue the
business of transferred undertaking while in slump sale it is
not so.
5.De merger is more tax efficient than slump sale.

Corporate Control

Share Buyback

Demergers: A demerger is a sensible option if negative synergies or

diseconomies of scale exist, which can be eliminated by separating
the firm.

Debt Restructuring: Debt restructuring is a process that allows

company facing cash flow problems and financial distress, to reduce
and renegotiate its delinquent debts in order to improve or restore
liquidity and rehabilitate so that it can continue its operations.

Tracking Stock: A tracking stock is a special type of stock issued by

a publicly held company to track the value of one segment of that
company. The stock allows the different segments of the company to
be valued differently by investors. Let's say a slow-growth company
trading at a low price-earnings ratio (P/E ratio) happens to have a
fast growing business unit. The company might issue a tracking
stock so the market can value the new business separately from the
old one and at a significantly higher P/E rating. Eg-General Motors
tracking stock for its EDS division

CORPORATE CONTROL
1. TAKEOVER DEFENSES intends to change the corporate control
position of the promoter. This includes pre-bid & post-bid defenses.
2. SHARE REPURCHASES leads to reduction in the equity capital of the
company thereby increasing the promoters stake.
3. EXCHANGE OFFERS involves exchanging common stock for debt or
vice versa for changing the capital structure &keeping the investment
policy unchanged.
4. PROXY CONTESTS is an attempt by a single shareholder or a group of
dissident shareholder to take control or seek membership of the
Board , to influence the management decision-making process of the
firm. Even if the dissident group obtains a minority position on the
Board, it can have positive impact on the share prices by virtue of
pressures they can exert on various corporate and functional policies.
5. TENDER OFFER involves making a public offer for acquiring the
shares of target company to acquire the management control in
that company.
6. DUAL CLASS STOCK RECAPITALISATION: Those with non-voting rights/
limited voting rights but preferential claim on the companys cash
flows, and those with voting rights ( Ford Company). Usually common
in closely-held companies.

1.
2.
3.

4.
.
.
.

CHANGES IN OWNERSHIP STRUCTURE

LEVERAGE BUYOUTS is a financing technique where debt is
used to acquire a company.
GOING PRIVATE converting public corporation into privately
held firm by purchasing entire equity interest by a small group of
investors.
ESOP is a mechanism whereby a corporation can make tax
deductible contributions of cash or stock into a trust. The assets
are allocated to the employees and are not taxed until withdrawn
by them.
MLPs Master Limited Partnership is a type of limited
partnership whose shares are publicly traded.
Reduction of capital for
Extinguishing or reducing liability in respect of share capital not
paid-up
Writing-off capital that is lost
Paying off or returning excess capital that is not required by the
company

MOTIVATIONS FOR GOING PRIVATE

Elimination of costs associated with being a publicly held firm

(e.g., registration, servicing of shareholders, and legal and
administrative costs related to SEC regulations and reports).
Reduces the focus of management on short-term numbers to
long-term wealth building.
Allows the realignment and improvement of management
incentives to enhance wealth building by directly linking
compensation to performance without having to answer to the
public.

ESOPs

A trust fund that invests in the securities of the firm

sponsoring the plan.

ESOPs are tax deductible

ESOPs are used to restructure firms

ESOPs may be used by employees in LBOs and MBOs

They are an effective antitakeover defense

TYPES OF MERGERS
1. Horizontal mergers
- Mergers between two firms operating & competing in
the same kind of business activity;
- Main purpose is
. economies of scale by elimination of duplication of
facilities and operations
. broadening the product line
. reduction in investment in working capital
. elimination of competition in a product
. reduction in advertising costs
. increase in market share etc.;
- Decrease in no. of firms in an industry;
- Potential to create monopoly.
- Timing is the key
Exxon-Mobil,

2. Vertical mergers
- Involves merger between firms that are in different stages of
production or value chain;
- Combination of companies that usually have buyer seller
relationships;
- Backward & Forward integration;
. Motive is to reduce inventories of raw materials and finished
goods-better competitive power through controlling input prices
. implements its production plans as per the schedules
. better working capital management
. elimination of transaction costs etc.
Eg-RIL-RPL MERGER,
Acquisition by Pepsico acquisition of bottlers of Pizzahut and KFC
AOLs purchase of media and content provider Time Warner
Merck and Medco containment Services (forward)
Ford buying Hertz (forward)
Auto Car Rental Acquisitions: Chrysler, GM, Ford

Sales to car rental companies add to market share but not

profitability

3. Conglomerate mergers
- Merger between the firms engaged in unrelated types of
business activity; example- GE
- Motive is to utilize financial resources, enhance the stability
of acquirer company by creating balance in the companys total
portfolio of diverse products production processes. Philip
Morris, a tobacco company, acquired General Foods in 1985
for $5.6 billion
Types of Conglomerate mergers:
- Product extension mergers or Concentric mergers
- Geographic market extension merger
- Pure conglomerate merger
- Financial conglomerate-TDPL merged with Sun Pharma for
funds
- Managerial conglomerate

TYPES OF MERGERS
COGENERIC MERGERS
Type of merger when two merging firms are in the same industry but
have no mutual buyer-customer or supplier relationship, such as a bank
and a leasing company. For Example-Prudentials acquisition of Bache
and Company.
Example: American Express acquisition of Shearson Hamil
REVERSE MERGER

In a reverse merger, a private company may go public by merging with

an already existing public company that is often inactive. The publicly
traded company is often known as a shell corporation. Which is almost
in bankruptcy and the private company acquires such a company
because it has viable business.

In India, companies go for reverse mergers to take advantage of the

tax savings. Example-Kirloskar Pneumatics merged with Kirloskar
Tractors, a sick unit.

Reverse merger may also arise on account of regulatory requirements.

For example- reverse merger of ICIC in to ICICI Bank. ICICI could
become a universal bank only through a reverse merger with its
banking subsidiary.

Reverse mergers-a healthy unit is merged with a sick

company as a result of which the former loses its identity.
However, following a lapse of sometime, the name of the
sick unit is usually changed to that of the healthy unit . As
a result of this, under Section 72 A of the Indian Income
Tax Act, the healthy company can take advantage of sick
companys carry forward losses.

Example-Ahmedabad Laxmi Mills and Arvind Mills.

Holding Company: An acquiring company becomes a holding

company when it chooses to purchase only a portion of the
targets stock. The holding company that holds sufficient stock
has a controlling interest in the target. The advantages are

Lower cost

No control premium

Control with fractional ownership

Accretive mergers: The acquiring companys EPS increase or a company

with a high P/E acquires a company with a low P/E.

Dilutive mergers: A company with a low P/E acquires a company with a

high P/E.
: Daimler merger of equals with Chrysler (1998)
Merger of Equals two companies of equal size
Usually one company ends up being the dominant one
Example Daimler merger of equals with Chrysler (1998)

Statutory merger Specifically means that it is a merger pursuant to state

laws in which the acquirer is incorporated. The acquiring company assumes the
assets and liabilities of the target in accordance with the statutes of the state
where combined companies will be incorporated

Subsidiary merger a merger of two companies in which the target

becomes a subsidiary. The target may be operated under its brand name but it
will be owned and controlled by the acquirer.

Example: GM acquired EDS and made it a subsidiary and issued Class E shares

Earn-outs

Earn-outs is an arrangement whereby a part of the purchase

price is calculated by reference to the future performance of
the target company. The deal describes a payment to
shareholders selling their shares in the target company and
the payment made by the acquirer is based on the companys
profits in a specified period, usually after the closing of the
sale. The acquirer typically pays 60-80%of the purchase
price up front and the remaining 20-40% structured as an
earn-out and paid over time as the acquired company
achieves certain levels of sales or profitability.

The Acquisition Process

Pre-Purchase Decision
Activities

Post-Purchase Decision
Activities

Phase 1: Business Plan

Phase 2: Acquisition Plan

Phase 3: Search

Phase 4: Screen

Phase 5: First Contact

Phase 6: Negotiation

Phase 7: Integration Plan

Phase 8: Closing

Phase 9: Integration

Phase 10: Evaluation

Motivations for M&A

Strategic realignment
Technological change
Deregulation
Synergy
Economies of scale/scope
Cross-selling
Diversification (Related/Unrelated)
Financial considerations
Acquirer believes target is undervalued
Booming stock market
Falling interest rates
Market power
Ego/Hubris
Tax considerations

Primary Reasons Some M&As Fail to Meet Expectations

Overpayment due to over-estimating synergy

Slow pace of integration

Poor strategy

Merger Waves (Boom Periods)

Horizontal Consolidation (1897-1904)

Efficiency, enforcement of Sherman Anti-trust Act

Metals, transportation, mining. JP Morgan created US Steel

Increasing Concentration (1916-1929)

Industry concentration

The Conglomerate Era (1965-1969)

Rising stock market

High P/E ratios

Increasing leverage

High prices paid for targets

The Retrenchment Era (1981-1989)

Rise of corporate raiders

Proliferation of LBOs and hostile takeovers

Divestment of unrelated acquisitions by conglomerates

Era concluded with junk bonds, LBO bankruptcies

Age of Strategic Megamerger (1992-2000)

M&As declined during 1990s

IT revolution

Deregulation

Reduction in trade barriers

Trends towards privatisation

Age of Cross Border and Horizontal Megamergers (2003-2007)

Syndicated debt

Private Equity Investments

CDOs

Major Components of Deal Structuring Process

1.

Acquisition vehicle

2.

Post-closing organization

3.

Form of payment

4.

Form of acquisition

5.

Legal form of selling entity

6.

Accounting Considerations

7.

Tax considerations

Strategic Acquisitions
Involving Common Stock
Strategic Acquisition Occurs when one company acquires
another as part of its overall business strategy.

When the acquisition is done for common stock, a ratio

of exchange, which denotes the relative weighting of
the two companies with regard to certain key variables,
results.
A financial acquisition occurs when a buyout firm is
motivated to purchase the company (usually to sell
assets, cut costs, and manage the remainder more
efficiently), but keeps it as a stand-alone entity.

Strategic Acquisitions
Involving Common Stock
Example Company A will acquire Company B with shares of common stock.

Company A
Present earnings
Shares outstanding
Earnings per share
Price per share
Price / earnings ratio

$20,000,000
5,000,000
$4.00

Company B
$5,000,000
2,000,000
$2.50

$64.00

$30.00
16

12

Strategic Acquisitions
Involving Common Stock
Example Company B has agreed on an offer of $35 in common stock of
Company A.

Surviving Company A
Total earnings

$25,000,000

Shares outstanding*
Earnings per share

6,093,750
$4.10

Exchange ratio = $35 / $64 = 0.546875

* New shares from exchange = 0.546875 x 2,000,000
= 1,093,750

Strategic Acquisitions
Involving Common Stock
The shareholders of Company A will experience
an increase in earnings per share because of the
acquisition [$4.10 post-merger EPS versus $4.00
pre-merger EPS].
The shareholders of Company B will experience a
decrease in earnings per share because of the
acquisition [.546875 x $4.10 = $2.24 post-merger
EPS versus $2.50 pre-merger EPS].

Strategic Acquisitions
Involving Common Stock
Surviving firm EPS will increase any time the
P/E ratio paid for a firm is less than the
pre-merger P/E ratio of the firm doing the
acquiring. [Note: P/E ratio paid for
Company B is $35/$2.50 = 14 versus premerger P/E ratio of 16 for Company A.]

Strategic Acquisitions
Involving Common Stock
Example Company B has agreed on an offer of $45 in common stock of
Company A.

Surviving Company A
Total earnings

$25,000,000

Shares outstanding*
Earnings per share

6,406,250
$3.90

Exchange ratio = $45 / $64 = 0.703125

* New shares from exchange = 0.703125 x 2,000,000
= 1,406,250

Strategic Acquisitions
Involving Common Stock
The shareholders of Company A will experience
a decrease in earnings per share because of
the acquisition [$3.90 post-merger EPS versus
$4.00 pre-merger EPS].
The shareholders of Company B will experience
an increase in earnings per share because of
the acquisition [0.703125 x $4.10 = $2.88 postmerger EPS versus $2.50 pre-merger EPS].

Strategic Acquisitions
Involving Common Stock
Surviving firm EPS will decrease any time the
P/E ratio paid for a firm is greater than the
pre-merger P/E ratio of the firm doing the
acquiring. [Note: P/E ratio paid for
Company B is $45/$2.50 = 18 versus premerger P/E ratio of 16 for Company A.]

 Merger decisions should

not be made without
considering the longterm consequences.
The possibility of future
earnings growth may
outweigh the immediate
dilution of earnings.

Expected EPS ($)

What About
Earnings Per Share (EPS)?
With the
merger
Equal

Without the
merger
Time in the Future (years)

Initially, EPS is less with the merger.

Eventually, EPS is greater with the merger.

Market Value Impact

Market price per share
of the acquiring company

Number of shares offered by

the acquiring company for each
share of the acquired company

Market price per share of the acquired company

The above formula is the ratio of exchange of market

price.
If the ratio is less than or nearly equal to 1, the
shareholders of the acquired firm are not likely to
have a monetary incentive to accept the merger offer
from the acquiring firm.

Market Value Impact

Example Acquiring Company offers to acquire Bought Company with shares of
common stock at an exchange price of $40.

Acquiring
Company
Present earnings
$20,000,000
Shares outstanding 6,000,000
Earnings per share
$3.33
Price per share
$60.00
Price / earnings ratio
18

Bought
Company

$6,000,000
2,000,000
$3.00
$30.00
10

Market Value Impact

Exchange ratio
= $40 / $60
= .667
Market price exchange ratio = $60 x .667 / $30 = 1.33
Surviving Company
Total earnings
$26,000,000
Shares outstanding*
7,333,333
Earnings per share
$3.55
Price / earnings ratio
18
Market price per share
$63.90
* New shares from exchange = 0.666667 x 2,000,000
= 1,333,333

Market Value Impact

Notice that both earnings per share and market price
per share have risen because of the acquisition. This is
known as bootstrapping.
The market price per share = (P/E) x (Earnings).
Therefore, the increase in the market price per share
is a function of an expected increase in earnings per
share and the P/E ratio NOT declining.
The apparent increase in the market price is driven by
the assumption that the P/E ratio will not change and
that each dollar of earnings from the acquired firm will
be priced the same as the acquiring firm before the
acquisition (a P/E ratio of 18).

 Target firms in a
takeover receive an
average premium of
30%.
Evidence on buying
firms is mixed. It is
not clear that
acquiring firm
shareholders gain.
Some mergers do
have synergistic
benefits.

CUMULATIVE AVERAGE
ABNORMAL RETURN (%)

Empirical Evidence on
Mergers
Selling
companies
+

Buying
companies

Announcement date

TIME AROUND ANNOUNCEMENT

(days)

Developments in Mergers
and Acquisitions
Roll-Up Transactions The combining of
multiple small companies in the same
industry to create one larger company.
Idea is to rapidly build a larger and more valuable firm with
the acquisition of small- and medium-sized firms
(economies of scale).
Provide sellers cash, stock, or cash and stock.
Owners of small firms likely stay on as managers.
If privately owned, a way to more rapidly grow towards
going through an initial public offering (see Slide 24).

Developments in Mergers
and Acquisitions
An Initial Public Offering (IPO) is a companys first offering of
common stock to the general public.

IPO Roll-Up An IPO of independent companies in the same industry

that merge into a single company concurrent with the stock offering.

IPO funds are used to finance the

acquisitions.

Closing the Deal

Consolidation The combination of two or more firms into
an entirely new firm. The old firms cease to exist.

Target is evaluated by the acquirer

Terms are agreed upon
Ratified by the respective boards
Approved by a majority (usually two-thirds) of
shareholders from both firms
Appropriate filing of paperwork
Possible consideration by The Antitrust Division of the
Department of Justice or the Federal Trade
Commission

Factors Affecting Alternative Forms of Legal Entities

1.

Control by owners

2.

Management autonomy
Continuity of ownership
Duration or life of entity
Ease of transferring ownership

3.
4.
5.
6.
7.
8.

Limitation on ownership liability

Ease of raising capital
Tax Status