Unit 4: Corporate Restructuring

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CONTENTS

● Introduction,
● Forms of corporate restructuring –
▪ Spin off,
▪ Split off,
▪ Split up,
▪ Leveraged Buyout,
▪ Divestiture and
▪ other forms of corporate restructuring

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Introduction
● Corporate restructuring refers to broad array of activities that expand or
contract firm’s operations or substantially modify its financial structure or
about a significant change in its ownership structure.

Inter alia, it includes activities such as

▪ mergers,
▪ purchases of business units,
▪ takeovers,
▪ slump sales,
▪ demergers, and
▪ equity carveouts.

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● Corporate restructuring refers to the changes in ownership mix,

business mix, assets mix and alliances with view to enhance the
shareholder value.

● Hence, corporate restructuring may involve

▪ Ownership restructuring,
▪ Business restructuring and
▪ Assets restructuring.

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● In other words, Corporate restructuring refers to changes in the

○ Ownership
○ Business mix
○ Assets mix
○ Alliances
● With a view to enhance shareholder value
● It may involve
○ Ownership restructuring: M&A, LBOs, Buy back of shares, Spin off, JVs,
Strategic alliances, takeovers, demergers etc
○ Business restructuring: Diversification, outsourcing, divestment, brand
acquisitions, etc
○ Asset restructuring: Securitization, Sale & Lease, Factoring etc
○ Organisational restructuring: Organisational redesign, performance
enhancement programs etc
○ Capital restructuring: Debt-Equity Mix

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● A company can affect ownership restructuring through mergers and

acquisitions, leveraged buyouts, buyback of shares, spin-offs, joint
ventures and strategic alliances.

● Business restructuring involves the reorganization of business units

or divisions. It includes diversification into new businesses,
outsourcing, divestment, brand acquisitions, etc.

● Asset restructuring involves the acquisition or sale of assets and

their ownership structure. The examples of asset restructuring are sale
and leaseback of assets, securitization of debt, receivable factoring,
etc.

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IS THERE A LINK BETWEEN

CORPORATE RESTRUCTURING AND
SHARE HOLDER VALUE
MAXIMIZATION ???

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Of course yes…
● The basic purpose of corporate restructuring is to enhance the shareholder
value.

● A company should continuously evaluate its portfolio of businesses, capital

mix, and ownership and assets arrangements to find opportunities for
increasing the shareholder value.

● It should focus on assets utilization and profitable investment

opportunities, and reorganize or divest less profitable or loss-making
businesses/products.

● The company can also enhance value through capital restructuring; it can
design innovative securities that help to reduce cost of capital.

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Types of corporate restructuring activities

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CORPORATE RESTRUCTURING

DIVESTITURES
ACQUISITIONS
• Partial Sell Offs
• Mergers and Amalgamation • Demergers
• Purchase of a unit or plant • Equity Carve-Outs
• Takeovers • Division of Family-managed
• Leveraged Buyouts (LBO) Business
• Sale of equity stake

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ACQUISITIONS

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1. MERGERS AND AMALGAMATION

● The terms merger and amalgamation are used

interchangeably in practice.

● A merger is said to occur when two or more companies

combine into one company. One or more companies may
merge with an existing company or they may merge to
form a new company.

● In a merger, there is complete amalgamation of the assets

and liabilities as well as shareholders' interests and
businesses of the merging companies.

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Merger or amalgamation may take two forms:

● Merger through absorption

● Merger through consolidation

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● Absorption: Absorption is a combination of two or more companies into an

existing company. All companies except one lose their identity in a merger
through absorption.

○ An example of this type of merger is the absorption of Tata Fertilizers

Ltd (TFL) by Tata Chemicals Ltd. (TCL). TCL, an acquiring company
(a buyer), survived after merger while TFL, an acquired company (a
seller), ceased to exist. TFL transferred its assets, liabilities and shares to
TCL. Under the scheme of merger, TFL shareholders were offered 17
shares of TCL (market value per share being 7114) for every 100 shares
of TFL held by them.

● Consolidation: Consolidation is a combination of two or more companies

into a new company. In this form of merger, all companies are legally
dissolved and a new entity is created. In a consolidation, the acquired
company transfers its assets, liabilities and shares to the new company.

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THE THREE MAJOR TYPES OF MERGERS

● Horizontal merger: This is a combination of two or more firms in similar type
of production, distribution or area of business.
▪ Examples would be combining of two book publishers or two luggage manufacturing
companies to gain dominant market share.

● Vertical merger: This is a combination of two or more firms involved in

different stages of production or distribution. Vertical merger may take the
form of forward or backward merger.
▪ When a company combines with the supplier of material, it is called backward merger and
▪ when it combines with the customer, it is known as forward merger.
For example, joining of a TV manufacturing (assembling) company and a TV marketing company

▪ Conglomerate merger: This is a combination of firms engaged in unrelated

lines of business activity.
▪ A typical example is merging of different businesses like manufacturing of cement products,
fertilizers products, electronic products, insurance investment and advertising agencies.

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Motives & Purpose of mergers

● Strategic benefit – leading to inorganic growth (Grasim Industries – L&T

Cernco; TATA- Corus, Heritage Food – Vikram Diary)
● Snuffing out competition or preventing their entry – (Reliance –IPCL, Jet-
Sahara)
● Increasing Market Share ( Jet-Sahara, Kingfisher-Air Deccan)
● Entry into new markets ( Tata – Tetley, Vodafone – Hutch, DHL- Blue dart)
● Acquisition of new tech or competence or capability (Citigroup – e-serve,
Ranbaxy – Zanotech, Infosys – Philips Finance and Accounts BPO)
● Tax Shields ( Muruguppa Electronics - EID Parry)
● Access & Utilization of Surplus funds ( TATA – VSNL)

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Process of Merger

● Target Search and identification

● Evaluation of opportunity (Compatibility)
● Term Sheet ( Preliminary negotiation)
● Due diligence ( Financial, Legal ,HR, technical)
● Valuation and Negotiation
● Structuring ( development of bidding strategy, valuation and pricing target
company, financing the acquisition, negotiating and closing the deal)
● Documentation and legal status

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AMALGAMATION
● This is yet another mode of merger.

● Section 2(1A) of the Income Tax Act, 1961, defines amalgamation as

● the merger of one or more companies (called amalgamating company or

companies) with another company (called amalgamated company)

● 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 company or
companies become assets and liabilities of the amalgamated company

● and shareholders holding not less than nine-tenths in the value of the shares
in the amalgamating company or companies become shareholders of the
amalgamated company.

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Legal procedure in Mergers

❖ Examination of object clause
❖ Intimation to stock exchanges
❖ Approval of draft amalgamation by respective boards
❖ Application to the NCLT
❖ Dispatch of notice to shareholder and creditors
❖ Holding of meeting with shareholders and creditors
❖ Petition to the NCLT for confirmation and passing orders
❖ Filing the order with the Registrar
❖ Transfer of assets and Liabilities
❖ Issue of shares and debentures

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2. ACQUISITION
● A fundamental characteristic of merger (either through absorption or
consolidation) is that the acquiring or amalgamated company (existing or
new) takes over the ownership of other company and combines its
operations with its own operations.

● Acquisition may be defined as an act of acquiring effective control over

assets or management of a company by another company without any
combination of businesses or companies.

● A substantial acquisition occurs when an acquiring firm acquires

substantial quantity of shares or voting rights of the target company. Thus, in
an acquisition, two or more companies may remain independent, separate
legal entity, but there may be change in control of companies.

● An acquirer may be a company or persons acting in concert, that act together

for the purpose of substantial acquisition of shares or voting rights or gaining
control over the target company.
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3. TAKEOVER

● Generally speaking takeover means acquisition. A takeover occurs when the

acquiring firm takes over the control of the target firm. An acquisition or
take-over does not necessarily entail full, legal control.

● A company can have effective control over another company by holding

minority ownership.

● Under the earlier Monopolies and Restrictive Trade Practices Act, which has
been replaced by the Competition Act, 2002, takeover means acquisition of
not less than 25 per cent of the voting power in a company. If a company
wants to invest in more than 10 per cent of the subscribed capital of another
company, it has to be approved in the shareholders general meeting and also
by the central government.

● The investment in shares of other companies in excess of 10 per cent of the

subscribed capital can result into their takeovers.
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TAKEOVERS
● 2 types
○ Friendly takeover – it is in the form of negotiated deal and not the other
way around. In M&A transactions, a friendly takeover is the acquisition
of a target company by an acquirer/bidder with the consent or approval
of the management and board of directors of the target company.
○ Eg: TATA > 1 MG, BYJUS> AKASH EDU. SERVICES, L&T IT >
MINDTREE.

○ Hostile takeover – A hostile takeover is a type of acquisition where a

company (the acquirer) takes control of another company (the target
company) without the approval or consent of the target company's board
of directors. In other words, the target company's management is not in
favor of the takeover, hence the term "hostile". This is in the nature of
uninformed targeting the lucrative company by accumulating stock
through market operations.
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● A hostile takeover is an acquisition strategy requiring that the entity acquire and
control more than 50% of the voting shares issued by the company. It is considered
bad business etiquette.

● A tender offer and a proxy fight are two methods for achieving a hostile takeover.

● A tender offer is a bid to purchase some or all of the shareholders' stock in a

corporation. Tender offers are typically made publicly and invite shareholders to sell
their shares for a specified price and within a particular window of time. The price
offered is usually at a premium to the market price.

● In a proxy fight, where the entity tries to persuade/instigate stockholders to vote out
the current management and vote in management that would allow the takeover.

● The hostile takeover attempt by Reliance Industries Limited of L&T Finance in 2011. The
former acquired a 14.98% stake in the subsidiary of the engineering conglomerate L&T, without
L&T’s approval.

● The takeover of Satyam Computer Services by Mahindra Tech was another instance of a hostile
takeover in India. The former was involved in huge scandals of fraud and Mahindra Tech had
taken over the company with the aim of restoring
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TAKEOVER BY REVERSE BID

● When the smaller company gains control of a larger company then it

is called Takeover by Reverse Bid.
● Followed for reviving sick companies
● 3 tests which are required to be satisfied –
○ Assets of the transferor company are greater than assets of the transferee
company
○ Equity capital to be issued by the transferee company
○ Change of control in the transferee company will be through intro of minority
holders
● Control goes to shareholders of the company that was formally the
target of the bid
● Same term is used for purchase of a listed company by an unlisted
company with control passing to the shareholders of the unlisted
company (AKA backdoor listing)
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4. LEVERAGED BUYOUTS
● A leveraged buyout (LBO) is an acquisition of a company in which the acquisition is
substantially financed through debt. The acquiring company borrows money by
keeping the target company’s assets as collateral for the loan. If the debt is not repaid,
the target company's assets may be used to cover the outstanding debt.

When the managers buy their company from its owners employing debt, the
leveraged buyout is called management buyout (MBO).

● Debt typically forms 70-90 per cent of the purchase price and it may have a low credit
rating. Debt is obtained on the basis of the company's future earnings potential. LBOs
generally involve payment by cash to the seller.

● The main motivation in LBOs is to increase wealth rapidly in a short span of time. A
buyer would typically go public after four or five years, and make substantial capital
gains.

● Tata-Tetley deal, Tata Steel acquired the UK-based steel-making company Corus
Steel. Today it is known as Tata Steel Europe Ltd.
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LBO Targets: Which companies are targets for the leveraged

buyouts?
The following firms are generally the targets for LBOs:

● High growth, high market share firms

● High-profit potential firms
● High liquidity and high debt capacity firms
● Low-operating risk firms
● The demand for the company's product should be known so that its earnings
can be easily forecasted.

● A typical company for a leveraged buy-out would be one that has high profit
potential, high liquidity and low or no debt.

● Low operating risk of such companies allows the acquiring firm or the
management team to assume a high degree of financial leverage and risk.

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DIVESTITURES

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1. DIVESTMENT

● A divestment involves the sale of a company's assets, or product lines,

or divisions or brand to the outsiders.

● It is reverse of acquisition. Companies use divestment as a means of

restructuring and consolidating their businesses for creating more
value for shareholders.

● In divestment, the selling company intends to create more value for

shareholders. It sells the part of the business for a higher price than its
current worth. The remaining business might also find its true value.

● Thus, divestment creates reverse synergy.

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The following are some of the common motives for

divestment:

● Strategic change: Due to the economic and competitive changes, a company

may change product-market strategy. It might like to concentrate its energy
to certain types of businesses where it has competencies and competitive
advantage. Hence it may sell businesses that fit more with the new strategy.

● Selling cash cows: Some of the company's businesses might have reached
saturation. The company might sell these businesses which are now cash
cows. It might realize high cash flows potential in the future. that it can
invest in 'stars' that have high growth Potential in the future.

● Disposal of unprofitable businesses: Unprofitable businesses are a drain

on the company's resources. The company would be better of discarding
such businesses.

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● Consolidation: A company might have become highly

diversified due to unplanned acquisitions in the past. It might
sell its unrelated businesses, and consolidate its remaining
businesses as a balanced portfolio.

● Unlocking value: Sometimes stock market is not able to value a

diversified company properly since it does not have full
disclosure of information for the businesses separately. Once
the businesses are separated, the stock market correctly values
the businesses.

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There are several types of divestments:

● Selloff
● Partial Sell off
● Spin-off
● Split-up
● Demerger
● Division of Family-Managed Business
● Equity carve outs

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Selloff: When a company sells a part of its business to a third party, it is called
sell-off.

● It is a usual practice of a large number of companies to sell-off to divest unprofitable

or less profitable businesses to avoid further drain on its resources.

● Sometimes the company might sell its profitable but non-core businesses to ease its
liquidity problems.

● A sell off is the sale of an asset, factory, division, product line or subsidiary by one
entity to another for a purchase consideration payable either in cash or in the form
of securities.

● Normally, sell-offs are done because the subsidiary doesn't fit into the parent
company's core strategy.

● The market may be undervaluing the combined businesses due to a lack of synergy
between the parent and the subsidiary. So, the management and the board decide that
the subsidiary is better off under a different ownership. Besides getting rid of an
unwanted subsidiary, sell-offs also raise cash, which can be used to pay off debts.
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● Partial Sell off: it is a form of divestiture, wherein the firm sells its
business unit or a subsidiary to another because it deemed to be unfit
with the company's core business strategy.

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Spin-off: When a company creates a new company from the existing

single entity, it is called a spin-off.

● The spinoff company would usually be created as a subsidiary. Hence,

there is no change in ownership.

● In a spin-off, the parent company distributes shares of the

subsidiary that is being spun-off to its existing shareholders on
a pro rata basis, in the form of a special dividend.

● The parent company typically receives no cash consideration

for the spin-off. Existing shareholders benefit by now holding
shares of two separate companies after the spin-off instead of
one.

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● The spin-off is a distinct entity from the parent company and

has its own management.

● The parent company may spin off 100% of the shares in its
subsidiary, or it may spin off 80% to its shareholders and hold a
minority interest of less than 20% in the subsidiary.

The reasons for spin off may be:

● (i) Separate identity to a part/division.
● (ii) To avoid the takeover attempt by a predator by making the firm
unattractive to him since a valuable division is spun-off.
● (iii) To create separate Regulated and unregulated lines of business.

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Split-up: This involves breaking up of the entire firm into a series of

spin off (by creating separate legal entities).

● The parent firm no longer legally exists and only the newly created
entities survive.

● For instance, a corporate firm has 4 divisions namely A, B, C, D. All

these 4 divisions shall be split-up to create 4 new corporate firms with
full autonomy and legal status.

● The original corporate firm is to be wound up. Since de-merged units

are relatively smaller in size, they are logistically more convenient
and manageable.

● Therefore, it is understood that spin-off and split-up are likely to

enhance shareholders value and bring efficiency and effectiveness.
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● In a split-off, shareholders in the parent company are offered

shares in a subsidiary, but the catch is that they have to choose
between holding shares of the subsidiary or the parent
company.

● A shareholder has two choices: (a) continue holding shares in

the parent company or (b) exchange some or all of the, shares
held in the parent company for shares in the subsidiary.

● A split-off is generally accomplished after shares of the

subsidiary have earlier been sold in an initial public offering
(IPO) through a carve-out. Since the subsidiary now has a
certain market value, it can be used to determine the split-off's
exchange ratio.

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Demerger:

● A demerger involves the transfer by a company of one or more

of its business divisions to another company which is newly set
up.

● For example, the Great Eastern Shipping Company transferred

its offshore division to a new company called The Great
Offshore Limited.

● The company whose business division is transferred is called

the demerged company and the company to which the business
division is transferred is called the resultant company.

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Divestiture
● A divestiture (or divestment) is the disposal of company's
assets or a business unit through a sale, exchange, closure, or
bankruptcy.

● A partial or full disposal can happen, depending on the reason

why management opted to sell or liquidate its business'
resources.

● Divestiture may be a voluntary act effected to raise money,

stem operating losses, or reorganize a corporation.

● It also may be compulsory, where a government or regulator

demands a divestment to achieve a public policy goal under the
threat of legal action.

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Division of Family-Managed Business:

● Many of the family-managed companies are arranging to hive off their

unprofitable businesses or divisions with a view to meeting a variety of
succession problems.

● Even otherwise, a group of such family-managed companies may undertake

restructuring of its operations with a view also to consolidating its core
businesses.

For this, the company will have to do the following:

● first step that may need to be taken is to identify core and non-core
operations within the group.

● The second step may involve reducing interest burden through debt
restructuring along with sale of surplus assets.

● The proceeds from the sale of assets may be employed for expanding by
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acquisitions and rejuvenation of its existing operations.
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The bottom line is that an acquisition must improve

● economies of scale,
● lower the cost of production, and
● generate and promote synergies.

● Besides acquisitions, therefore, the group may necessarily have

to take steps to improve productivity of its existing operations.

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Equity carve outs:

● In an equity carveout, a parent firm sells a portion of its equity in a wholly
owned subsidiary. The sale may be done to the general investing public or a
strategic investor.

● Here a parent company makes its subsidiary public through an initial

public offering (IPO) of shares, amounting to a partial sell-off: A new
publicly listed company is created, but the parent keeps a controlling stake
in the newly traded subsidiary.

● A carve-out is a strategic avenue a parent firm may take when one of its
subsidiaries is growing raster and carrying higher valuations than other
businesses owned by the parent.

● A carve-out generates cash because shares in the subsidiary are sold to the
public, but the issue also unlocks the value of the subsidiary unit and
enhances the parent's shareholder value.
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The M&As are catalyzed by several factors:

● Technological changes: Advances in computers, information

systems, communication, and transportation have facilitated mergers.

● Globalisation: Adoption of international agreements such as the

General Agreement on Tariffs and Trade (GATT) have promoted
globalisation and free trade, forces which are conducive to mergers.

● Deregulation: Deregulation in major industries such as

telecommunications, transportation, financial services, and the utilities
has spurred mergers.

● Overcapacity:Global overcapacity in several industries has motivated

firms to resort to mergers as a means of consolidation.

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● Favourable financial environment: Buoyant stock market, benign

interest rates, and ample liquidity have created a financial
environment which is favourable for deal making.

● The race to become bigger: Currently there is a management

mindset that views mergers as a means to achieve the size and
capabilities to compete globally. Al Rappaport calls it "the race to
become bigger." He argues that acquisitions are made to catch up with
a competitor or pre-empt a competitor from making the acquisition.

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