Transcript Chapter 7
Chapter 7 Corporate Restructuring 1 A. Corporate Restructuring Activities Expansions and take over a) • 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 2 Corporate Control and defenses b) • 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 • Management Buy-out (MBO) • 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 3 Contraction c) • 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 4 Changes in ownership structure d) • 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) 5 B. The motives of Corporate Restructuring Tax Benefit a) • • 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) • • 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 6 • 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) 7 B. The motives of Corporate Restructuring Cash disgorgement c) • Management return control of discretionary cashflow 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 8 B. d) The motives of Corporate Restructuring Achieving a better business fit • • • e) Management team Divestitures Sharpening management focus Organization imperative Soft hard Equity is forgiving, debt insistent a pillow a sword 9 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 • • • • g) 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 10 C. Take over Motives a) • • • • • • • Create operating synergies Build corporate portfolio Acquire undervalue asset Improve efficiency by restructuring Maintain independence Tax motives Free cash-flow theory 11 b) Approaches Friendly takeovers 1. • • • • • • 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. • • • • • 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 12 D. Leverage Buy Out (LBO) Background a) • • • • • 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 13 b) The LBO process LBO buyers Individual buyers Larger corporations Persons with self-ego Increase short-term EPS Smaller private companies Cash flow 14 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 15 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 16 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 17 b) The LBO process Financing LBO Junk bonds 1. • • Pioneered by Drexel Burnhom Lambert (DBL) ＄200 billion Junk bond market in 1989 Mezzanine Financing 2. • • Private placement to a small group of institutions, such as pension funds of insurance companies Inexpensive and quick issue 18 3. Bridge financing • • • 4. Venture capital • • 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 • • Take a portion of the target firm’s equity on its own book A high-stakes games 19 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. • 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. • • • Agency problem Efficient in decision making, publication of sensitive information, production, portfolio Tax benefit from saving of interest depreciation and ESOP 26 e) Investment Banking in the LBO Preliminary analysis of the targets cash flow 1. • • • Sensitivity analysis 2. • 3. 4. 5. 6. Reduce debt Acquire asset Pay cash dividend Underlying assumption (sales) ROI Debt Sources adequacy ESOP When to cash out 27