Corporate Restructuring

G. Thouseef Ahamed
Introduction
Corporate restructuring includes:
Mergers and acquisitions (M&A),
Amalgamation,
take-overs,
Spin-offs,
Leveraged buyouts,
Buyback of shares,
Capital reorganization ,
Sale of business units and assets, etc.
Meaning
“Corporate restructuring refers to the
changes in ownership, business mix,
assets mix and alliances with a view to
enhance the shareholder value.”

Hence, corporate restructuring may involve:

Ownership restructuring,
Business restructuring and
Assets restructuring.
Ownership restructuring:
 A company can affect ownership restructuring
through mergers and acquisitions, leveraged
buyouts, buyback of shares, spin-offs, joint ventures
and strategic alliances.
Business restructuring:
 It involves the reorganization of business units or
divisions.
 It includes diversification into new businesses,
outsourcing, divestment, brand acquisitions, etc.
Asset restructuring:
 It 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.
TYPES OF BUSINESS COMBINATIONS
Merger or 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
Merger or amalgamation may take two
forms:
Merger through absorption
Merger through consolidation
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:
 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.
 TFL shareholders were offered 17 shares of TCL 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.
An example of consolidation is the merger or
amalgamation of Hindustan Computers Ltd,
Hindustan Instruments Ltd, Indian Software
Company Ltd and Indian Reprographics Ltd.
in 1986 to an entirely new company called
HCL Ltd.
Acquisition
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.

Substantial acquisition occurs when an

acquiring firm acquires substantial quantity of
shares or voting rights of the target company.

In an acquisition, two or more companies may

remain independent, separate legal entity, but
there may be change in control of companies.
Takeover:
Generally speaking takeover means acquisition.
A takeover occurs when the acquiring firm takes
over the control of the target firm.
A company can have effective control over another
company by holding minority ownership.
Competition Act, 2002, takeover means
acquisition of not less than 25 per cent of the
voting power in a company.
Sometimes, a distinction between takeover and
acquisition is made.
The term takeover is understood to connote
hostility.
When an acquisition is a ‘forced’ or ‘unwilling’
acquisition, it is called a takeover.
Holding company:
A holding company is a company that holds
more than half of the nominal value of the
equity capital of another company, called a
subsidiary company, or controls the
composition of its Board of Directors.
Both holding and subsidiary companies retain
their separate legal entities and maintain
their separate books of accounts.
Forms of Merger
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.
For example, joining of a TV manufacturing
(assembling) company and a TV marketing company
or the joining of a spinning company and a weaving
company.
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.
When it combines with the customer, it is known
as forward merger.
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.
MOTIVES AND BENEFITS OF MERGERS
AND ACQUISITIONS
1. Accelerated Growth:
Maintaining or accelerating a company’s
growth, particularly when the internal growth
is constrained due to paucity of resources;
Attract the most talented executives but it
would also be able to retain them.
Provide challenges and excitement to the
executives as well as opportunities for their job
enrichment and rapid career development.
Growth leads to higher profits and increase in
the shareholders’ value.
 A company can achieve its growth objective by:
1. Expanding its existing markets
2. Entering in new markets
Mergers and acquisitions may help to
accelerate the pace of a company’s growth in a
convenient and inexpensive manner.
2. Enhanced Profitability
This may happen because of the following
reasons:
1. Economies of scale
 when increase in the volume of production leads to
a reduction in the Cost of production per unit.
1. Operating economies
 May avoid or reduce overlapping functions and

facilities.
 Example: Eliminate duplicate channels of
distribution, or create a centralized training centre,
or introduce an integrated planning and control
system
2. Synergy
 Combined firm is more valuable than the sum of the

individual combining firms.

 It is defined as ‘two plus two equal to five’ (2 + 2 =

5) phenomenon.
3. Diversification of Risk
Diversification implies growth through the
combination of firms in unrelated businesses.
Total risk will be reduced if the operations of
the combining firms are negatively correlated.
4. Reduction in Tax Liability
In India, a profitable company is allowed to
merge with a sick company to set-off against its
profits the accumulated loss and unutilized
depreciation of that company.
A number of companies in India have merged
to take advantage of this provision.
5. Financial Benefits:
 Financing constraint:
 Surplus cash
 Debt capacity
 Financing cost
6. Increased Market Power
A merger can increase the market share of
the merged firm.
Valuation of Enterprise
Discounted Cash Flow Approach
Comparable Company Approach
Discounted Cash Flow Approach
The DCF method starts by forecasting the future cash
flows of the business.
The future cash flows are then discounted back to their
present value using a discount rate.
This rate typically reflects the weighted average cost of
capital (WACC).
Since cash flow projections cannot be made indefinitely,
a terminal value is often calculated to account for the
value of cash flows extending beyond the forecast
period.
Building blocks:
• The cashflow
• The timing of the cashflow
• The rate at which the cash flow gets
discounted
Enterprise Valuation:
FCFF
Equity Valuation:
FCFE

Both begin with Free Cash Flows:

Free cash flow calculation

FCFF =PAT + Depreciation + Amortization +

Deferred Taxes + Interest charges – Change in
working capital – change in fixed asset
investments.
From the free cash flow equation, if we
separate the principal repayment and the
interest payments, we are left with the ‘Free
cash flow to the Equity.’
Terminal value:
We are projecting the future cash flow up to the
next five years; on the other hand, we expect
the company to exist forever, which implies it
will continue to generate a cash flow as long as
it exists.
Present value of Terminal Value = C (1+
g)/(r-g)
Where –
C = cash as of today
g = growth rate i.e. inflation rate
r = discount rate (either for equity investors or
the firm as such)
Terminal Growth value:
= 5th Year cash flow * (1+terminal growth
rate)/(WACC-terminal growth rate)
Comparable Company Approach
Comparable Companies (Comps) Analysis involves
identifying publicly traded companies in the same
industry with similar growth prospects, and economic
characteristics.
Analysts use financial metrics and multiples such as
Price to Earnings (P/E), Enterprise Value to EBITDA
(EV/EBITDA), and Price to Book (P/B) ratios and apply
them to the target company’s financials.
Example:
find the EBITDA from the business
multiply this by the EBITDA multiple(EV/EBITDA ratio)
Corporate Value Based Management
VBM is a framework utilized in financial
management to align a company’s overall
management processes and operations with
the goal of maximizing shareholder value.
This approach ensures that every decision
made adds value to its shareholders, thereby
increasing the over all corporate value.
Principles
Focus on Value Creation:
Primary objective of VBM is to create added
value for shareholders.
Done by managing company in a way that its
long-term intrinsic value is maximised.
 Metrics and Measurements:
VBM employs specific metrics to measure
value creation.
Eg Economic Value Added, Market Value
Added, Cash flow Return on Investment.
Integrated Management Processes:
VBM integrates value creation into strategic
decision, resource allocation, performance
management and incentive systems.
This ensures a coherent and unified approach
towards Company’s value maximization goal.
VAM Approaches
Marakon Approach
McKinsey Approach
Marakon Approach
The Marakon model was developed by
Marakon Associates, a management
consulting firm.
According to Marakon model, a
firm’s value is measured by the ratio of its
market value to the book value.
An increase in this ratio depicts an increase in
the value of the firm
A reduction reflects a reduction in the firm’s
value.
The model further states that a firm can
maximize its value by following these four
steps:
1.Understand the financial factors that determine
the firm’s value
2.Understand the strategic forces that affect the
value of the firm
3.Formulate strategies that lead to a higher value
for the firm
4.Create internal structures to counter the
divergence between the shareholders goals and
the management’s goals.
1. Financial Factors
The first step in this model is to identify the
financial factors that affect the value of the
firm.
The model states that a firm’s market value
to book value ratio, and hence, its value
depends on three factors:
return on equity,
cost of equity, and
growth rate.
This conclusion is drawn indirectly from the
constant growth dividend discount model.
P/B = M/B = (rxb) / (k-g)
where,
• M, be the current market price of the firm’s
share
• k, be the cost of equity
• g, be the growth rate in earnings and dividends
• r, be the return on equity
• B, be the current book value per share
• b, be the dividend pay-out ratio.
2. Strategic Forces
The financial factors that affect a firm’s value are
in turn affected by some strategic forces.
The two important strategic factors that affect a
firm’s value:
1. Market economics
 Level of entry barriers
• Level of exit barriers
• Degree of direct competition
• Degree of indirect competition
• Number of suppliers
• Kinds of regulations
• Customers influence.
• Competitive position
2. Competitive position
Competitive Position refers to a firm’s
relative position within the industry.
• Access to cheaper sources of finance
• Access to cheaper raw material
• State-of-the-art technology resulting in better
quality control
• Better management
• Strong dealer network
• Exceptional labor relations.
3. Formulation of Strategies
Once a company has identified its potential
growth prospects and analyzed its strengths
and weaknesses:
It needs to develop strategies that would help
it utilize its strengths and underplay its
weaknesses.
For achieving this objective two kinds of
strategies are required:
Participation strategy and
Competitive strategy.
Participation strategy
Either operate in an area where the market
economies are favorable, or has to produce
those products in which it can enjoy a highly
competitive position.

Competitive strategy.
Plan of action required for achieving and
maintaining a competitive advantage in those
markets
4. Creation of Internal Structures
The separation of ownership and
management create conflict between them.
A firm needs internal structures which can
control or reduce this conflict.
These may include:
• The management’s compensation being linked
to the company’s performance.
• Corporate governance mechanisms that specify
responsibilities and holds managers
accountable for their decisions.
• Resource allocation among projects guided by
the specific requirements of the projects rather
than the past allocations and capital rationing.
Corporate Governance
Corporate governance is the system of rules, practices,
and processes by which a company is directed and
controlled.
Principles
• Fairness: The board of directors must treat shareholders,
employees, vendors, and communities fairly and with equal
consideration.
• Transparency: The board should provide timely, accurate,
and clear information about such things as financial
performance, conflicts of interest, and risks to shareholders
and other stakeholders.
• Risk Management: The board and management must
determine risks of all kinds and how best to control them.
They must act on those recommendations to manage risks
and inform all relevant parties about the existence and status
of risks.
Responsibility:
The board is responsible for the oversight of corporate
matters and management activities.
Part of its responsibility is to recruit and hire a
chief executive officer (CEO). It must act in the best
interests of a company and its investors.
Accountability:
 The board must explain the purpose of a company's
activities and the results of its conduct.
Eg “Why did you appoint this CEO over other
candidates? Why did you select this as a top
priority?