Mergers, Acquisitions & Corporate Restructuring

Corporate Restructuring
Definition A. Change in the capital structure that is not in the ordinary course of the business or B. Change in the ownership structure or control over management or C. Change in the business capacity or portfolio by an inorganic route.

Why Corporate restructuring?

Nothing is permanent except change. What could be the reasons for change ? Increased competition, Advent of a new & more efficient technology, Emergence of competing products Emergence of new markets/ new class of consumers Demographic changes Business cycles, etc To achieve economies of scale /scope. To avail tax benefits. To achieve synergy To increase market share /revenue

Illustrating Economies of Scale

Period 1: Firm A (Pre-merger) Assumptions: Price = $4 per unit of output sold Variable costs = $2.75 per unit of output Fixed costs = $1,000,000 Firm A is producing 1,000,000 units of output per year Firm A is producing at 50% of plant capacity
Period 2: Firm A (Post-merger) Assumptions: Firm A acquires Firm B which is producing 500,000 units of the same product per year Firm A closes Firm Bs plant and transfers production to Firm As plant Price = $4 per unit of output sold Variable costs = $2.75 per unit of output Fixed costs = $1,000,000 Profit = price x quantity variable costs fixed costs = $4 x 1,500,000 - $2.75 x 1,500,000 - $1,000,000 = $6,000,000 - $4,125,000 - $1,000,000 = $875,000 Profit margin (%)2 = $875,000 / $6,000,000 = 14.58% Fixed costs per unit = $1,000,000/1.500,000 = $.67

Profit = price x quantity variable costs fixed costs = $4 x 1,000,000 - $2.75 x 1,000,000 - $1,000,000 = $250,000 Profit margin (%)1 = $250,000 / $4,000,000 = 6.25% Fixed costs per unit = $1,000,000/1,000,000 = $1

Key Point: Profit margin improvement is due to spreading fixed costs over more units of output. 1Margin per $ of revenue = $4.00 - $2.75 - $1.00 = $.25 2Margin per $ of revenue = $4.00 - $2.75 - $.67 = $.58

Illustrating Economies of Scope

Pre-Merger:
Firm As data processing center supports 5 manufacturing facilities Firm Bs data processing center supports 3 manufacturing facilities

Post-Merger:
Firm As and Firm Bs data processing centers are combined into a single operation to support all 8 manufacturing facilities By combining the centers, Firm A is able to achieve the following annual pre-tax savings: Direct labor costs = $840,000. Telecommunication expenses = $275,000 Leased space expenses = $675,000 General & administrative expenses = $230,000

Key Point: Cost savings due to expanding the scope of a single center to support all 8 manufacturing facilities of the combined firms.

Activities which are not termed as corporate restructuring

A. Intial creation of a corporation B. Change in the internal command structure or hierarchy C. Change in the business process D. Downsizing E. Outsourcing, ERP, TQM, franchising, networking, licensing

Forms of Corporate Restructuring

Merger Consolidation Acquisition Divestiture Demerger Carve out Joint venture Reduction of capital Buy- back of securities Delisting of securities/ Company

Merger
Combination of all the assets, liabilities, loans & businesses of 2 or more companies such that one of them survives. Merger of JSW Steel & JSW Ispat. Merger of RTIL & Mynylon. A ltd. is proposed to be merged with B ltd., wherein based on relative valuation of both companies , shareholders of A ltd. will be given 2 shares of B ltd for every 5 shares of A ltd. held by them.

A ltd No. of Shares Share capital 1 Cr of Rs. 10/- each Rs. 10 Cr

B ltd 5 Cr of Rs. 10 each Rs. 50Cr

B ltd 5.4 of Rs. 10 each Cr Rs. 54 Cr

Consolidation
Creation of an altogether new company owning assets, liabilities, loans and businesses of 2 or more companies, both/all of which cease to exist. A ltd. & B Ltd. decide to consolidate into C Ltd.. Based on relative valuation it is decided that for every 2 shares of A Ltd. the shareholders of A ltd. will get 1 share of C ltd. and for every 5 shares of B Ltd. The shareholders will get 2 shares of C Ltd.
A Ltd Shares Share Capital 1 Cr. of Rs. 10 each Rs. 10 Cr B Ltd 5 Cr. of Rs. 10 each Rs. 50 Cr C Ltd. 2.5 Cr. of Rs. 10 each Rs. 25 Cr.

Example of Consolidation
Federal steel Co., American Steel & wire Co., National tube Co., American Tin Plate Co., National Tube Co., American steel hoop Co. & American Sheet Steel Co. were consolidated to form

U.S . Steel Co.

Acquisition
An attempt by which a company, or an individual or a group of individuals acquires control over other company or right to control management & policy decisions. From a legal point of view, in an acquisition, the target company still exists as an independent legal entity, which is controlled by the acquirer. Ways of acquisition: A. Acquiring substantial percentage of voting capital of the target company B. Acquiring control over an investment or holding company , whether listed or unlisted, that in turn holds controlling interest in the target company C. Simply acquiring management control through a formal or informal understanding or agreement with the existing person in control of the target company.

Divestiture
Sale of all or substantially all the assets of the company or any kind of its business undertakings/ divisions, usually for cash or for a combination of cash & debt and not against any equity shares. Also known as slump sale as all assets: fixed assets, net current assets and investments are sold as one lump for one lump sum amount and not for each asset separately. Normally the loans are not taken over by the purchaser. Divestiture is normally used to mobilize resources for core business or businesses of the company by realizing value of non-core business assets which helps them focus on the core businesses and hence improve its P/E multiple and hence the market cap. Example- Camlin Limited.

Demerger
Spin off : It involves transfer of all or substantially all the assets, liabilities, loans and business of one of the business divisions or undertaking to another company whose shares are allotted to the shareholders of the transferor company on a proportionate basis. Split- up: It involves transfer of all or substantially all the assets, liabilities, loans and business of one of the company to two or more companies in consideration for equity shares on a proportionate basis but the transferor company ceases to exist. Split- off : is a spin off with a difference that all the shareholders of the transferor company do not get the shares of the transferee company in the same proportion in which they hold the shares in the transferor company; instead they get shares in the transferee company in exchange of shares in the transferor company.

Example
Demerger of Indal Indal demerged its aluminum business into HINDALCO which acted as the resulting company whereas the Demerged Indal was left with a small business of aluminum foil. Spin-offs & split-ups are normally resorted to achieve focus in the respective businesses, especially if the businesses are non-synergetic. Split-offs are used to realign the inter se holding of promoters

Carve- Out
It is a hybrid of divestiture & spin-off. A company transfers all the assets, liabilities, loans & business of one of its divisions to its 100% subsidiary Thus, at the time of transfer the shares of the resulting company are issued to the transferor company itself & not to the shareholders. Later on the company sells the shares in parts to outsiderswhether institutional investors by private placements or to retail investors by offer for sale. Carve-outs are used to separate capital hungry businesses from the businesses requiring normal levels of capital so that further fund raising by equity dilution can be restricted to only capital intensive businesses sparing the other businesses from equity dilution.

Joint Venture
An arrangement by which two or more companies called joint venture partners contribute to the equity capital of a new company called joint venture in pre-decided proportion JVs are formed to pool the resources of the partners and carry out a business or a specific project beneficial to both the partners But none of the partners wants to carry out under its own corporate entity.

Reverse Takeover & Reverse Merger

A smaller firm will acquiring management control of a larger and/or longer-established company and retain the name of the latter for the postacquisition combined entity. This is known as a reverse takeover. Reverse merger, a form of transaction that enables a private company to be publicly listed in a relatively short time frame. A reverse merger occurs when a privately held company (often one that has strong prospects and is eager to raise financing) buys a publicly listed shell company, usually one with no business and limited assets.

 A horizontal merger is usually between two companies in the same business sector. The example of horizontal merger would be if a health cares system buys another health care system. This means that synergy can obtained through many forms including such as; increased market share, cost savings and exploring new market opportunities. A vertical merger represents the buying of supplier or marketing & distribution channels of a business. In the same example as above if a health care system buys the ambulance services from their service suppliers is an example of vertical buying. The vertical buying is aimed at reducing overhead cost of operations and economy of scale. Conglomerate M&A is the third form of M&A process which deals the merger between two irrelevant companies. The example of conglomerate M&A with relevance to above scenario would be if health care system buys a restaurant chain. The objective may be diversification of capital investment.

 Buy-Back Of Securities: A very important tool of Capital restructuring ( capital reduction ) When a company holds excess cash, which it does not require in the medium term; it is prudent for the company to return its excess cash to its shareholders via buy-back of securities Manners in which reduction of capital can be effected: 1. By extinguishing or reducing the liability in respect of share capital not paid-up (since not called up yet.) 2. By writing off or cancelling the capital which is lost 3. By paying off or returning excess capital that is not required by the company Provisions regarding the buy-back of securities..docx

Delisting of securities
Delisting of securities: delisting of equity shares from all the stock exchanges. Refer to the SEBI guidelines for delisting of securities.SEBI Guidelines for delisting of securities.pdf

Takeover Tactics
1. Dawn raid 2. Bear hug 3. Saturday night special or godfather offer Successful takeover tactics in India 1. Market accumulation followed by an open offer 2. Negotiated deal with FI followed by an open offer 3. Negotiated deal with the partner followed by an open offer. 4. Direct offer to the shareholders of the target company

Anti Takeover/ Defense Tactics

Crown jewels Blank Cheque Shark repellents a) Poison pill Issue of rights/warrants Selling shares at a very high price Borrow large amount of long-term loans Leveraged cash out Leveraged recap

b) c) d) e) f) g) h) i) j)

Poison put Scorched Earth People pill Golden parachute Pac man Green mail White knight Grey knight Buy-back