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Chapter 32

CORPORATE RESTRUCTURING

Brealey, Myers, and Allen


Principles of Corporate Finance
11th Global Edition
McGraw-Hill Education Copyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
CHAPTER OVERVIEW

Corporate restructuring
Leverage buyouts (LBOs) and
management buyouts (MBOs)
Fusion and fission in corporate finance
Private equity
Bankruptcy

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32-1 LEVERAGED BUYOUTS
Leveraged buyouts (LBOs)
Acquisition of a company financed largely by
borrowed funds
Very high leverage, up to 90% debt
Facilitate by the invention of junk bonds by
Michael Milken in 1980s.
Assets of the company are used as collateral
Usually the company later goes private
Acquisitions are usually hostile

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LBO

In 1985, R. J. Reynolds, a tobacco


company completed its merger with
Nabisco, a biscuit company. The new
company is called: RJR Nabisco.
In 1989 Kohlberg Kravis Roberts uses junk
bonds to finance its $26 billion hostile
takeover of RJR Nabisco. This was the
largest LBO in history at the time.

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CORPORATE RAIDERS

Corporate raiders specialise in


launching hostile takeovers of companies
with undervalued assets.
Three veteran corporate raiders - or activist
investors as they are also known - who still
hit the headlines are Nelson Peltz, Carl
Icahn and Kirk Kerkorian.
Others include: T. Boone Pickens

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NELSON PELTZ
Nelson Peltz is worth $1.4bn (700m). Born in
Brooklyn, he dropped out of college in the
1960s to work in the family food business
selling frozen and fresh produce to New York
restaurants. He sold it, making $8m.
For much of the next two decades he was as
likely to be spotted on the Hollywood party
circuit than Wall Street, with actresses including
Diana Rigg and Victoria Principal on his arm.

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NELSON PELTZ - CONTD
With financing arranged by the infamous junk
bond king Michael Milken, he bought a small
copper-wire and coin changing business,
Triangle Holdings, in the early 1980s and used it
as a vehicle for a series of acquisitions of larger
firms. He sold the business in 1990 and banked
an $830m profit.
He is perhaps best known for buying the soft
drinks brand Snapple for $300m from Quaker
Oats in 1997. He sold the business to Cadbury
three years later for $1.5bn after reviving sales.
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CARL ICAHN
Carl Icahn is worth $13bn. Raised in Queens, New
York, he studied philosophy at Princeton and began
studying medicine, but dropped out.
He is said to have arrived on Wall Street with just
$4,000, which he parlayed into a massive fortune in
the junk bond heydays of the 1980s. He is said to
have been a model for the character Gordon Gekko
in the film Wall Street.
In 1985 he took control of the airline TWA, although
his talents as a manager are less certain than his
ability as deal-maker. The airline went bankrupt in
the early 1990s. 32-8
CARL ICAHN - CONTD
He targeted oil firms Texaco, Philips and US
Steel, agitating for change. Sometimes they
would buy his shares back at a premium just to
make him go away (known as greenmail).
He tried to buy RJR Nabisco but it was bought
by Philip Morris, making Icahn $980m.
Icahn sees himself as a champion of shareholder
value, cutting the fat and bureaucracy from companies.
He recently said companies "by and large, are run
abysmally". He has also been a fierce critic of
excessive boardroom pay.
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KIRK KERKORIAN
Kirk Kerkorian is worth $15bn. Born in Fresno,
California, to Armenian immigrants, Kerkorian dropped
out of school and became an amateur boxer. He joined
the British Royal Air Force and was a pilot in the
second world war.
When he arrived home, he paid $60,000 for a small
plane and began a charter service to fly gamblers
between Los Angeles and Las Vegas. He sold the firm
two decades later for $104m.
He invested the proceeds in Las Vegas in the 1960s
and built some of the largest hotels in the city, including
the MGM Grand. He sold the company but later
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KIRK KERKORIAN - CONTD
It paid $8bn for another resort group, Mandalay, two
years ago and now owns more than half the hotel
rooms on the Las Vegas strip.
Kerkorian also bought and sold the MGM film studio
three times, most recently to Sony for $5bn.
In the mid-1990s he launched a failed hostile
takeover bid for Chrysler, the American carmaker.
But he was left with a large stake, making about
$3.5bn when it merged with Daimler.
Kerkorian has been described by people who know
him as "a born gambler". He almost never gives
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32-1 MANAGEMENT BUYOUTS (MBO)
MBOs are LBOs done by existing management
Used as exit strategies for large corporations who
wish to sell divisions that are not part of their core
business
Also used by private businesses where the owners
wish to retire
The financing required for an MBO is usually a
combination of debt and equity that is derived from
the buyers, financiers and sometimes the seller.

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32-1 LEVERAGED BUYOUTS REASONS
Corporate Control
Power to make investment and financing
decisions
Corporate Governance
Control of the board - shareholder voting, proxy
fights and actions taken by shareholders to
influence corporate decisions
Board appoints top management

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What are the benefits of a public listed
company going private?

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TABLE 32.1A RECENT LEVERAGED BUYOUTS

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TABLE 32.1B RECENT LEVERAGED BUYOUTS

Dells EMC LBO: http://marketrealist.com/2015/10/dells-proposed-


acquisition-emc-67-billion/comments

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32-1 LEVERAGED BUYOUTS: GAINERS AND LOSERS
Junk-bond markets high risk, high yield bonds
with high probability of default. Popular in the
1980s, but less favored in the 1990s
Leverage and taxes high debt means high tax
savings, but is this an important motive for LBOs?
Shareholders vs. bondholders selling
shareholders gain but the financing bondholders
lose if the company turns bad
Improved incentives successful LBOs are the
results of management hard work and improved
efficiency due to improved incentives
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LEVERAGE RESTRUCTURING (WITHOUT LBO)
Just go for high leverage, without buyout and
going private
The case of 1989 Sealed Air (see page 840)
High leverage forces employees to work
harder to pay debt greater incentives
Do we want to suggest this approach to
managers in Malaysia?
But would banks be willing to lend the
money?
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32-1 LEVERAGED BUYOUTS
LBOs (versus Acquisitions)
Large fraction of purchase price is debt
financed
In LBO the company goes private, no longer
traded on open market
Three Characteristics of LBOs
High leverage
Incentives to management
Going private

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RJR NABISCO LBO
In October 1988, Ross Johnson, the CEO of RJR Nabisco
lead a group of investors to buyout all RJRs stock for $75
per share (an MBO attempt)
RJR price immediately jumped from $56 to $75; while its
bonds fell. The offer put RJR in play
Four days later KKR bid $90 per share (paid $79 cash
and $11 in preferred stock)
After some contest, KKR bid $109 per share ($81 cash,
$10 sub bonds, 18 preferred stock)
Johnson counter bid $112 in cash and securities
RJR Board chose KKR! WHY?

(Read page 837-8 for the rest of the story and here.
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32-2 FUSION AND FISSION IN CORPORATE
FINANCE
Fusion strategies
Mergers, acquisition, takeover, LBOs, MBOs,
consolidation
Fission strategies
Spin-offs, carve-outs, divestitures, asset sales,
privatizations

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32-2 FUSION AND FISSION IN CORPORATE
FINANCE
Spin-off (or split-up)
Creating an independent company by detaching
part of parent company's assets and operations
Shares of the new company are distributed to
shareholders of the parent company
Useful strategy for companies wanting to focus
on core business activities
Beneficial to the new company because it is
running its own operations and incentives to
employees improved efficiency
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32-2 FUSION AND FISSION IN CORPORATE
FINANCE
Carve-outs
Creating an independent company by detaching
part of parent company's assets and operations
But shares of new company are sold as an IPO
to the open market (not given to existing
shareholders as in the spin-off case)
But parent usually keep a majority control

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32-2 FUSION AND FISSION IN CORPORATE
FINANCE
Divestiture or Asset Sales
Disposal of a business unit through sale or closure.

As companies grow they tend to diversify to too many lines of


business; they must close some business units in order to
focus on more profitable lines.
Divestiture may be due to a court order under anti-trust laws.
Companies may also sell off business lines if they are under
financial duress and need cash.
One of the most famous cases of court-ordered divestiture
involves the breakup of the Bell System in 1982, that created
several new telephone companies, including AT&T and the
Baby Bells as well as new equipment manufacturers.
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FIGURE 32.1 AT&T ANTITRUST SETTLEMENT

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32-2 FUSION AND FISSION IN CORPORATE
FINANCE
Privatization
Sale of government-owned companies (or
statutory bodies) to private investors. Examples
in Malaysia, privatization of Telecom, NEB, MAS
Privatization is like government carve-outs
Privatization motives
Raising cash to government
Increased efficiency more market oriented
Shared ownership
Revenue for the government
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32-3 PRIVATE EQUITY
Equity capital that is not quoted on a stock exchange.
Private equity consists of investors and funds that make
investments directly into private companies or conduct
buyouts of public companies.
Capital for private equity is raised from retail and
institutional investors, and can be used to fund new
technologies, working capital or make acquisitions (LBOs)
Private equity consists of institutional and accredited
investors who can commit large sums of money for long
periods of time to allow for a turnaround of a distressed
company or a liquidity event such as an IPO or sale to a
public company.

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FIGURE 32.2 PRIVATE EQUITY PARTNERSHIP

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TABLE 32.2 PRIVATE EQUITY PORTFOLIO -
BLACKSTONE GROUP 2012

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TABLE 32.3 CONGLOMERATES 1979

Ranked by Sales Compared with U.S.


Industrial Corporations

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TABLE 32.4 PRIVATE EQUITY FUND VS.
PUBLIC CONGLOMERATE

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32-4 BANKRUPTCY
A legal proceeding involving a person or business that is
unable to repay outstanding debts.
The bankruptcy process begins with a petition filed by the
debtor (most common) or on behalf of creditors (less
common).
All of the debtor's assets are measured and evaluated,
whereupon the assets are used to repay a portion of
outstanding debt.
Upon completion, the debtor is relieved of the debt
obligations
Bankruptcy offers an individual or business a chance to
start fresh by forgiving debts that simply can't be paid while
offering creditors a chance to obtain some repayment.
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TABLE 32.5 LARGEST NONFINANCIAL
BANKRUPTCIES

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