Chapter 22 Corporate Restructuring © 2001 South-Western College Publishing

2 Corporate Restructuring External Expansion Failure Merger Acquisition Bankruptcy

3 Types of Combinations u Merger ä Vertical ä Horizontal ä Conglomerate  Geographic market  Product extension  Pure u Consolidation ä Holding company ä Joint venture u Acquisition Synonymous with merger

4 Leveraged Buyout ( LBO ) u Buyer borrows most of the purchase price u Purchased assets used as collateral u Buyers frequently are the managers u Anticipate CF’s sufficient to service debt u Reasonable ROI u Sell assets to pay off debt u Employee Stock Ownership Plan ( ESOP ) ä Tax advantage

5 Types of mergers u Stock Purchase ä Acquiring company buys the stock of the target company ä Assumes liabilities u Asset Purchase ä Acquiring company buys assets of target company ä NO assumption of liabilities u Tender Offer / Hostile Takeover ä Purchase the C/S of the merger candidate ä Offering price > market price  Induce shareholders to sell

6 What Happens After a Merger ? u Divestitures u Part of the company sold for cash u Spin-off u Equity carve-out u Restructurings u Operational u Financial

7 Why Has Restructuring Been Increasing ? u Failure of internal control mechanisms u Unproductive investment u Organizational inefficiencies u Large active investors u Available financing High Yield Bonds u Long economic expansion u Increased revenues u Increased asset values

8 Anti-Takeover Measures u Staggering board u Golden parachutes u Supermajority rule u Poison pills u White knight u Standstill agreement u “Pacman” defense u Litigation u Asset/Liability restructuring u Greenmail

9 Boardmail u Institutional investors use it to fight anti-takeover devices u Requires the board of directors to adopt weaker anti-takeover measures u In exchange for voting support from institutional owners u Vote in sympathetic board members

10 Why Do Companies Seek External Growth ? u Less Expensive u Economies of scale u Vertical merger Availability u Rapid growth u Diversification u Tax-loss carryforward

11 Taxes on Mergers u Cash or nonvoting securities u Gains are taxable at the time of the merger u Voting equity securities u Tax-free

12 Accounting for Mergers u Purchase method u Total value paid recorded on books u Tangible assets at fair market value u Excess as goodwill Not a tax-deductible expense Must be amortized Must be amortized Deducted from NI after taxes Deducted from NI after taxes u Pooling-of-interest u Assets recorded at book value u No goodwill u Higher NI No deduction for goodwill

13 Valuation of a Merger Candidate Valuation of a Merger Candidate u Comparative P/E Ratio Method u Examines prices and P/E ratios of similar companies u Adjusted book value method u Determine market value of the company’s assets u Discounted C/F method u Capital budgeting techniques Future free C/F’s Risk-adjusted rate

14 Terms of a Merger Cash Stock Other Financial Instruments

15 EPS of the Surviving Company Determined in the marketplace E 1 + E 2 + E 1,2 E 1 + E 2 + E 1,2 EPS c = NS 1 + NS 2 ( ER ) NS 1 + NS 2 ( ER ) u Post-merger price of C/S u Post-merger P/E

16 Failures u Technically insolvent u Unable to meet current obligations u Legally insolvent u Assets < liabilities u Bankrupt u Unable to pay debts u Files bankruptcy Fed bankruptcy laws

17 Why Do Businesses Fail ? u Business risk Symptoms u Industry downturns u Over expansion u Inadequate sales u Increased competition u Technological change u Financial risk Symptoms u Leverage u Too much S-T debt u Poor management of A/R A/R A/P A/P u Incompetent management

18 Failing Firm Resolve its Difficulties Declare Bankruptcy

19 Reorganization Vs Liquidation u Reorganize if going-concern value exceeds its liquidation value u Going-concern u Liquidation u Liquidate if liquidation value is more than its going-concern value

20 Alternatives for C/F Problems u Stretch A/P Buy a few weeks time u Debt restructuring Voluntary u Extension u Composition u Suppliers make concessions u Sell off assets u Real estate / operating divisions u Sale and leaseback u Creditors’ committee u Assignment Liquidation outside bankruptcy

21 U. S. Bankruptcy Chapter 11 Chapter 7

22 Chapter 11 u Seek protection from creditors u Attempt to work out a plan of reorganization u Court may appoint trustee to run the business u Reorganization plan must be approved u Court u Creditors u SEC Review for fairness and feasibility u Company’s security holders 2/3 debt holders 2/3 debt holders Majority of stockholders Majority of stockholders

23 Chapter 7 u Court selects a referee u Handles the administrative procedures u Arranges a meeting of the creditors u Creditors select a trustee u To liquidate the business u Distribute the proceeds According to chapter 7 priorities According to chapter 7 priorities

24 Priorities u Debts satisfied from sale of secured assets u Administration expenses u Business expenses After petition before trustee u Wages owed Three months prior u Contributions to employee benefit plans $ u Customer lay-away deposits $ u Taxes owed u General /unsecured claims Creditors u P/S and finally C/S holders