1. Copyright ©2003 South-Western/Thomson Learning Chapter 22 Corporate Restructuring

2. Introduction This chapter focuses on forms of corporate restructuring, including external expansion (mergers) and business failure (bankruptcy).

3. Corporate Restructuring External Expansion Failure Merger Acquisition Bankruptcy Corporate Restructuring

4. Types of Combinations Merger –Vertical –Horizontal –Conglomerate  Geographic market  Product extension  Pure Consolidation –Holding company –Joint venture Acquisition Synonymous with merger

5. Leveraged Buyout (LBO) Buyer borrows most of the purchase price. Purchased assets used as collateral. Buyers frequently are the managers. Anticipate CFs sufficient to service debt Reasonable ROI Sell assets to pay off debt Employee Stock Ownership Plan (ESOP) –Tax advantage

6. Types of mergers Stock Purchase –Acquiring company buys the stock of the target company. –Assumes liabilities Asset Purchase –Acquiring company buys assets of target company. –NO assumption of liabilities Tender Offer/Hostile Takeover –Purchase the C/S of the merger candidate –Offering price is greater than the market price  Induce shareholders to sell

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

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

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

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

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

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

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

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

15. Terms of a Merger Cash Stock Other Financial Instruments Terms

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

17. Failures Technically insolvent –Unable to meet current obligations Legally insolvent –Assets are less than liabilities Bankrupt –Unable to pay debts –Files bankruptcy Federal bankruptcy laws

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

19. Failing Firm Resolve its Difficulties Declare Bankruptcy Alternatives for Failing Businesses

20. Reorganization Vs Liquidation Reorganize if going-concern value exceeds its liquidation value –Going-concern –Liquidation Liquidate if liquidation value is more than its going-concern value

21. Corporate Restructuring in Japan Explore the social changes of corporate restructuring in Japan at this Web site: http://www.jinjapan.org/insight/html/in_pers ctive/corporate/index.html

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

23. U. S. Bankruptcy Chapter 11 Chapter 7 Bankruptcy Alternatives

24. Information on Bankruptcy Check out this SEC Web site to find out what happens when a public company files for bankruptcy: http://www.sec.gov/answers/bankrup.htm Check out the American Bankruptcy Institute Web site to find additional information on Chapter 7 Bankruptcy and Chapter 11 Reorganization. http://www.abiworld.org/media/chapters.html

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

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

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