Basics of Corporate Restructuring #
Definition Reorganizing the legal, ownership, operational, financial or other structures of a company for the purpose of making it more profitable, or better organized for its present needs
Types of restructures #
Business (or operational) restructuring: Significant changes in the mix of assets owned by a firm or the lines of business in which a firm operates (Refining the optimal boundary of a firm)
Financial Restructuring
- Improve on capital structure or ownership of the firm
- Leveraged transactions(LBO/MBO) and Debt restructuring
Organizational restructuring
- Significant changes in the organizational structure of the firm
- Divisional redesign and employment downsizing
Rationale #
Breaking up business lines man create value as it unlocks the diversification discount
Detailed points
- To better align the interests of shareholders and managers (Agency problems)
- To transfer assets to owners who can better utilize them
- To focus deeper on what the managers can manage
- To correct strategic mistakes of management
- Reflects new information about the value of various parts of the company to another party
- To prevent cross-subsidisation - prevent the inefficient part from absorbing efficient part
Diversification discount #
In multi-segment firms, each segment underperforms to some extent
Benefits of diversification: Tax shields and debt capacity increased
Inferred reasons
- Overinvestment - investing beyond positive NPV projects
- Cross-subsidisation - poorly performing units are kept afloat by star performers
- Benefits were not enough to offset the diversification discount
Business Restructuring #
Diverstitures (Asset Sales) #
Sale of assets to third parties - Simplest way to make a company’s business simpler and more focused
Rationale
- Negative synergies arising from poor decisions on past decisions
- Lack of expertise to run that segment of the company
- Needs for funds to pursue investments, or to pay off debts - especially after LBOs
- Regulatory measures to create more competitions
Spin-offs (Split-up and Demergers) #
List one of a firm’s operating units as a separate listed entity
- All shares in the newly established listed entity are distributed to existing shareholders on a pro-rata basis - then shareholders may freely decide whether to continue to hold the shares
- No money comes into the parent company
Rationale
- Widen investors’ choice
- Better alignment of intereste of management with shareholders (easier to monitor and reward managers) - formerly, the performance of the management is buried up by the overall performance of the conglomerate, and all managements receive compensation packages based on that firm’s performance, and maybe the management of part underperforming can still play golf as the conglomerate offset their underperformance. After the spin-off, their performance is now supervised publicly and their compensation package is now based solely on the share price of the separated entity. So they will be supervised more closely and their incentives are more clear
- Increases transparency for investors
- Sometimes it precedes a takeover
Equity Carve-out #
Like spin-offs, this creates a new entity, however, its shares in the new entity are sold off the the market, and the parent firm receives money - yet typically the parent company maintains a significant shareholding in the new entity, often less than 20% is sold so that it retains control
Rationale
- An alternative to equity financing - when the firm cannot raise capital in a usual way
- Showcase the subsidaries to prospective future buyers - get the stock market to understand their business, revalue the subsidary (and also the firm) and eventually spin-off
Financial Restructuring #
Leverage transactions (LBO/MBO) #
LBO: Leveraged buyouts MBO: Management buyouts Or PE buyouts
Process
- A small group of investors purchase a company by using a relatively small portion of equity and a relatively large portion of debt
- Then the company (if public) goes private temporarily - Those investors seek to cash out through listing again
- If the investors are institutional (PEs), then it is LBO
- If mostly existing management, then MBO
- Greater focus to cut expenses, dispose non-core assets, tax benefits and increase efficiency
- Can only be done in firms with assets with debt capacity and stable cashflows since the large debt
- Target firms are mainly existing or mature firms with low risk that have enough assets and can generate stable cash flows
Profitability
- Financial engineering: From high debt, it obtains discipline, tax benefits and financial leverage
- Governance
- High equity to management - Improved incentives
- PE investors closely monitor CEO and portfolio companies
Exit strategy: IPO, trade sale, sale to another PE player
Keypoints
- May not be successful - financial risk and management inefficiency
Debt restructuring #
Definition Reorganization of companies’ outstanding liabilities when facing difficulties in repaying their debt payments in financial distress - less expensive and preferable alternative to bankruptcy for creditors
Keypoints
- Debt-for-equity-swap: Creditors agree to accept equity instead of debt payments
- Bondholder haircuts: Reduce or delay the promised interest payments and principal payment - debt still exist but with modified terms