Corporate Restructuring

Restructuring ◦ To give a new structure ◦ To rebuild or rearrange

Corporate restructuring ◦ Consolidate business operations ◦ Strengthen its position in the market◦ To achieve corporate objectives

Corporate restructuring

India – highly regulated economy Government participation and intervention Closed economy

◦ Demand supply not allowed to rule the market Restrictive government policies Rigid regulatory framework

Not much scope for corporate restructuring

Historical background

To achieve faster economic growth

Industrial policy, 1991 Opening up of the economy Industrial licensing relaxed Foreign investment encouraged Transfer of foreign technology

Indian corporate sector started restructuring to meet the opportunities and challenges of competition

Liberalization

Market oriented globalized economy Easy and free flow of technology, capital

and expertise

Restructuring ◦ Tata Steel – Corus group◦ Hindalco – Novelis ◦ Mittal Steel – Arcelor◦ Vodafone – Hutch-Essar

Current scenario

Redirection of firm’s activities Deploy surplus cash from one business to

finance growth in another Exploit interdependence among businesses

within the corporate structure Risk reduction Develop core competencies

Cost cutting and Value addition – key to succeed in a competitive environment

Need and scope

Organic growth ◦ The growth rate that a company can achieve by

increasing output and enhancing sales.

Inorganic growth ◦ Arises from mergers or takeovers, rather than an

increase in the companies own business activity. gain access to new markets fresh ideas available through successful mergers and

acquisitions

Organic vs. Inorganic growth

Developing new business areas ◦ May or may not be connected with its traditional

business areas

Exploiting some competitive advantage it has

Business growth

Three alternatives:1. Formation of a new company2. Acquisition of an existing company 3. Merger with an existing company

Decision would depend on:◦ Cost ◦ Likelihood of success◦ Degree of managerial control

Enter new business area

Growth of mergers, acquisitions and corporate restructuring ◦ 2004 - $ 4.5 Billion◦ 2010 - $ 62 Billion (971 deals)◦ 2012 (first 4 months) $ 23 Billion (396 deals)

2005 – year of mergers and acquisitions ◦ India - $ 13 billion

M & A Activity

Merger – unification of 2 entities into one

Amalgamation – by merger of companies under Companies Act

Acquisition ◦ One entity buying out another and absorbing the

same. ◦ Acquisition through take over - regulated by SEBI

Definitions

Acquisition ◦ Both acquiring and acquired companies are still

left standing as separate entities

Merger ◦ Legal dissolution of one of the companies

Consolidation ◦ Dissolves both parties and creates a new one

Legal identity

Started by Lord Swaraj Paul◦ Takeover of Escorts

Some major takeovers◦ Ashok Leyland by Hindujas◦ Ceat Tyre by Goenkas◦ Consolidated Coffee by Tata Tea

Corporate takeovers - India

Interest of general public

Promotion of industry and trade

Government - Safeguard interest of citizens, consumers, investors and shareholders, creditors, workers.

Rationale

Reconstruction / Compromise / Arrangement ◦ Sec. 391 – 394 of the Companies Act

Acquisition ◦ Sec. 395

Amalgamation ◦ Sec. 396

Reconstruction of sick industrial company ◦ Sec. 17, 18 of the Sick Industries (Special Provisions) Act.

Revival of financially unviable companies ◦ Sec. 72A of Income Tax Act, 1961

Control / Governance

Relevant provisions of:

FEMA, 2000 Income Tax Act, 1961 Industries (Development and Regulation)

Act, 1973 The Competition Act, 2002 SEBI Act, 1992 Restrictions imposed by any other relevant

Act

Control…

One company involved – rights of shareholder and creditors are varied◦ Reconstruction◦ Reorganization◦ Scheme of arrangement

Two or more existing companies – fused into one by merger or one company taking over another ◦ Amalgamation ◦ Shareholders of each blending company become

substantially the shareholders of the company which is to carry on the blended undertaking

Companies involved

Fusion of two companies

Dissolution of one or more companies / firms / proprietorships◦ Form or get absorbed into another company

Merger increases the size of the undertaking

Types of mergers

Two companies in the same industry

Market share of new consolidated company would be larger

Closer to being a monopoly / near monopoly - to avoid competition

Economies of scale / economies of scope

Eg.

1. Horizontal merger

Two companies – different stages of industrial or production process

A (potential) ‘buyer – seller’ relationship

Lower transaction costs

Demand – supply synchronization

Independence and self sufficiency

Eg.

2. Vertical merger

Firms engaged in unrelated type of business operations ◦ Business activities not related either horizontally, or

vertically

No important common factors◦ Production / marketing / research and development

Unification of different kinds of businesses ◦ One flagship company

Foray into varied businesses ◦ Without having to incur large start-up costs

3. Conglomerate merger

Purpose ◦ Utilization of financial resources◦ Enlarged debt capacity◦ Synergy of managerial functions

Leads to increase in the value of outstanding shares by ◦ increased leverage and earnings per share, and ◦ lowering the average cost of capital

Eg.

Acquirer and target companies are related through ◦ Basic technologies ◦ Productions processes◦ Markets

Acquired company represents an extension of ◦ Product line◦ Market participants ◦ Technologies

4. Congeneric merger

Outward movement by acquirer ◦ from its current business scenario ◦ to other related business activities

Eg.

Also known as a ‘cash-out merger’

The shareholders of one entity receive cash in place of shares in the merged entity.

Common practice in cases where the shareholders of one of the merging entities do not want to be a part of the merged entity.

5. Cash merger

For regulatory and tax reasons.

A tripartite arrangement ◦ the target merges with a subsidiary of the acquirer.

Based on which entity is the survivor after such merger, a triangular merger may be ◦ forward (when the target merges into the

subsidiary and the subsidiary survives), or ◦ reverse (when the subsidiary merges into the

target and the target survives).

6. Triangular merger

Involves acquisition of a public (shell) company by a private company ◦ Public company may have little or no assets ◦ Only the internal structure and shareholders exist

Also called ‘back door listing’◦ Helps the private company to by pass lengthy and

complex process in order to go pubic ◦ Without incurring huge expenses

7. Reverse merger

Easy access to capital market

Increase in visibility of company

Tax benefits on carry forward losses (of the acquired public company)

Cheaper and easier route to become a public company

Benefits of Reverse Merger

Downstream merger ◦ Merger of parent company into its subsidiary

Upstream merger ◦ Merger of subsidiary company into its parent

company

Other forms

Rationale for M&A

Synergistic operating economics

Growth

Diversification

Taxation

Consolidation of production capacities

Increasing market power

Rationale…

Synergy defined as◦ V (AB) > V(A) + V(B)

Combined value of 2 entities > addition of their individual values

Increase in performance of the combined firm◦ Result of complimentary services

And / Or ◦ Economies of scale

1. Synergistic operating economics

Complimentary activities ◦ One company with an efficient production system◦ Other with a good networking of branches

Economies of scale ◦ Lower average cost of production – reduction in overhead

costs

Real economies ◦ Reduction in factor input per unit of output

Pecuniary economies ◦ Lower prices for factor inputs due to bulk transactions

Synergy…

Enables firm to grow at a faster rate than organic growth

Shortening of ‘Time to Market’ - Avoid delays associated with ◦ Purchasing of building◦ Site preparation ◦ Setting up of plant ◦ Hiring personnel ◦ Supply chain

2. Growth

Merger between 2 unrelated companies ◦ Reduction in business risk ◦ Increase market value

Combination of independent or negatively correlated income streams of merged companies ◦ Higher reduction in business risk

3. Diversification

Set off and carry forward of business losses as per Income Tax Act, 1961

Tax saving or tax reduction of merged entity

4. Taxation

Increase in production capacity ◦ By combining 2 or more plants

Reduced competition◦ Leads to increase in marketing power

5. Consolidation of production capacities

Increase in financial strength

Advantage of brand equity

Competitive advantage

Eliminate / weaken competition

Revival of sick company

Survival

Other reasons for mergers / amalgamations

Underlying objectives and benefits of Mergers

Enhance value for shareholders for both companies◦ Greater access to market resources

Increased market share ◦ Higher control on price ◦ Increase in profitability

Increased bargaining power◦ Labour, suppliers,

Market leadership

Increase in volume of production◦ Ratio of output – input improves◦ Lower cost of production per unit◦ No increase in fixed costs

Optimum utilization of management resources

Competitive advantage◦ Reduce price – increase market share◦ Maintain price – higher profits

Economies of scale

Avoid overlapping functions

Eliminate duplicate channels ◦ Integrated planning and control system

Common R&D facilities

Operating economies

Deployment of surplus cash

Enhanced debt capacity

Low cost of financing

Stability of cash flows

Borrow at lower interest rates

Financial benefits

Exploit existing brand name ◦ Buy existing manufacturing unit ◦ Higher market share

Takeover company with a strong brand name ◦ Increase market share for own products

Acquiring a new product / brand name

Diversify into various segments

Growth through combination of unrelated companies / products

Widen growth opportunities

Smoothen ups and downs of product life cycles

Diversifying the portfolio

Complementary nature of companies ◦ Commercial strength◦ Geographical profiles

Increase cost effectiveness and efficiency

Optimal utilization ◦ Infrastructural and manufacturing assets◦ Utilities and other resources

Strategic integration

Substantial cost saving

Standardization and simplification of business processes

Elimination of duplication

Eliminate disadvantage of each company

Synergies

Loss making company – carry forward losses◦ Merged with another company◦ Absorbs tax liability of the latter

Company – modernizing or investing in P&M – investment incentives ◦ Not much taxable profits◦ Merge with profit making company to utilise the

investment incentives

Taxation / Investment incentives

Mergers limit or restrict competition

Company becomes a monopoly / near monopoly◦ Price benefits◦ Market share

Limiting competition