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CORPORATE RESTRUCTURING

Learning objectives After reading the chapter you will be able to understand The concept of corporate restructuring The organization restructuring The financial restructuring The portfolio restructuring The tools of portfolio restructuring The nature and scope of Alliances & Joint Ventures The nature and scope of Divestitures, spin-offs, demerger and sells offs The nature and scope of Mergers and acquisition

Concept in practice

In 2000 world’s biggest corporate brand coca cola and world’s first product Brand Company P&G decided to float a joint venture. The joint venture was aimed at combining Juice and chips of the two brands to achieve growth and long term value. The Joint Venture stood at $ 4 Billion named simply Juice; Coca Cola would make new health oriented beverages with the help of P&G’s expertise on the subject. P&G had large resources in R&D division that had to its expertise in health beverages. P&G agreed to Punica, Sunny delight and Pringles Chips. The two company joined forces with an intention to market snacks along with juice drinks globally, Coca Cola agreed to transfer its juice brands minute maid five alive, Fruitopia, Cappy, Capo, Sonfil, Qoo brands. P&G was to benefit from the Coke’s powerful global distribution network. The Joint Venture aimed at generally annual sales of about $4Billion with more than 5000 people and would reduce the cost by $50 million. Coke would share 50% of the profits from the fast growing business segment with a rival that could not compete in its core business. The advantage was more towards P&G which stood as the winner while Coca Cola was more on the loosing end. Market was abuzz with the fact that Coca Cola should have bought the health soft drink technologies it required rather than going for alliance with a weak rival in the core business. The share price of Coca Cola immediately after the announcement fell by 6% on the day of announced of Joint Venture while that of P&G rose by 2%. Both the companies specially Coke realized the mistake and called off the deal in July 2001. The deal announced in February 2001 was unable to take off because of the miscalculated alliance objective and synergy gains. A grand corporate brand like Coke should have opted for a buyout rather than an alliance. CHAPTER OUTLINE CORPORATE RESTRUCTURING Organizational Restructuring

Organization restructuring models Financial Restructuring Portfolio Restructuring

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Divestment or Divestiture Equity carve out Spin off /demerger Asset Sell Off

Joint Venture and Strategic Alliances Mergers and Acquisition.

Horizontal Merger Vertical Merger Conglomerate Merger

CORPORATE RESTRUCTURING Markets world wide have become more competitive in an extremely challenging environment. The shareholders have become more demanding emphasizing more on corporate value creation. In this regard, companies attempt all efforts to create value for the shareholders. Any corporate activity or action that results in enhancing productivity, enhancing revenues, reducing cost (operational cost and cost of capital) or enhancing shareholder wealth is the flavour of the management. Many companies reorganize that is restructuring to attain the above objectives. Reorganization is aimed at streamlining the business operation, restructuring the business divisions, restructuring the funding sources (capital structure) or consolidating by spin off or demerger. Ultimately, all restructuring exercises lead to improving the wealth of the firm in the long run. Restructuring activities include diverse initiatives taken by firms like acquiring a new business, reducing debt from its capital structure, selling off traditional business or merging its business units or dividing existing business unit into subsets etc. Each activity of restructuring results in a different out comes smart execution of well thought and well crafted restructuring initiatives result in wealth maximization of wealth for the business. Generally the market gives a positive reaction to restructuring initiatives. The market movement as measured by firm’s stock price movement before and after announcement of corporate restructuring initiative. These movements may be positive or negative depending on the type of restructuring initiative and market trend. Apart from market performance measure restructuring initiative can also be measured in terms of internal performance metric like return on equity (ROE), return on capital employed (ROCE), gross margin and net margin, earning per share(EPS) etc. Comparison of pre and post restructuring performance of the firm helps to access and evaluate the financial performance of the firm due to restructuring. It is up to the analyst to choose between accounting based performance measure like ROE, ROC, EPS and market based performance measure like market price per share (MPS), price earning ratio (PE). Some analysts and shareholders like to use both the methods to access the performance of corporate restructuring. Corporate Restructuring at Accenture It is a global management consulting and technology outsourcing company spread across 120 counties. It is the largest consulting firm in the world. Accenture originated as an

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accounting firm ‘Andersen, Delany & Co. named after its owners Arthur Anderson and Clarence Delany in 1913. In 1918 Delany exits the partnership and the firm was rebranded as Arthur Andersen. In 1950s, the company along with its accounting business started management consulting and advisory services. As consulting business grew dramatically in the next three decades, Arthur Anderson grew with a larger contribution to growth coming from consulting. In 1989 Arthur Andersen split the company in two independent units Arthur Andersen and Andersen consulting under the parent organization Andersen Worldwide Societe Cooperative (AWSC) (see figure 1).

Next two decades consulting business unit overshadowed the accounting business unit and a bitter battle of ownership and split followed that lead to a resolution sought through Arbitration. In 2000, August the Andersen Consulting separated from Andersen Worldwide organization.

Arthur Andersen Andersen Consulting

2000 Separated & Rebranded Figure 1: corporate restructuring at accenture In December 2000, the Company separated and was rebranded as Accenture which was a combination of words ‘accent’ and ‘future’. The new logo comprised of greater than sign hanging over the ‘t’ like an accent mark. In July 2001, the company came out with IPO and raised $1.7 billion on the very first day. The company thus charged its ownership structure from partnership to a corporation. Only 12% of the shares of the newly incorporated Co. were raised through IPO and the 82% of Companies shares were distributed among the 2400 partners in exchange for their partnership rights. 6% of the remaining shares were distributed to non-partner employees. Next the Co. explored organizational restructuring through layoffs. But unlike other companies that adopted direct layoff Accenture adopted a ‘Flex Leave’ policy where consultants are paid 20% of their salary and heath benefits are maintain 6-12 months provided they take leave from Co. It was a sabbatical program where the consultants could take up any profession or study program during the period and were guaranteed a job at same level when they

1989

AWSC

Accenture

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returned. Today Accenture is a leading worldwide example of corporate restructuring that involved: Rebranding, Restructuring and Repositioning to a highly successful level of high end consulting. Broadly, corporate restructuring can be categorized into three broad categories as developed by Bowman and Singh, namely,

1. Organizational Restructuring. 2. Financial Restructuring 3. Portfolio Restructuring

Let us discuss the three corporate restructuring categories in detail. ORGANIZATIONAL RESTRUCTURING Organizational restructuring takes place when the firm makes important changes in its organizational structure like span of control, hierarchy and firm divisions. Redesigning the over all organizational structure of a firm, its divisional boundaries, markets, employees, product portfolio reduction etc form an integral part of organizational restructuring. This exercise should create wealth for the firm to put it simply it should result in improved financial firm performance. Organizational restructuring includes restructuring of business process and operations to align the organizational structure with the vision of the firm. The strategic fit for organizational restructuring is value creation through vision attainment of the firm. Over the last decade the firms across globe have reformed and redesigned there management hierarchy, divisions, span of control, performance linked compensation methods and corporate governance initiatives. Some firms have even gone to the extent of reducing its employees that is down sizing. For example, Xerox Corporation in 1980’s lost much of its market share to cannon a Japanese manufacturer of photocopiers. Cannon ate into the market share of Xerox by providing low cost, good quality copiers. Xerox reacted by improving the quality and reducing the cost of its product. However, the initiative and the exercise took around 10 years to regain the lost market share. As a matter of fact, Xerox focused on leadership initiatives by launching “Leadership through Quality” programme in 1984 and “Xerox 2000” programme in 1990. Both these programmes repositioned Xerox as a manager of documents and not as manufacturer of photocopiers. The important thing to understand in this initiative is that zerox adopted an organizational restructuring exercise to achieve it’s above two programmes. The company did a way with its classical functional type of organizational structure. It moved to adopt the strategic business unit model (SBUs). The company was divided into nine SBUs and each SBU focused on its niche market. The autonomous structure of the SBUs and restructured value linked compensation policy together helped Xerox to compete with Canon and by 1994 the company’s stock price looked up and it was able to regain its lost market share. Many a time organizational restructuring may not result in improved financial performance. For example, several instances show that downsizing and unfriendly lay offs have a negative impact on the future performance of the firm. Organizational restructuring has to align with the over all vision of the firm. It has to explicitly aim at

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enhancing economic performance. One has to remember not every type of organizational restructuring will work equally well. Once it is initiated the management must ensure that it creates some additional value for the firm even if it is of small magnitude. Organization restructuring models Organizational restructuring would include broad activities like changing divisional boundaries, flattening hierarchical structures, changing the product diversified portfolio and redesigning the structure. The core objective is that whatever the mode of organizational restructuring it should enhance the organizational effectiveness and make it more efficient. Freeman and Cameron (1993) proposed a theoretical framework focusing on downsizing implementation processes. During internal restructuring phase the focus of the strategist should be on downsizing in such a way that the downsizing strategies aim at reinforcing and aligning with the organization’s mission, strategy, and systems. Similarly when the focus is on internal reorientation, the organization aims at changing its current mission, strategy and aligns the systems with the same. In the Freeman and Cameron proposed model on downsizing process the downsizing focuses on seven different levels in the organization namely:

a) Structural redesign b) Lay offs c) Redesign d) Communication e) Inter organizational relationships f) Culture g) Effectiveness versus efficiency orientation.

The convergent and reorientation periods described by Freeman and Cameron (1993) are normative periods during he life of a corporation. Therefore, the manager needs to be clear about the period the corporation is in so that the adopted organizational restrcutring practices reflect effective strategy. Organizational restructuring can be initiated both during pure organization restructuring or as a part and parcel of other restructuring initiative like portfolio or financial restructuring. When Organizational restructuring is a part of core restructuring initiative it aligns with current vision of the firm. However, when organizational restructuring is a result of other restructuring initiative it aligns with the new strategic focus. Scope for Organizational restructuring occurs when either the strategic focus of the firm changes or the existing structure drafts far away from the earlier fit with the vision. Hence, both ways the firm has to align it structure with the strategic focus (vision) to unlock value. Johnson study of antecedents and outcomes of downsizing identifies four antecedents to restructuring namely environment, governance, strategy and performance. These four antecedents to restructuring are considered interrelated and are not mutually exclusive. Freeman and Cameron (1993) defined organizational downsizing as “….a set of activities, undertaken on the part of the management of an organization, designed to improve organizational efficiency, productivity, and/or competitiveness”. There are

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further described four key elements to organizational downsizing. First, it is an intentional endeavour. Second, it usually involves reduction of personnel. Third, it affects work processes and finally, it focuses on improving the efficiency or effectiveness of the organization. Johnson’s model of organizational restructuring identifies four antecedents to restructuring namely environment, governance, strategy and performance (1996). These antecedents are inter-related and as such not mutually exclusive. Critical factors of business environment directly affect the business strategy and its outcome. Several major environment changes like, FDI investment policy relaxation, FPI policy liberalization, rupee convertibility policy, easier access to international funds etc. bear direct impact on organizational performance. In times of crisis like that of 2008 the world economy witnessed large layoffs, sell offs and streamlining of processes, practices, output, and personnel. Good governance would logically always be the cause of a firm’s growth initiatives and less dependence on restructuring Activities. The effective strategy formulation and implementation create lifelong growth firm that not only continue to expand but also keep on creating the value for its stakeholders. Then the financial performance of a firm has direct bearing on its restructuring initiatives. Lack of funds, lack of cash flow and poor performance are the most likelihood causative factors fro internal organizational restructuring. FINANCIAL RESTRUCTURING Financial restructuring caters to changes in the capital structure of the firm resulting in value enhancement for the firm. Capital structure is broadly the mix of debt and equity the firm has. Any change in debt equity mix results in change in the overall cost of capital fro the firm impacting its value. Firm activities like converting high cost debt to low cost debt, debt recapitalization, making a leveraged buyout (buyout through loan), equity swap etc affect the capital structure of the firm and hence the overall cost of capital. Any type of financial restructuring will always have a significant impact on firm performance. Several studies have examined leveraged buyouts and management buyouts (management of the firm buys the firm from shareholders) and stated that these are often followed by an increase in free cash flows for the acquiring firm. Enhanced efficiency of the merged entity in a leverage buyout eminates from the fact that high leverage makes the management focus more on creating and sustaining the inner core competence of the firm and achieve value maximization through economies of scale and economies of scope. In the year 1988, the Wall Street was shaken by a strategic organizational disaster of RJR Nabisco. RJR Nabisco manufacture cigarettes and its Chief Executive F. Ross Johnson attempted several tactics for appreciating its stock value. One day he decided to make a leverage buyout of RJR Nabisco which he thought would generate value for its shareholders. With the help of the investment Banking and Brokerage House Shearson Lehmann Hutton announced to buy RJR Nabisco for $ 17 billion at the rate $75 per share (the actual share price was $55 per share). At that time, the companies by law required

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bidding for a buyout from different competitors. The bids were opened and the highest bidder usually won the deal. Mr. Johnson did not anticipate real competition from any bidder and went ahead with his plan. Mr. Johnson actually had discussed this LBO with Kravis of KKR (Kohl Berg, Kravis, Roberts and Company) but later on hired the Huttons. Due to large size of the transaction the consulting fee was around $ 200 million Kravis was upset that the deal had landed up with Huttons. He tried to get the deal from Johnson but unfortunately landed up as a co-bidder along with Mr. Johnson for RJR NABISCO. Kravis offered a bid for 90$ per share. And Mr. Johnson lost the bid finally with Kravis ending the battle at 108 $ per share. KKR acquired RJR Nabisco but the bottom line was clear that the loser was RJR Nabisco and the winner KKR. Soon after the high profile LBO RJR Nabisco’s immediate competitor Philip Morris became the market leader by capturing the neglected segment of RJR Nabisco. KKR with a $30 billion debt raised cash by selling overseas operations and later on coming out with a public issue (1991-1995). Much focus of KKR was aimed at debt restructuring post the LBO it lost its market share further as competitors reduced the price followed by RJR further adding to its financial woes from being a market leader RJR became a struggler and by 2003 its sales declined by more than 20 per cent and operating income declined by 60 per cent. The world’s first high profile leverage buyout ended up in a disaster for both the acquirer KKR and the target firm RJR Nabisco. Now we discuss a company that serves a good example of successful leveraged buyout namely Harley Davidson. Harley Davidson was a market leader in heavy weight motorcycle in USA. Soon, Japanese manufacturer, most notably Honda entered the motorcycle sector but in light weight segment. Initially, Harley Davidson did not face any problem and ignored the competition. However, Honda launched its gold wing line to enter the heavy weight market and after this Harley Davidson which had around 80 per cent market share in 1969 dropped to 20 per cent in 1980 due to Japanese competitors. In 1981 the owners of Harley Davidson AMF (had bought Harley Davidson in 1969) decided to sell off the Harley Davidson division. A management team from Harley Davidson had strong belief in its brand value and decided to buy out the firm. A leveraged buyout was arranged with the help of Citi Bank and the management eventually bought 10 per cent of the equity for about $ 82 million and the remaining 90 per cent was financed with debt. With such high debt level in its capital structure the management of Harley Davidson focused on revamping the brand in terms of its quality, viability and pricing. They bench marked their operations against Honda and improved Harley Davidson’s quality. By 1983, with high management involvement Harley Davidson successfully adopted several cost reductions activities and productivity improvement strategies and regained its lost market share and became the market leader once again. By 1986, Harley Davidson’s market share increase to 33 per cent and by 1989, it increased to 59 per cent. On the other hand, Honda’s market share declined from 34 per cent to 15 per cent in the same period. With Citi Bank refusing to finance further in 1990, the company came out with a successful initial public offering along with significant portion distributed as employee stock option plan. This is one of the most successful leverage buyout in the world that helped management to not only acquire a firm but also gain wealth from successful financial restructuring of the firm.

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Leveraged buyouts have had a great impact on the financial performance of the firm. Leveraged Buyout is an acquisition where the acquirer finances the buyout predominantly through debt and less through equity. Generally acquisition financing through debt includes Bank loans, inssuance of bonds with low credit rating popularly known as junk bonds. The assets of the target firm are generally held as collateral for debt financing. As equity proportion is quite less many financial consulting firms, investment bankers, private equity firm carry LBO’s to make money. They buy distress firms or targets at bargain low price to later sell them off in parts. However, highly leveraged deals may also lead to bankruptcy of target firm as bulk of earnings is used to pay off the debt. Usually, LBO’s are hostile in nature as the acquirer uses the target company’s assets to collate as well as pay off the debt in future. The first LBO of the world was probably the acquisition of Pan Atlantic by McLean industries, Waterman Steam Ships Corporation. In 1955, roughly $ 42 million was raised through debt by using Pan Atlantic as collateral. The financing arrangement was made through National City Bank of New York. Further, they raised $7 million through issuance of preferred capital. The concept of LBO existed even much before but was known as bootstrap. In 1969, a businessman Victor Posner further popularized the concept of LBO. His acquisition of Sharon Steel Corporation in 1969 was a hostile LBO. He acquired Sharon Steel due to its undervalue and high cash flows. Sharon Steel was under priced with good cash position and zero debt. Posner owned a company called NVF a small laminated plastic company. He offered Sharon Steel Shareholders to swap their shares for NVF bonds having face value of $ 70. The bond value was around 40% more than the under priced share of Sharon Steel’s Stock at New York Stock Exchange. Posner intelligently avoided any payment to Shareholders of Sharon. The $ 99 million deal, was executed with NVF bonds for a period of 1964-1994 the maturity year of Bonds. Thus, with NVF Posner acquired the equity of a large company Sharon Steel (seven times the size of NVF) through debt of NVF (bonds) in a hostile attempt. This LBO give way to many people at Wall Street accepting the concept of Junk Bonds and LBOs. Some important LBO firm are Bain Capital, Blackstone Group, Carlyle Group, JPMorgam Partners, Kohlberg Kravis Robert and Company. Another man who contributed much to LBO’s was Campeau. In 1980’s he embarked upon a series of LBOs. He gained controlling stake in Allied Stores and Federated Department Stores (now known as Macy’s Incorporated) through issuance of junk bonds. Famous banker Bruce Wasserstein helped Campeau with the leverage buyouts. Both these firms were consolidated after the leverage buyout by Campeau Corporation. They could not sustain the high debt burden and the high valuations of the target leading them to enter Chapter II bankruptcy protection in 1990. Campeau first acquired Allied Stores Corporation in October 1986 for $ 4.4 billion through junk bonds (financed through Citibank and first Bostan) with small proportion of own funds of $ 150 million by Campeau. In order to pay off high debt Allied sold 16 of its smaller units for $ 1.2 billion in 1987. In around 1988 Campeau turned its attention to acquisition of Federated Department

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Stores. He acquired Federated at $ 73.5 per share and financed 97% of the cost through debt. The fortune magazine called it the biggest looniest deal ever, high valuation based highly leveraged buyout had to bankruptcy of the firm. Two examples of high profile, large sized Indian leverage buyout are Tata Steel’s Acquisition of Corus, and Hindalco’s acquisition of Novelis in the year 2007. Tata acquired Corus for about $ 11 Billion of which a large amount was financed through debt. Debt amounted to roughly more than $ 6 billion. Tata decided to raise debt through a new subsidiary of Corus called ‘Tata Steel UK’. The financial advisors Credit Suisse which helped the Corus (seelers) to structure the deal value was hired by Tata to advise on financing of the deal. ABM Amro and Dentsche Bank appointed by Tata Steel on deal financing backed out from rainy debts to the desired level. Later on Credit Suisse became the lead financing bank along with ABN Amro and Deantsche Bank (in consortium). Out of the $3.3 billion financing raised at SPV level, Credit Suisse committed to raise 45 % and ABN Amro and Deutsche back to contribute 27.5% each. Another $1.8 billion bridge loan was accepted by Tata and Steel to be raised in India with the support of Standard Chartered and ABN Amro. Another Indian LBO was by Hindalco Industries of Aditya Birla Group. Hindalco acquired American Aluminum Company, Novalis Corporation. It was a cash acquisition and about 1/4th of the total cost was financed through loans (2007). Financial Restructuring as is evident from several examples helps to generate value for the firm. Several value drivers post financial restructuring create larger economic benefit relative to pre financial restructuring phase. As a matter of fact financial restructuring placed heavily on cost reduction activities, eliminating redundant and over lapping and duplicate resources and activities. PORTFOLIO RESTRUCTURING Portfolio Restructuring relates to changes in the asset composition owned by the firm and the business line mix the firm operates in. It includes activities like alliances and joint ventures, mergers and acquisition, spin offs and demerger etc. An important question that may emanate at this point is why firms need to change their asset and business portfolio when they are already sustaining the existing assets and business portfolio? One argument that encompasses all justification for all portfolio restructuring activities is that firms need to continue to explore value maximization. Value maximization can come from different restructuring initiatives like an asset sell off or an asset buyout. For example, Air Sahara may be considered a good sell off by Sahara group (Sahara group intends to shift its focus from low cost carrier business) and Air Sahara buyout may be a good buy decision for Jet Airways due to its long term focus (Jet intends to add low cost carrier along with its high end niche carrier). This way restructuring of business of portfolios and asset portfolios creates value for firms by helping it to achieve value maximization for its owners. Portfolio Restructuring has to align with the vision and mission of the firm. It has to help the firm in attaining wealth and avoid any wealth destruction activities. Firms in the same industry differ in their vision and mission and hence adopt different portfolio restructuring initiatives. Firms adopting any of the

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portfolio restructuring initiative creates value for itself and its shareholders in the long run. A buyer of an asset or a business will have an understanding that it would be able to manage the business or the asset better. At the same time, the seller understands that by selling off it will be able to generate more value from its existing assets and businesses. Portfolio Restructuring recomposes the asset mix of a firm by selling off undesired assets and or buying desired types of assets. A firm’s decision to sell off a particular set of assets depends on the vision of the firm and how it aligns the asset as a long term prospect. Firms make differ refocusing or eliminating non core businesses a sell off may curtail diversification and signal to the market the firm’s preference to concentrate on its core businesses. Sometimes innovation in technology or products also cause firm to sell off assets with obsolete technology or when they are unable to invest in the new technology. Sometimes businesses see new opportunities in new businesses and may sell existing business to finance new acquisition. For example, Aditya Birla Group adopted several restructuring initiatives to add value to the company. Indo Gulf Fertilisers Limited (Indo Gulf) and Birla Global Finance Limited (Birla Global) group Companies of Aditya Birla Group were merged into the Indian Rayon and Industries Limited (Indian Rayon). The restructuring made Indian Rayon had a diversified, high-growth company. The combined entity post restructuring nine businesses-textiles, insulators, carbon black and VFY from the brick and mortar segment and life insurance, telecom, mutual funds, garments and IT from the new age businesses. Before restructuring the promoters held 28.6 per cent in Indian Rayon, 58 per cent in Indo Gulf and 75 per cent in Birla Global. After restructuring the promoter’s shareholding was at 38 per cent, financial institutions at 15 per cent and banks at 22 per cent and the remaining 25 per cent by the public. The company reinvested the generated profits from Value Business like VFY, Carbon Black, Textiles and Insulators into high growth businesses like garments, insurance, IT/ITes & Telecom. Thus, cash flows from value businesses were used to target growth from high growth business (see figure 2). Indian Rayon was renamed as Aditya Birla Nuvo. The new company had a stronger balance sheet and financials. The spelling of Nuvo had been fabricated and it signified the spirit of the new company. The new name mirrored the restructured character of the company. Some of the businesses of Birla Global Finance like the rationale behind merging Birla Global into Indian Rayon is to bring all the financial service businesses under a single entity. Amarchand Mangaldas and Suresh Shroff and company, one of India’s leading law firms, acted as legal advisors. The valuers to the transaction were Deloitte Haskins & Sells and Bansi S. Mehta & Co.

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figure 2: corporate restructuring at Aditya birla group In simple words Portfolio Restructuring includes asset divesture and asset expansion strategies. Portfolio restructuring involves other restructuring like financial restructuring and organization restructuring. For example, an acquisition may be simply financed through debt and thus involves financial restructuring as debt equity ratio alters. Further the acquisition may involve organizational restructuring in the process to include the acquired business in the existing lines of businesses. As a matter of fact organizational Restructuring may further include lay off executive turnover and create negative public perception. Downsizing employee lay off are organizational restructuring activities that help the firm to manage poor financial results and poor operating performance especially in a contracting economy. In 2001, after 9/11 attack the US economy slowed down and number of corporate lay offs increased. Similarly, in 2008 & 2009 due to financial crisis the US economy showed negative growth and number of corporate lay offs further increased. Portfolio restructuring generally lead to diversification of the parent company. Diversification of the company across businesses help the parent firm to reduce the risk stabilized through diversification. In this way operating profit of the parent business becomes steadier, reducing volatility in its profits figure. Steady profits help the parent company to negotiate a larger debt proportion without increasing financial distress. In 1985, IBM a world known computer technology and service company had around four lakh employees. The company in 1992 suffered huge losses of around $ 5 billion what followed was a series of restructuring activities that also involved a lay of around two lakh employees. In the year 2002, IBM diversified its business portfolio with the purchase of the price water house coopers consulting for around $ 3 billion.

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Restructuring initiative post 1992 did not stop here but the company further sold off its low and businesses like hard disk drive division to Hitachi and its PC business to Lenovo in 2005. Thus, IBM transformed itself to match the changing environment challenges and continued to restructure its assets maintaining itself as one of the industry major. Portfolio restructuring can be broadly classified into:

1 Divestment or divestiture 2 Alliances & joint ventures 3 Mergers and acquisition

DIVESTMENT OR DIVESTITURE Divestment or divestiture is a portfolio structuring strategy by which a company sells off non-strategic assets. Asset sell off is also known as Asset Divesture or Spin off. Sometimes series of asset expansion decisions (Mergers and Acquisitions) may force the company to consolidate or divesture to realign its focus on the core businesses. Empirical evidence suggest that shareholders holding more than 50 per cent of times acquisitions are followed by divestment. Most of the times the acquisitions were bad and unsuccessful. Divestitures that are focused on specific core businesses show higher returns. Generally asset sell off in the form of divestitures help the firm focus on high end assets that are strategically aligned with the corporate vision. The firm divest those assets which it considers low end. There is a redeployment of assets from firms that are not able to manage them efficiently to firms that are more capable of efficiently managing these assets. A low end asset for a selling firm is a high end asset for buying firm the perspective is simply strategic alignment of the asset with firms vision and core ideology. Sometimes asset sale is purely to raise funds when access to other sources is limited. Large corporate firms that are highly leverage generally use two-stage process to divest their subsidiaries like General Motor’s divestment of Delhi automotive, AT & T’s divestment of lucent technologies. Divestment or sell off provides the divestors the benefit of eliminating negative synergies and improved focus and efficient management of core assets. It further provides funds when other means of financing are expensive and inaccessible. Then the market too generally reacts positively to the value gained by divestor in the process. Further sell off helps the divestor in gaining competitive edge and cater to market needs in a better manner. The ever changing business processes, enhance did competitive and innovations in Technology create a need for reorganization of firm. Apple computer has restructured through spin off. Divestitures can take three different forms namely

1. equity carve out, 2. spin off or demerger 3. asset sell off.

Let us understand each of these in detail. Equity carve out (ECO)

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Equity carve outs are a form of divestiture wherein the divestor sells a part of its assets or a unit for cash and retains control of the unit. Equity carve out is a partial spin off. The company creates a new subsidiary and IPOs it later retaining its control. A 10-20% of the equity of created subsidiary may be offered to public. Two separate entities are created namely parent and the subsidiary company. Subsidiary creation helps the company to have better access to funds, access to capital market, tap more growth opportunities as an independent organization. Equity carve out (ECO) is sale of a subsidiary by a publicly traded company. The process is done by carving out a portion of its outstanding shares through IPO. Parent firm retains a controlling interest in the partitioned subsidiary. Carve out can be said to be a partial spin off. Parent firm sells a partial stake which is a minority stake in a subsidiary through an IPO or rights issue. The Carved out subsidiary has its own independent unit with separate CEO, financial statements with parent keeping a control over its operations and management. Equity carve out the parent company issues equity of its subsidiary. The process of selling a small stake in a subsidiary by the parent company in an equity carve out is generally done. Through issue of an IPO (Initial Public Offering) or rights issued. In an IPO a definite number of shares are offered to public. By maintaining the controlling stake in the subsidiary the parent company is able to extend its resources and management expertise to the subsidiary carve out generally helps the parent firm to raise funds. In 2008 several infrastructure majors like Lanco Infrastructure and GVK Power & infrastructure took the route of Equity carve out. These companies wanted to set up new division their power business. Equity Carve out helped these companies to find new projects without diluting the holding company’s control. Under ECO the division or unit is converted into wholly owned subsidiary. ECO brings in new shareholders in the firm. Spin off / Demerger Spin off or demergr is creation of an independent company from the parent company through divestiture. The spin off is done through sale of the asset or distribution of new shares of an existing business. Generally parent firms spin off their less productive assets. The basic rationale is that the spin off unit will operate more efficiently than as a part parent company. Thus value of stock will increase post spin off. The parent company may keep a controlling stake in the spin off visit and may later sell off the stake gradually spin off are similar to equity carve assets as they involve equity issuance. However, they differ from equity carve assets as a new firm is created in a spin off unlike equity carve out in a spin off the parent company does not receive cash as new shares are distributed to the existing shareholders. Spin offs redistribute the assets and liabilities between the parent company and its subsidiaries to the existing shareholders as a pro rata dividend. The shareholders of parent firm continue to hold the shareholding of the spin off unit. The share distribution

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in spin off is a tax free transaction provided at least 80% of the new shares are distributed amongst all shareholders. In a spin off there is neither dilution of equity nor a transfer of ownership from existing shareholders. In US it is popularly termed as spin off while inn UK it is termed as demerger. In a Spin off the shares are distributed to existing shareholders. In a carve out the shares are issued to a new set of shareholders. In a carve out the firms incur large expenses in form of transaction cost and have to adhere to stringent disclosure requirements. Carve assets require greater scrutiny and hence require more management time and effort that adds to the cost. When the firm is under valued and has undervalued assets it may choose to spin off these assets. In the spin off the undervalued assets remain in hands of current shareholders. When firms are more keen on raising cash they choose curve outs which help in raising additional funds. Then higher disclosure norms and higher coshareholders involved may compel the management to select spin off over, carve out firms that are highly leveraged or have poor credit rating may not prefer to go to the capital market but divest through spin off. Let us take the example of AT&T. the company underwent series of spinoffs to unlock value. Alexander graham bell invented the telephone and subsequently owned two patents and went on to establish bell telephone company in 1877. The company started selling license for telephone in 1878 to various franchise and bell telephone company became a part of the bell system. In 1882 bell telephone company acquired substantial controlling stake in western electric company which was supplier of telephone equipment. By 1885 company started to build long distance telephone network. In 1894 as the telephone patent expired the telephone industry witnessed emergence of several competing players in the telephone communication industry. in 1899 the company reorganized American bell telephone by merging its subsidiary the American telephone & telegraph company ( which was formed in 1885) with its parent company making it the parent of the bell system. During the following few decades the American telephone & telegraph company developed the concept of cellular telephony, transatlantic telephone service, moving image transmission, mobile telephone, cellular telephony, international long distance calls, Unix computer operating system, fiber optic cable system etc. In 1991 the American telephone & telegraph company acquired NCR corporation a computer maker with the objective of realizing synergies due to integration of computing and communication business. In 1993 it went on to acquire Mc Caw Cellular communication Inc which was largest cellular service provider in US. McCaw Cellular communication was renamed as AT&T wireless. In the following year the American telephone & telegraph company was legally renamed as AT&T corp. in 1996 the company realized negative synergies between its various business lines. It decides to spin off AT&T corp into three companies namely

1. The service company that retained the name as AT&T corp 2. Product and systems company called Lucent Technologies which became an

independent company. The shareholders of AT&T corp received .324084 shares

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of lucent technologies for every share of AT&T corp. cash was given in lieu of any fractional shares held by shareholders.

3. Computer company called NCR which became an independent company. AT&T corp shareholders received .0625 shares of NCR for every share of AT&T . cash was paid in lieu of any fractional shares held by shareholders.

In 1999 AT&T corp acquired TCI the second largest cable company in US followed by acquisition of MediaOne another cable company in year 2000 (see figure 3). In 2000 the company spin off the wireless division into AT&T wireless and broadband company. In 2002 the AT&T broadband was sold to Comcast corporation. The AT&T wireless in 2004 was sold to cingular which rebranded it as new cingular wireless services ltd. in 2005 the main company AT&T corp was acquired by SBC communications for $16 billion. SBC communications had majority partnership 60% in cingular. It rebranded AT&T corp as New AT&T. new AT&T acquired BellSouth valued at $86 billion in 2006 . BellSouth had a 40% stake in Cingular. 1.325 shares of AT&T were received by shareholders for each share of BellSouth. By 2007 the company Cingular became the all in all owner of AT&T corp. in 2008 the company executed internal restructuring and decided to lay off around 12000 employees and removal of pay phones. Post Internal restructuring it acquired Dobson Cellular ( cellular one) provider of service in rural area for USD $2.8bn ($13/share) assuming debt of $2.3 bn USD. Later in 2008 it also acquired centennial communications corp. for $944 million and Wayport Inc which was a major provider of internet hotspots in US.

American Bell Telephone Co (1877)

Acquired (1882) Western Electric Co for supplying telephone equipment

Subsidiary creation (1885) American Telephone & Telegraph Company

1894 G h B ll’ P t t E i

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Figure 3: Corporate Restructuring of AT&T

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DEMERGER IN INDIA In India several companies spin off their units to create wealth for its shareholders. In a demerger we know that there is no change in ownership of the business. A shareholder who holds stake in pre demerger firm stands to held stake in the demerged subsidiary created through merger. The advantage shareholders have post demerger that they hold stake in parent and subsidiary firm separately. They may decide to keep both under their portfolio of investment or exit from both or either of the two. Post Demerger Pre Demerger De-merger is essentially a scheme of arrangement under Section 391 to 394 of the Companies. Demerger, in relation to companies, means the transfer, pursuant to a scheme of arrangement under Sections 391 to 394 of the Companies Act, 1956, by a demerged company of its one or more undertakings to any resulting company in the manner specified in Section 2(19AA) of the Income Tax Act. The provisions of Section 395 of the Companies Act, 1956 are available to protect the interest of shareholders dissenting from the scheme approved by the majority. As per the companies Act, 1956 the demerger process also requires approval by majority of shareholders holding shares representing three-fourths value in meeting convened for the purpose, and Sanction of High Court. The De-merger involves ‘transfer’ of one or more ‘undertakings’. The transfer of ‘undertakings’ is by the demerged company, which is otherwise known as transferor company. The company to which the undertaking is transferred is known as resulting company which is otherwise known as ‘transferee company’. The demerged company means the company whose undertaking is transferred, pursuant to a demerger, to a resulting company. The transfer of the undertaking is on a going concern basis. Plus The demerger should be in accordance with the conditions, if any, notified under sub-section (5) of section 72A by the Central Government in this behalf. Section 2(42C) of the Income Tax Act, 1961 and introduced a concept of ‘slump sale’. Slump sale means the transfer of one or more undertakings as a result of sale fro a lump sum consideration without values being assigned to the individual assets and liabilities in such sale. Therefore, demerger cannot be accomplished with slump sale since such a sale is only for sale of undertaking. The demerger should be in accordance with the act by the Central Government in this behalf which envisages the Companies Act, 1956.

Shareholders

Parent Parent

Subsidiary

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As per the Sub Section 19AA of Section 2 of Income Tax Act, 1961. [(19AA) “demerger”, in relation to companies, means the transfer, pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act, 1956 (1 of 1956), by a demerged company of its one or more undertakings to any resulting company in such a manger that-

1. All the property of the undertaking, being transferred by the demerged company immediately before the demerger, becomes the property of the resulting company by virtue of the demerger.

2. All the liabilities relatable to the undertaking, being transferred by the demerged company, immediately before the liabilities of the resulting company by virtue of the demerger.

3. The property and the liabilities of the undertaking or undertaking being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger.

4. The resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis;

5. The shareholders holding not less than three-fourths in value of the shares in the demerged company (other than shares already held therein immediately before the demerger, or by a nominee for, the resulting company or, its subsidiary) become share-holders of the resulting company or companies by virtue of the demerger,

Steps involved

1. Generally the following steps are adopted in a demerger process: 2. Preparation of scheme of demerger 3. Application to court for direction to hold meeting of the members/creditor 4. Obtaining court’s order for holding meetings of members/creditors 5. Notice of the meetings of members/creditors 6. Holding meeting(s) of members/creditors 7. Reporting the result of the meeting by the chairman to the court 8. Petition to the court for sanctioning the scheme of demerger 9. Obtain order of the court sanctioning the scheme 10. Court’S order on petition sanctioning the scheme of demerger

Compliances relating to de-merger: Resulting Companies are required to submit the Corporate Action Forms to depositories and pay fee for the same. Then they need to go ahead with the Printing of share certificates, cover letter, envelops and Dispatch of Share certificates or demat credit of equity shares of the resulting companies and Dispatching share certificate. Send intimation to the shareholders of each of the resulting companies regarding the corporate Action. Application to Stock exchange, attaching dispatch certificate/demat credit

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certificate and copy of advertisement, for trading permission. Then the Publication of the Advertisement (as per Schedule 28 of SEBI DIP Guidelines) in one English daily, Hindi Daily and Regional Daily. Let us discuss a few Indian demergers. Jubilant Organosys a drug maker spin off its non-pharma business into a new unit named as Jubilant Industries Ltd. Jubilant Industries Ltd. would focus on agri segment and list separately on stock exchange by January 2011. This firm is expected to focus on polymers and fertilizers. This sits of Jubilant are expected to get one share in Jubilant Industries Ltd for every 20 shares held. The new entity Jubilant Life Screens Ltd. would focus on Life scenes segment. The spin off is expected to unlock value in pharma business. The margins in Agri Polymer business are low which were drawing down performance of Jubilant’s pharma business before spin off. The APP business contributed only 11% of the total revenue Rs. 37.8 bill of Jubilant Organosys before spin off (see figure 5).

Jubilant Organosys

Jubilant Industries Ltd. Jubilant Lift Scrences Ltd. Figure 5: structure of jubilant organosys At the same time Jubilant Organosys Ltd. (JOL) is expected to amalgamate its wholly owned subsidiary Specialty Molecules Ltd. (SML) and Pace marketing Specaletues Ltd. (PMSL) an exclusive contract manufacturer for adheres into JOL. With the spin off of Agri and Performance Polymer business into Jubilant Life Scrience Ltd. and proposed amalgamation the JOL would be renamed as. Reliance Energy an Indian private sector power utility company along with the Anil Dhirubhai Ambani Group promotes Reliance Power. The market Capitalization of Reliance Energy was 40437 crore in 2008 Feb. while Market Capitalization of Reliance Power was Rs. 86935 crore in the same period (when Reliance Power had not yet set up a single power project). Reliance Power is part of Anil Ambani Dhirubhai Group ADAG which is an ffshoot of the reliance group that was founded by late Shri Dhirubhai Ambani. ADAG comprises of several companies in the following sectors (see figure 4).

1. Telecommunications: Reliance communications – Rcom 2. Financial services: reliance general insurance, reliance life insurance, reliance

portfolio management, reliance mutual fund. 3. Media and entertainment : reliance big entertainment 4. Infrastructure and energy sector: reliance infrastructure ltd, reliance natural

resources ltd, reliance energy transmission, reliance energy trading, reliance power ltd.

ADAG

Media & Entertainment

Financial services

Telecommunications

Infrastructure & Energy

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Figure 4: corporate restructuring at ADAG Reliance power; key business objective is to develop and construct and operate power projects domestically and internationally. As on 2010 the operational projects of the firm were Samalkot and Goa Power Project, Kochi Power Project and Rosa Stage1 and more than 11 projects are under development. the company expects to become the largest private sector coal mining company in India once the captive coal mines become operational. The company announced in july 2010 to merge with reliance natural resources ltd. RNRL. RNRL and RPower is expected to merge in an all stock deal worth US$11 BN. The boards approved an exchange ratio of 1 share of reliance power for every 4 shares of RNRL. The proposed merger is expected to bring about large synergies in form of benefit to RPower from RNRL’s Gas Supply Master Agreement (GSMA) with RIL. Reliance Power would further benefit from gas from RNRL’s 4 CBM blocks. Thus there would be Enhanced reliability and cost efficiency for Reliance Power through RNRL’s coal supply logistics and shipping business. At the same time the RNRL shareholders to benefit from Reliance Power’s diversified generation portfolio of 37,000 MW and substantial coal reservesi. RNRL shareholders holding around 80% of its capital are also shareholders of Reliance Power, and over 80% of them received their shares free on demerger from RIL. RIL demerged into several companies as Anil Ambani and Mukesh ambani separated their ownership in Dhiribhai ambani group of companies. In 2005 due to certain irreconciliable differences between the two brothers the reliance group was demerged. The demerger was as per the scheme of rearrangement laid down by companies act and was approved by the Bombay High Court. The demerger scheme divided the reliance group with Mukesh Ambani who took over Reliance Industries and Indian Petrochemicals Corporation, while Anil Ambani got control of Reliance Energy, Reliance Infocomm and Reliance Capital. Demerger at Wipro limited In 2012 Wipro announced that it would hive off non- IT business into an unlisted subsidiary. In November 2012 shareholders held meeting after getting approval from

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court and approved the demerger process. Wipro is expected to hive off its three units namely Wipro Consumer Care & Lighting (including Furniture business), Wipro Infrastructure Engineering (Hydraulics & Water businesses), and Medical Diagnostic Product & Services business (through its strategic joint venture), into a separate company to be named Wipro Enterprises Limited. Wipro enterprises will be an unlisted company. The reason for the proposed demerger is that these three non IT businesses of wipro contributed only 14% to its revenue. The IT business contributes about 86% to the revenue. The IT business will continue to be listed company. According to the restructuring scheme as currently proposed, resident Indian shareholders of Wipro Limited on the record date can choose from multiple options as per their investment objectives. They may opt to: (i) receive one equity share with face value of Rs.10 in Wipro Enterprises Limited for every five equity shares with face value of Rs.2 each in Wipro Limited that they hold; or (ii) receive one 7% Redeemable Preference Share in Wipro Enterprises Limited, with face value of Rs.50, for every five equity shares of Wipro Limited that they hold; or (iii) exchange the equity shares of Wipro Enterprises Limited and receive as consideration equity shares of Wipro Limited held by the Promoter. The exchange ratio will be 1 equity share in Wipro Limited for every 1.65 equity shares in Wipro Enterprises Limited. Each Redeemable Preference Share shall have a maturity of 12 months and shall be redeemed at a value of Rs.235.20 Non-resident shareholders (excluding ADR holders) and the ADR holders on the record date would be entitled to receive equity shares of Wipro Enterprises Limited in the aforesaid ratio. The Non-resident shareholders (excluding ADR holders) shall further have the option to exchange the Wipro Enterprises Limited equity shares that they are entitled to and receive equity shares of Wipro Limited held by the Promoter in the aforesaid ratio. The demerger is anticipated to also assist Wipro Limited in increasing public float for the purpose of the meeting the minimum public shareholding requirement under clause 40A of its listing agreement subject to SEBI approval. This clause states that minimum public shareholding of 25% in listed companies is mandatory by march 2012. azim premji who holds about 80% shares in the company will shell off some of his holding in the process. The board of wipro would remain unchanged and demerger will have no impact on the management structure of wipro limited. The Valuation process was jointly undertaken by Deloitte Touche Tohmatsu India Private Limited and N. M. Raiji & Co, while fairness opinions were provided by JM Financial Institutional Securities Private Limited and Citigroup Global Markets India Private Limited. JM Financial also acted as the sole financial advisor to Wipro Limited. Source: press release November 01, 2012 (http://www.wipro.com/newsroom/Wipro-Ltd-Announces-Demerger-of-its-Consumer-Care-&-Lighting-incl-Furniture-Business-Infrastructure-Engineering-Hydraulics-&-Water-Business-and-Medical-Diagnostic-Product-&-Services-Business-into-a-Separate-Company-to-be-Named-Wipro-Enterprises-Ltd Asset Sell Off

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Here the parent firm sells off the subsidiary to a third party. They parent firm receives cash in the transaction. No new firm is created in the process. The sold assets or subsidiary are simply absorbed by the buying firm. Asset sale off is a private transaction and does not involve the public. Larsen and Toubro Ltd. (L&T) India’s largest engineering Technology Construction Company sold off its shares in Voith paper technology India limited VPTIL in 2009 to its joint venture partner Voith Gmbtt, Heidenheim Germany. VPTIL was a 50:50 partnership between Voith and L&T that provided consultancy services to Indian Paper Industry along with Paper manufacturing1. Further in 2009, the Larsen and Toubro Limited – L&T sold its complete stake in Ultratech Cement Limited in the open market to the tune of 11.49%. L&T had in 2004 had exited its cement business Ultratech through a demerger of its cement business Ultratech and sale to Grasim. However, it had retained 11.49% stake in Ultratech. Thus, with complete sale of its stake in cement L&T preferred to focus on its core business. In 2008, L&T sold off its Ready Mix Concrete (RMC) business to Lafarge India following its exit from Cement business in 2004. L&T in its restructuring plan in 2007 had spun off its power, shipbuilding and hydrocarbon businesses as subsidiaries. L&T retained railways defense nuclear power business under the parent company umbrella. The Engineering and Construction division (ECC) of L&T contributed 75% of the revenues in 2006, 14% of profits was contributed by electronic division and 10% by industrial product division, 4% by three other divisions. The ECC division was further split into four separate companies namely Building and Factories, Infrastructure, Power Transmission and Distribution, Mineral Metal and Water in July 2008. STRATEGIC ALLIANCES and JOINT VENTURE Alliances and joint venture are another form of portfolio restructuring. Joint venture is business agreement between two parties where they agree to form a new entity. In many cases the two companies come together for a common project or purpose. An Example of successful joint venture is Dow corning which is fifty-fifty joint venture between Dow chemical and Corning. Dow chemical is a multinational corporation typically known as chemical manufacturer manufacturing plastics, chemicals and agricultural products. Corning is an American manufacturer of glass ceramics and other material primarily used for industrial and scientific applications. The Dow corning JV produces silicone sealants, adhesive, lubricants and related products harnessing the competencies of both the firms. Another example is that of Sony Ericsson mobile communications AB is a joint venture between Sony Corporation and Swedish telecom company Eriksson formed with an objective to manufacture mobile phones. Sony is a Japanese manufacturer of consumer electronic company leveraged its consumer electronic related expertise in this JV while Ericsson leveraged its technological know-how in communication sector. Before further

1(L&T Press Release Oct. 26, 2009)

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discussion let us understand that joint venture and strategic alliance do not connote the same meaning although used interchangeably on several occasions. Generally joint ventures can be equity based or simply contractual based or simply knowledge sharing based. In Equity based Joint Ventures the partner’s pool in funds and other resources in the name of the new company. Whereas in contractual alliances, the partners collaborate on specific factors like technology and know-how etc, without creating any new entity. JVs as a norm seem to be established with relatively low involvement initiatives as compared to mergers and acquisition. Companies are highly disciplined about mergers and acquisition; they do not show similar commitment in JVs. Some JVs require deep focus as the JV leads to a consolidation of pooled resources. Skill Transfer JV also require critical skill transfer from one partner to another Co-ordination JV the focus is on complimentary resources and capabilities of the partners. New Business JV the partners confirm existing resources (complementary and supplementary) to create new growth. The objective in all, types of JVs is to focus on the maximizing the synergy gain from the partnership. Whirlpool Corporation global manufactures and marketer of home appliances headquartered at Michigan USA, Company is an MNC reaching out its brands to nearly every country across globe, it acquired Maytag Corporation (have & Commercial appliance Co.) on March 31, 2006 to become largest have appliances maker in the world in Stock purchase. In 1988 Whirlpool began a joint venture with Phillips and the JV was called Whirlpool one of the largest electronics companies in the world International where whirlpool owned 53% and Phillips 47%. In 1991 the JV was terminated and whirlpool bought 47% stake of Phillips to become full owners of Whirlpool international.

Thus was Phillips major Domestic Appliance Division. For Whirlpool it was a market entry card into Europe. This JV (in form of 53% acquistion of Phillips Domestic appliances Division) offered economies of scale and scope to whirlpool. Philips received a handsome piece for its European Appliance division to Whirlpool. MERGERS AND ACQUISITION Merger and acquisition is also a strong form of portfolio restructuring tool along with divestiture and alliances M&A forms a tool set for corporate to do portfolio restructuring. It is through these three tools that firms change the mix of their core assets and portfolio of their business lines in which they operate. Merger occurs when firms consolidate to form new entity or the dominant player absorbs the target player. Acquisition occurs when acquirer acquires a controlling stake in the public listed company by acquiring its outstanding shares. Merger can be categorized into following types:- 1. Horizontal Merger 2. Vertical Merger 3. Conglomerate Merger.

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Horizontal Merger A typical Horizontal merger involves two firms that operate in same business line and compete each other in the same industry. Horizontal mergers realize economics of scale. It expands the existing business geographically into new territories by offering similar products and services to layer customer base. It does not involve additional products or services. When markets reach saturation point the best option for the firm is to expand through horizontal merger. Organic growth in a saturated market like hiring sales force and managers, developing efficient sales and marketing channel and developing effective, customer relationship management practices does not seem a lucrative business decision. However, the basic strategy for growth is a saturated market is to organize a competing firm in some market or in distant geographic markets. Organic expansion involve large amount of money and time to hire and train people for new markets, new system and new processes. Sometimes it may become an added burden on the organization. Acquiring a firm in distant geographic market does away with such establishment and set up costs. It is an established business already running operation and delivering goods or services. Vertical merger Vertical Merger happens when two companies in different stages of production or distribution or value chain combine. Generally, it involves companies upstream and another is downstream. Vertical mergers neither change market shares in a relevant market nor eliminate a direct source of competition. Vertical mergers make the merged firm cost-efficient by streamlining its distribution and production costs. It ideally leads to optimal utilization of resources. When a firm integrates with its supplies it is known as backward integration. Here post merger the company controls inputs used in its production operations. For example a steel industry may acquire iron ore mines. Sugar Mill acquires sugarcane farm, automobile company acquires tire or spare part manufacturer.

When the company acquires a firm forward like distribution, retailers it is known as forward vertical integration. Disney’s acquisition of American Broadcasting Company. (ABC). Vertical integration reduces transportation costs if production, supplies and distribution system are in close proximity and at the same time enhances supply chain activity coordination. It may also leads to creation or expansion of core competency and competitive advantage of firm vertical merger does not directly create monopoly but creates entry barriers to new players and competitors.

Conglomerate merger Such merger happen between companies that have no common business link and are completely unrelated. Such mergers happen to diversify the rank of business portfolio of the parent firm. Diversification of a firm into different business lines that are having low or negative correlation tends to reduce the overall risk of the conglomerate grant firm (parent firm). The diversification helps the firm to diversify away the business specific

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risk and hence reduce the fluctuation in operating profit (EBIT) of the parent firm. The volatility in operating profits (EBIT) i.e. business risk is high in individual business and hence diversification across low or uncorrelated business us reduced in a portfolio of business for parent firm. Parent firm’s volatility in operating profit reduces due to diversification. This helps the parent firm to go for greater diversification. For example, diversified firms like Reliance Industries, Aditya Birla Group, NUVO. Kelso’s acquisition of Nortek Where Nortek Inc. is a international designer manufacturer and marketer of building products while Kelso & Company LP is a private equity firm. Merger and acquisition as corporate restructuring tool creates new companies by way of vertical mergers, horizontal merges and diversified conglomerate mergers. M&A adds to the core growth and creates inorganic growth opportunities for companies. Through mergers and acquisition firms add new businesses, products, brands, services, geographical market and create value in the long run. Merger and acquisition is discussed in detail in a separate chapter…. MERGER AND ACQUISTION AS INORGANIC GROWTH TOOL Apart from being termed as a tool for corporate restructuring M&A is also termed as an inorganic growth tool. This is because through M&A companies acquire other firms, businesses which adds to their existing growth. Hence M&A is termed as inorganic growth tool. Let us also understand the difference between organic and inorganic growth of company. A typical business firm may expand organically by investment into its core assets. Or the firm may expand inorganically by buying growth or enter into an alliance for a partnership for growth. All Green field and Brownfield projects are organic growth focused. Organic growth basically relates to existing business growth by enhancing customer base, new sales, capacity etc. Organic growth comes from a company’s existing business and reflects the management capability in utilization of existing resources. Efficient and optimum utilization of existing resources to generate higher growth reflects organic growth focus can be easily measured as:

1

1

t

tt

ROC

ROCROCg

Where g is organic growth ROCt is return on capital in time ‘ t’. ROCt-1 is return on capital in period t-1. Core growth focuses on the company’s internal assets and intangible capabilities built by the firm in a period of time. It accumulates as resources of the firm that represent the firm Assets (tangible and intangible) capabilities developed by the firm attributes of the firm processes of the firm that it excels in knowledge and information developed and controlled by the firm. These resources yield competency for the firm like customer relationships, good and efficient networks (backend as well as front-end) that yield competitive advantage for it.

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Leveraging upon internal core assets and resources help firm to generate higher growth and sustain more growth that acquiring growth. Core growth mutes cannablization and focuses on core and products and business generality and enhancing core competencies. But generally higher core growth is very difficult. Rather one can say that over a long period there is a limit to core growth. If you see the developed economies, most of sectors have reached saturation point and market segmentation have fragmented it further. Further investment in R&D has not shown a consistent growth across industries leading to lesser innovation. Hardening of core growth will only lead to exploration of inorganic growth opportunities.

Figure 6: Growth strategies – Classification Inorganic Growth refers to external growth by alliances, joint ventures, spin-offs, divestitures, takeovers, mergers and acquisition. Inorganic growth happens when firms purchase growth. It is fast and allows immediate utilization of acquired assets. Bruner (2004). It is less risky as it does not result in expansion in capacity. The classification of inorganic growth strategies is given in figure 6 above. The growth from new investments

Organic growth Inorganic growth

Merger /Acquisition

Core Assets growth Strategic Alliance/Joint Venture

Same Business Line

Same Value Chain

Diversified

Corporate Growth

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is generally a product of firm’s reinvestment rate and quality of the new investments. The reinvestment rate is measured by the proportion of freely available after tax cash profit generated by the firm invested in capital expenditure etc. the quality of the new investments relates to the cash generating potential of eth new assets. It is measured by the return on capital. Growth from new investments = Reinvestment rate x Return on capital invested. Generally in today’s competitive environment Inorganic growth is defined more by business growth generated by acquiring new business by way of merger and acquisition, or spinoffs and other modes of restructuring. It is basically all about acquiring/purchasing growth. It is a shortcut way to growth relative to inorganic growth.

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KEY TERMS Merger Acquisition Corporate Restructuring Vertical Merger Horizontal Merger Conglomerate Organizational Restructuring

Financial Restructuring

Portfolio Restructuring

Divestment or Divestiture Equity carve out

Joint Venture

Spin off

Asset Sell Off

Strategic Alliances

Reliance industries: growth through M&A tool Reliance Industries ltd in India has shown great foresight in identifying key value drivers through merger and acquisitions. In the year 2007 Reliance industries ltd RIL created value through acquisition and integration of IPCL. It was indeed a landmark merger of Indian Petrochemicals Corporation Limited (IPCL) with Reliance Industries Ltd. (RIL) as huge synergy gains were expected to be realized. The exchange ratio was 1:5 that meant that for every 5 shares held by IPCL shareholders they would receive 1 share of RIL. At this exchange ratio RIL issued around 6 cr new shares to IPCL shareholders. This would expand the RIL’s equity to INR 1454 cr from INR 1394 cr. Mukesh Ambani had been building his take in IPCL since 2002 when the government divested its 26% stake in the company at INR 231 per share. Post the divestment purchase Mukesh Ambani lead RIL had purchased additional shares from open market through open offer thereby increasing their stake to 46%. Reliance industries is a consolidated group of several companies floated for specific projects and later on merged with the parent company like Reliance Petrochemicals ltd, reliance polyethylene ltd etc which were floated for certain specific projects and then later on were merged with RIL. The original Reliance petroleum successfully launched its IPO in 1993 and was merged with RIL in 2002. Then again Reliance petroleum ltd was re-launched and later again merged with RIL in 2009. The main reason was the huge value creation through scale and synergies. The merger of Reliance Petroleum Limited (RPL) with Reliance Industries Limited (RIL) was expected to create boundless operational scale and financial synergies that existed between the two Companies. Assets and liabilities of RPL were transferred to RIL with effect from 1st April 2008, as per the approval granted by the High Courts of Mumbai and Gujarat. Shareholders of RPL received 1 share of RIL in lieu of every 16 shares of RPL held by them, as per the scheme of merger. Accordingly, 6.92 crore new equity shares of RIL were allotted to the shareholders of RPL1. Source : http://www.ril.com/html/aboutus/major_milestones.html

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i Reliance power media release on may 28th 2010, media release 4th July 2010.