Corporate Expansion and Contraction

Question 1

How can corporate expansion be achieved?

Answer 1

1. Organic Growth

2. Mergers and Acquisitions (M&A).

Question 2

What are the elements of organic growth?

Answer 2

1. Incremental (slow)

2. Low risk and returns

Question 3

What are the elements of mergers and acquisitions (M&A).

Answer 3

1. Transformational (rapid)

2. High risk and returns

Question 4

What is the definitions for Mergers?

Answer 4

1. Friendly
2. Similar sized companies
3. Pooling of interests in new company

Question 5

What is the definitions for Acquisitions?

Answer 5

1. Friendly or hostile
2. Size imbalance
3. Bidding company acquires:

• All of the shares in the target (a takeover)
• A subsidiary of the target.

Question 6

What are the 3 classifications of M&A?

Answer 6

1. Horizontal expansion - bidder and target in same sector at the same stage.
2. Vertical expansion - Bidder and taregt in the same sector but at different stages.
3. Diversification - Bidder and target in different sectors

Question 7

What are the 2 stages within vertical expansion?

Answer 7

1. Target is the supplier to the bidder (backwards)

2. Target is a customer of the bidder (forwards)

Question 8

What are the 5 motives for M&A’s?

Answer 8

1. To increase the wealth of shareholders in the bidder.
2. To gain control of the target company’s directors, assets, employees etc.
3. To gain economies of scale as they will have increased pricing power so therefore higher revenues as well as lower costs from purchasing power and eradication of duplicating costs.
4. To gain control over supply channels and reduce unsytematic risks.
5. To gain entry to new makrts (think geographically).

Question 9

What are the risks for M&A?

Answer 9

The wealth of the shareholders in the bidder can be destroyed.

Question 10

What 3 reasons are for the destruction of shareholder wealth?

Answer 10

1. Bidders management will overpay to acquire target leading to insufficient due diligence and a deal driven by dubious managerial motives.
2. Integration issues such as failure to gain expected cash flows from economies of scale and synergies.
3. Control Issues such as the inapproproate managerial skill set.

Question 11

What is the typical M&A process? (Slide 10).

Answer 11

1. Directors of the bidding company will evaluate a potential target company. Then approach directors of the target to discuss / negotiate. Then make a formal offer to shareholders of target.
2. Directors of the target company will then recommend that its shareholders either:
   Accept the offer (friendly reaction); or
   Reject the offer (hostile reaction)
3. Acceptance level (percentage of shares in target):
   Below 50% - bidder can increase offer or walk away
   50% or above - offer goes unconditional (succeeds)

Question 12

What do bidders consider when evaluating a target?

Answer 12

1. Whether the deal can be funded.
2. The activities of the target such as the Scope for economies of scale, synergies & risk reduction.
3. Stakeholder reactions.

Question 13

What is a takeover in consideration to traget pricing?

Slide 12

Answer 13

A takeover is an investment project so appraise using discounted cash flow techniques based on available information on the target

• Friendly: public plus internal information (due diligence)
• Hostile: only publicly available information

Question 14

What is the minimum price of a target? Slide 12.

Answer 14

Current market capitalisation of the target plus a premium for control:

Market price – minority shareholding and no control
Takeover price – majority shareholding and control

Both at 10% - 50% premium.

Question 15

What is the maximum price of a target? Slide 13.

Answer 15

Maximum price:

Target’s forecast future cash flows in perpetuity; plus
Incremental forecast cash flows from economies of scale and synergies; which are both
Discounted to present value at an appropriate risk-adjusted rate

Question 16

What does the actual price depend on?

Answer 16

1. Negotiating skills of directors in bidder and target
2. The success of the target’s defence tactics
3. The level at which the target shareholders are prepared to sell their shares to the bidder

Question 17

How can the bidding company offer to pay for shares in the taregt company? (funding)

Answer 17

Using…

1. Cash only from existing resources; and/or new capital issue.
2. Shares only
3. Cash and shares

Question 18

What 2 types of strategy can a corporate contraction be?

Answer 18

1. A planned strategy to create shareholder wealth by divestment.
2. A necessary strategy
   to avoid corporate failure
   by restructuring.

Question 19

What is a divestment method?

Answer 19

The action or process of selling off subsidiary business interests or investments

Question 20

What types of divestment methods can be made?

Answer 20

1. Spin-off as a parent company sells subsidiary to another company.
2. Management buy-out as a parent company sells subsidiary to its incumbent management
3. A Demerger as two new companies formed as subsidiaries are transferred to each whilst shareholders receive shares in each in exchange for shares in old parent company.

Question 21

What is a subsidary?

Answer 21

a company controlled by a holding company?? check this.

Question 22

What is the MAIN motive of divestment?

Answer 22

1. To increase shareholder wealth by concentrating on the management of core activitie and generating funds for acquisitions and reinvestment in core activities etc.

Question 23

How does a company experiencing financial distress avoid insolvency? (inability to pay its creditors).

Answer 23

They restructure as their prime corporate objective becomes the protection of creditors. If unsuccessful the company will become insolvement and will be:

Question 24

What happens id there is an unsuccesful restructure of a company’s solvency?

Answer 24

If restructuring is unsuccessful then the company will become insolvent and will be:

Involuntarily liquidated; or
Placed into administration

Both of these will destroy shareholder wealth.

Question 25

What are the 4 restructuring methods?

Answer 25

1. Negotiate with primary creditors
2. Reduce and/or defer expenditures
3. Reduce working capital such as inventories, trade receiveables and trade payables
4. Reduce cost base by making
   redundancies and closures.

Question 26

What should the directors consider when restructuring?

Answer 26

1. Likelihood of success. I.e. may not be able to raise external finance.

2 Upfront costs such as redundancy payments.

3. Time required. i.e. divesting a subsidiary may take months.
4. Effect on the company’s ability to trade i.e. loss of supplier goodwill if exceed trade credit period.

Question 27

What happens when a court judge agrees to no alternative to involuntary liquidation?

Answer 27

1. Trading ceases
2. Assets sold as quickly as possible
3. Creditors are repaid in the following order of priority:

Fixed charge creditors (i.e. bondholders)
Preferential creditors (i.e. employees)
Floating charge creditors (i.e. banks)
Unsecured creditors (i.e. tax authorities, suppliers)
Shareholders

Question 28

What is an alternative to liquiditation?

Answer 28

Administration.

Question 29

What administrations intent?

Answer 29

1. Recover more money for creditors and have a milder social impact

Question 30

What happenes to an administrator is appointed by the court?

Answer 30

1. Replaces the board of directors and manages the company as a going concern.
2. Has one year to restructure the company.
3. Proposes an arrangement to creditors at the end of the year to accept a fraction of their debt or liquidate.