Lecture 9: Corporate Restructuring

Question 1

What is Corporate Restructuring

Answer 1

It is a transaction where a company is reduced in size by

a. ) Asset Disposal (Divestiture)
b. ) Divided into Separate Entities (Spin-off/Equity Carve-Out)
c. ) Transferred to Private Ownership (Buyout)

Question 2

What are the 6 Reasons for Restructuring

Answer 2

Main aim: To Create Value
ATSMNC (AT So Many New Cars)

1. ) Reduce Agency Conflict
2. ) Transfer assets to owners who may better utilize assets
3. ) Sharper focus for managements who may lack skill set to manager different types of business
4. ) Correct strategic mistakes of management (Reverse mistakes of acquisition)
5. ) Reflect new information about various parts of the company to other parties (Equity Clienteles)
6. ) Prevent cross-subsidization of business units

Question 3

What is ‘Diversification Discount’

Answer 3

Process of value creation by restructuring

Question 4

What is an evidence of ‘Diversification Discount’

Answer 4

Single-segment firms (e.g. woolworths) outperform multi-segment firms (e.g. Coles in WF)

Question 5

Why do Single-segment firms outperform multi-segment firms

Answer 5

1. ) Over-investment: Additional effort in under performing firm
2. ) Cross-subsidization: Additional resources in under-performing firm which impedes entire enterprise (esp. in conglomerate firms)

Question 6

What are the 4 types of restructuring transactions

Answer 6

1. ) Divestiture
2. ) Spin-off
3. ) Equity Carve-out
4. ) Leverage Buyout

Question 7

Restructuring Transaction 1: Divestiture. What is the market response

Answer 7

Sell off business units for cash (Hence lose ownership)

Create value for sellers

0.5%

Question 8

Reasons for Divestiture (Restructuring Transaction 1). Which of ATSMNC is not applicable and why?

Answer 8

To reflect new information about part of the firm (N)

N relates to making the public aware of the new firm/ form equity clienteles. Nothing to do with selling off asset

Question 9

Example for Divestiture: Kraft Food

Answer 9

To address need for liquidity and Management lack enterprise.

Kraft sold off frozen pizza to Nestle. Nestle could also utilize asset better.

Question 10

Restructuring Transaction 2: Spin-Off. What is the market response

Answer 10

• Listing one of its business units as a separate entity
• All shares in new business entity are distributed to existing shareholders on pro-rata basis (not fund-raising activity)
  3. 3%

Question 11

Example of Spin-Off: Kraft

Answer 11

• Kraft spun off North American Operations
• Kraft became Mondelez - High Growth
• North American Operations became Kraft- Stable, Low Growth

Form Equity Clienteles (is this N)

Question 12

Restructuring Transaction 3: Equity Carve-Out. What is the market response

Answer 12

• Establish a new entity
• Shares in new entity are sold and not distributed

Minor shares: Public (to provide cash for…)
Major shares: Firm

Usually precedes a spinoff
Common against companies who need equity over debt

1.9%

Question 13

Do the parent company maintains significant shareholding in new entity

Answer 13

Yes they do (remember: cash to parent company, not shareholders)

Question 14

Example of Equity Carve-Out + Spin off: 3Com and Palm 3 Details

Answer 14

• 3Com spun off Palm
• Sold 5% of Palm and retained 95% throughIPO
• Each 3Com Share cost $82 and Palm Share cost $95 (but each 3Com SH get 1.5 Palm Shares)

Question 15

Example of Equity Carve-Out + Spin off: 3Com and Palm 2 Reasons

Answer 15

1. ) Market Inefficiency

2. ) New information

Question 16

Restructuring Transaction 4: Leveraged Buyout. What is the market response

Answer 16

• Private equity investors borrow funds to buy a listed firm (High debt finance) - Stock increase and avoid listing fees

OR
- If buyers are existing managers, it is a MANAGEMENT BUYOUT - Management gain from both salary and ownership

37%

Question 17

What kind of firms can do leverage buyout

Answer 17

Suitable for low business risk, general-purpose, tangible assets (low-growth)

Question 18

What is the focus on management on buyouts

Answer 18

Greater focus of reducing expenses, disposing of non-core assets and increasing efficiency

Question 19

What are the effects of buyout using agency conflict

Answer 19

High leverage (debt) combined with high equity ownership by the buyer increase incentive to maximize value of the firm: Reduce agency cost!

Question 20

Are buyouts correlated with the market?

Answer 20

Yes they vary significantly over time and correlate with the market

Question 21

What is the objective of a leveraged buyout

Answer 21

It is to sell the asset via an “EXIT” (Trade Sale, IPO, Sale to Private Equity Investor, Sale to Management, Etc)

Question 22

CASE STUDY: LEVERAGED BUYOUT BK and Trio

Answer 22

• Sold BK to trio of private equity. (>1 bil debt; 325mil equity)
• Private equity paid over 500mil and BK exited
• BK de-listed once more by 3G and private equty trio received 3.26bil

Question 23

Empirical Evidence to Restructuring 1: Motive

Answer 23

1. ) Increased Focus (35.9)
2. ) Divest in low-performance division (35.9)
3. ) Increase marginal efficiency (9.8%)
4. ) Achieve specific-organisational form (7.6)
5. ) Others (10.9)

Question 24

Empirical Evidence to Restructuring 2: Types of Restructuring and Returns. Explain why for LBO

Answer 24

1. ) Leveraged Buyout (37.0%) - Because of control premium
2. ) Spin-Off (3.3%)
3. ) Equity-Buyout (1.9%)
4. ) Divestiture (0.5%)

Question 25

In all the restructures, who gets the cash? and what is the implication in Equity Carve Outs

Answer 25

The firm gets the cash, NOT the shareholders (they might get indirectly).

Since it is the firm, the SHs cannot sell the shares

Question 26

Reasons for Spinoff. Which of ATSMNC is not applicable and why?

Answer 26

Transfer new assets to those who can better utilize them. T

Question 27

Main reason for a LBO. Which of ATSMNC is not applicable and why?

Answer 27

All is, but mainly is A. Reduce Agency Conflict since management is now shareholders

Question 28

In an equity carve out, how much shares do the parent company usually offer

Answer 28

Usually about 5-10% of the shares offered to the public with the cash going to the parent firm (not shareholders)

Question 29

Explain the 2 stage process in equity carve-out

Answer 29

Stage 1: Establish new entity. Sell 10% of shares for Cash.
Stage 2: New shares usually 10% undervalued. Wait for new information/price to increase and sell it/SPINOFF to parent shareholders

Question 30

Why factors might companies consider in electing whether to engage in a spin-off or an equity carve-out?

Answer 30

Equity carve-outs:

1. ) Parent company have more difficulty in obtaining financing from conventional sources such as debt and new stock issues.
2. ) Used to showcase the subsidiaries to prospective future buyers as part of a two-stage process - By not selling off 100% of the shares, it permits the parent to benefit from the potential upside when the market realizes the true value of the subsidiary in the second stage of the selling process.