Module 19: Restructuring Flashcards
Divestment: two main forms of divestment
Sell offs
Spin offs
Divestment: Sell-offs
SELLING PART OF A BUSINESS to a THIRD PARTY, usually for cash
Most common reason for a sell-off are to:
- dispose of less profitable
- dispose of non-core business units
- or to raise cash
The owner may wish to sell because they are not willing to allocate valuable resources to it or because they do not have the cash to fully develop its potential
Disinvestment: spin-offs/demerger
There is NO CHANGE IN OWNERSHIP of the business
Usually a spin off takes the form of a NEW COMPANY being created with assets transferred into it
New mgmt team usually put in place to manage the spin-off, with the SHs having SHings in two companies rather than one
Reasons for sell-offs and spin-offs
- removal of negative synergy
- market recognition
- different types of businesses
- defence strategy
- Improved efficiency
- Improved use of resources
- after an acquisition
- removal of negative synergy
2+2 = 3
- little common ground between the businesses => fare better if they were run separately
- Market recognition
As part of the group has good potential for growth but, growth potential is not recognised by the market => ‘unlock’ the unrealised value by ‘spinning off’ part of the business that has growth potential.
Investors will be able to value the two businesses, now separately owned and managed.
- Different types of businesses
UK and overseas parts of a business have a large number of different characteristics => may fare better if they were run separately
e.g. heavily regulated business and reg requirements are fundamentally different in overseas jurisdictions
may also be tax advantages for effecting such a split
- Defence strategy
Defence strategy against a hostile takeover bid. Sell offs and spin offs may reduce the likelihood of a hostile takeover bid where the bidder recognises underperforming assets in a group
- Improved efficiency
The creation of a clearer mgmt structure and strategic vision of the two companies should result in greater efficiency and effectiveness
- Improved use of resources
Divestment of underperforming assets will enable companies to move their resources to more profitable investment opportunities
- After an acquisition
Sometimes a company is bought but not all the parts of the business are wanted
Parts of the business that are not wanted can be sold off = asset stripping
Potential drawbacks of divestment:
- VULNERABILITY
- smaller => may be greater vulnerability to takeover - LOSS OF ECONOMIES OF SCALE
- where the demerged business shared central OHs - HARDER TO RAISE FINANCE
- being smaller => may be harder to raise finance or the cost of finance may be higher
Management buy-outs
transaction in which the MANAGERS of a business join with institutions (VC funds and banks) to BUY THE BUSINESS FROM ITS CURRENT OWNERS
Following incentives will often be features of the deal:
- ENVY RATIOS
- mgmt team invests less than VC to obtain a certain % of shares - RACHETS
- where mgmt team outperforms forecasts, their % SHing increases
The VC will assess the skills and experience of mgmt and appoint additional mgmt if necessary
Types of buy-out
- Management buy-out (MBO)
- Institutional buy-out (IBO)
- Mgmt and employee buy-out (MEBO)
- Employee buy-out (EBO)
- Management buy-in (MBI)
- Buy-in mgmt buy-out (BIMBO)
- Leveraged buy-out (LBO)
Types of buy-out: Management buy-out (MBO)
- existing mgmt of business backed by institutions
- benefit from existing mgmt expertise
- often useful in niche sectors
Types of buy-out: Institutional buy-out
- Institutions via an auction (achieves a higher price than traditional MBO)
- more common than MBOs for large deals (>£50m) where it is too hard for mgmt to raise finance
- mgmt will often be offered equity incentives to motivate
Types of buy-out: Other buy-outs
Management and employee buy-out
- key employees and exec management buys
Employees buy-out
- all employees offered am opportunity to buy a stake
Management buy-in
- outside mgmt backed by institutions
Types of buy-out: Buy-in management buy-out
- external managers join forces with internal mgmt and financial institutions
Ads:
- more reliable info because existing mgmt invited to join new venture
- less acquisitional slippage as existing managers are motivated to make the deal succeed
- vendor knows employees are more likely to be safe after the sale
Types of buy-out: Leveraged buy-out
- can imply cross-border ownership
- highly leveraged deal
- many MBOs are actually LBOs because of the amount of debt finance used for the purchase
Circumstances behind buy-outs:
- Needs investment
- company is being stripped of cash/starved of financial resources by its parent => ability to remain competitive is eroded - Parent needs to reduce borrowings
- comp’s parent needs to divest to reduce its borrowing or reinvest elsewhere - Retirement
- company is privately owned and principal SHs are reaching retirement - Peripheral operations
- comp is a sub or division of larger group but its operations are peripheral to the core business of the group or to its strategic development - Insolvent parent comp
- company is a profitable sub/division of a parent that is insolvent - Insolvent company
- company itself is unprofitable and its parent sees a buy-out as an alternative to closure - Privatisation
- of a state-run industry
Buy-out structures: two types
- Sale of shares
- most straight-forward form of MBO
- managers acquire the shares in the target, generally incorporating an off-the-shelf company (Newco) which raises finance to purchase the shares in target - Sale of assets
- may be neither desirable or possible to acquire the shares in the target so the Newco will acquire the assets and trade of the target instead
Use of a Newco
- single overriding reason for the use of Newco = ability of Newco to obtain tax relief for interest paid on the borrowings it obtained to acquire the target and to OFFSET that relief against the target’s taxable profits
- without the Newco structure, the post-tax cost of borrowing would render the transaction uneconomic
- another advantage = as Newco is top company, the desired SHing structure can be more easily achieved with a fresh company
Financing the buy-out
Balance of debt and equity in a buy out is crucial
- will affect the economics of investment to finance provider as well as the underlying performance of the target comp
- eventual mix between equity and debt influenced by the objectives of the lead finance provider
- equity in principle = more expensive than debt but over-leveraging a business with debt may be risky => balance is struck
The majority of finance for Newco will be in the form of debt. Two types of acquisition debt:
- senior debt
- Mezzanine debt
Acquisition debt: Senior debt
Funded by core earnings of the business
Usually
- secured by first-ranked charge over assets
- repaid 5-7 years
- Margins of 1.5%-2.5% over LIBOR typically in SME sector
Acquisition debt: Mezzanine debt
Emerged to fill gap between senior debt and equity
Typical features:
- higher priced debt often structured against identified, but new, forecast earnings streams
- generally unsecured - ranks behind senior debt legally and in payment
- Typically bullet repayment
- returns generally generated through equity warrants (right to subscribe to shares in the borrower for nominal sum)
- other means of generating returns are redemption premiums and interest roll-up
- lenders may require board representation
- lenders will require protection from any dilution in the value of their warrants
- providers include conventional commercial banks, dedicated funds created for the purpose and non-banking financial institutions e.g. insurance comps
- enables debt providers to participate in the future growth of the company
- offers a cheaper source of finance than equity
Companies Act reconstructions
s895 allows companies to enter into any type of scheme regarding either TP or its SHs as long as it doesn’t breach general law or another statutory provision
- this type of reconstruction is similar to CVA => spirit of the reconstruction is that the business must have some future otherwise it might be better for the creditors if they went into liquidation
- the most likely form of reconstruction = TP and debenture holders to ACCEPT an allocation of OS in exchange for their existing liability
(only attractive if the current position is such that on liquidation they would receive less than the reconstruction offers) - COURT must sanction the scheme and the procedure can be LONG, DRAWN OUT and EXPENSIVE => used only by larger companies
see example in notes
s895 reconstruction hardly examined but use the following if it is:
calculate:
- position of each stakeholder under liquidation
- the position of each stakeholder in terms of the proposed scheme
scheme will only be accepted if everyone is better off
