Module 19: Restructuring

Question 1

Divestment: two main forms of divestment

Answer 1

Sell offs

Spin offs

Question 2

Divestment: Sell-offs

Answer 2

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

Question 3

Disinvestment: spin-offs/demerger

Answer 3

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

Question 4

Reasons for sell-offs and spin-offs

Answer 4

1. removal of negative synergy
2. market recognition
3. different types of businesses
4. defence strategy
5. Improved efficiency
6. Improved use of resources
7. after an acquisition

Question 5

1. removal of negative synergy

Answer 5

2+2 = 3

- little common ground between the businesses => fare better if they were run separately

Question 6

2. Market recognition

Answer 6

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.

Question 7

3. Different types of businesses

Answer 7

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

Question 8

4. Defence strategy

Answer 8

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

Question 9

5. Improved efficiency

Answer 9

The creation of a clearer mgmt structure and strategic vision of the two companies should result in greater efficiency and effectiveness

Question 10

6. Improved use of resources

Answer 10

Divestment of underperforming assets will enable companies to move their resources to more profitable investment opportunities

Question 11

7. After an acquisition

Answer 11

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

Question 12

Potential drawbacks of divestment:

Answer 12

1. VULNERABILITY
   - smaller => may be greater vulnerability to takeover
2. LOSS OF ECONOMIES OF SCALE
   - where the demerged business shared central OHs
3. HARDER TO RAISE FINANCE
   - being smaller => may be harder to raise finance or the cost of finance may be higher

Question 13

Management buy-outs

Answer 13

transaction in which the MANAGERS of a business join with institutions (VC funds and banks) to BUY THE BUSINESS FROM ITS CURRENT OWNERS

Question 14

Following incentives will often be features of the deal:

Answer 14

1. ENVY RATIOS
   - mgmt team invests less than VC to obtain a certain % of shares
2. 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

Question 15

Types of buy-out

Answer 15

1. Management buy-out (MBO)
2. Institutional buy-out (IBO)
3. Mgmt and employee buy-out (MEBO)
4. Employee buy-out (EBO)
5. Management buy-in (MBI)
6. Buy-in mgmt buy-out (BIMBO)
7. Leveraged buy-out (LBO)

Question 16

Types of buy-out: Management buy-out (MBO)

Answer 16

• existing mgmt of business backed by institutions
• benefit from existing mgmt expertise
• often useful in niche sectors

Question 17

Types of buy-out: Institutional buy-out

Answer 17

• 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

Question 18

Types of buy-out: Other buy-outs

Answer 18

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

Question 19

Types of buy-out: Buy-in management buy-out

Answer 19

• 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

Question 20

Types of buy-out: Leveraged buy-out

Answer 20

• can imply cross-border ownership
• highly leveraged deal
• many MBOs are actually LBOs because of the amount of debt finance used for the purchase

Question 21

Circumstances behind buy-outs:

Answer 21

1. Needs investment
   - company is being stripped of cash/starved of financial resources by its parent => ability to remain competitive is eroded
2. Parent needs to reduce borrowings
   - comp’s parent needs to divest to reduce its borrowing or reinvest elsewhere
3. Retirement
   - company is privately owned and principal SHs are reaching retirement
4. 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
5. Insolvent parent comp
   - company is a profitable sub/division of a parent that is insolvent
6. Insolvent company
   - company itself is unprofitable and its parent sees a buy-out as an alternative to closure
7. Privatisation
   - of a state-run industry

Question 22

Buy-out structures: two types

Answer 22

1. 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
2. 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

Question 23

Use of a Newco

Answer 23

• 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

Question 24

Financing the buy-out

Answer 24

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:

1. senior debt
2. Mezzanine debt

Question 25

Acquisition debt: Senior debt

Answer 25

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

Question 26

Acquisition debt: Mezzanine debt

Answer 26

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

Question 27

Companies Act reconstructions

Answer 27

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

Question 28

s895 reconstruction hardly examined but use the following if it is:

Answer 28

calculate:

1. position of each stakeholder under liquidation
2. the position of each stakeholder in terms of the proposed scheme

scheme will only be accepted if everyone is better off