Session 1b Key Definitions

Question 1

What are the two categories of corporate restructuring?

Answer 1

1. Operational restructuring
2. Financial restructuring

Question 2

What is operational restructuring?

Answer 2

Entails changes in the composition of a firm’s asset structure (e.g., business combinations, sale, spin-off, downsizing, etc.)

Question 3

What is financial restructuring?

Answer 3

Describes changes in a firm’s capital structure (e.g.,
share repurchases).

Question 4

What is a merger?

Answer 4

A merger is a combination of two or more firms, often comparable in size, in which all but one ceases to exist legally.

Question 5

What is a consolidation?

Answer 5

A consolidation is a combination of two or more firms, which are joining to form a new company.

Question 6

What is an acquisition?

Answer 6

Unlike a merger, acquisition can occur at any share control percentage and involve minority, majority, or totality stakes.

Question 7

What is an asset sale?

Answer 7

Asset sale: the purchase of individual
assets and liabilities.

Question 8

What is a stock sale?

Answer 8

Stock sale: the purchase of the owner’s
shares of a corporation.

Question 9

What is the buyer’s viewpoint in an asset sale?

Answer 9

Good: Tax benefits. By allocating a higher value for assets
that depreciate quickly (like equipment, which has a 3-
7 year life) and by allocating lower values on assets
that amortize slowly (like goodwill, which has a 15 year
life), the buyer can gain additional tax benefits,
improving the company’s cash flow during the first
years.
Good: Avoid inheriting potential liabilities, especially
contingent liabilities in the form of product liability,
contract disputes, product warranty issues, or
employee lawsuits.
Bad: Difficult to transfer some assets. Risk of
assignability, legal ownership, and third-party
consents issues (i.e., certain intellectual property,
contracts, etc.).

Question 10

What is the seller’s viewpoint in an asset sale?

Answer 10

Bad: Higher taxes. Intangible assets, such as goodwill, are
taxed at capital gains rates, other “hard” assets can be
subject to higher ordinary income tax rates. In the US,
capital gains rates are currently 20%. Ordinary income
tax rates depend on the seller’s tax bracket.
Bad: Double taxation. The corporation is first taxed upon
selling the assets to the buyer. The corporation’s
owners are then taxed again when the proceeds
transfer outside the corporation.

Question 11

What is a friendly (hostile) takeover?

Answer 11

A friendly (hostile) takeover occurs when one acquiring corporation take over the target firm, with (without) the agreement of the target corporation’s board of directors.

Question 12

What are two ways a hostile takeover is accomplished?

Answer 12

• tender offer: the corporation seeks to purchase shares from outstanding shareholders of the target corporation at a premium to the current market price.
• proxy fight: the acquiring corporation tries to persuade shareholders to use their proxy votes to install new management or take other types of corporate action.

Question 13

What is a horizontal M&A?

Answer 13

Horizontal M&A involves firms that operate in the same industry. Usually, the goal is to achieve economies of scale

Question 14

What is a vertical M&A?

Answer 14

Vertical M&A involves firms that operate in the same industry but at different stage of the supply chain. Usually, the goal is to achieve economies of scope.

Question 15

What is the purpose of a conglomerate?

Answer 15

Conglomerates involves firms that operate in different industries. Usually, the goal is to lower the operational risk by implementing a diversification strategy.

Question 16

What is a divestiture?

Answer 16

Divestiture is the sale of a portion of a firm’s assets to an outside party, generally resulting in a cash infusion to the parent. Such asset may include a product line, subsidiary, or division.

Question 17

Why divest?

Answer 17

• Divested assets may have a higher value to the buyer of these assets. For assets to have a higher value, they have to either generate higher cash flows for the buyers or result in lower risk (leading to a lower discount rate)
• Satisfy a cash-flow need. Firms that find themselves unable to meet their current operating or financial expenses may have to sell assets to raise cash.
• Restructure the portfolio and unfold value of the existing businesses.

Question 18

How to determine to sell or not to sell a business?

Answer 18

• Estimate the enterprise value of the business on a stand-alone basis (DCF approach)
• Adjustments to cash flows. To decide if a business is worth more to the shareholder if sold the parent must first estimate the after-tax cash flows of the business viewed on a stand-alone basis (i.e., as if it were operated as an independent operating unit). - This requires adjusting the cash flows for intercompany sales and the cost of services (e.g., legal, treasury, and audit) provided by the parent.
• Define the cost of capital. Once the after-tax stand-alone cash flows have been determined, a discont rate should be estimated that reflects the risk characteristics of the industry in which the business competes.. The cost of capital of other firms in the same industry (or firms in other industries exhibiting similar profitability, growth opportunities and risks characteristics) is often a good proxy for the discount rate of the Business being analyzed.

Question 19

What is a demerger?

Answer 19

• A demerger is a separation of the activities of a group: the original shareholders become the shareholders of the separated companies.
• The transaction can be carried out by distributing the shares of a subsidiary (a spin-off), or by dissolving the parent company and distributing the shares of the ex-subsidiaries to the shareholders (a split-up). There is no infusion of new cash.

Why?
* Reviewing the Corporate portfolio and divest assets that are difficult to sell.
* Rewarding shareholders with a nontaxable dividend (if properly structured)