Corporate Restructuring - A Financial Perspective

CorporateCorporate
RestructuringRestructuring
Prepared by:Prepared by: Hany RagaieHany Ragaie
Mohamed ElnagyMohamed Elnagy
Mohamed IbrahimMohamed Ibrahim
Supervised by:Supervised by: Dr. Hussein SeoudiDr. Hussein Seoudi

08/11/14 Corporate Finance Project 2
Agenda
• Introduction
• Mergers & Acquisitions
• Leveraged Buyouts
• Divestitures
• Financial Restructure
• Valuing Corporate Restructuring Process
• Case Study: Exxon-Mobil Merger

• any substantial change in a company’s business portfolio or financial
structure in a way that helps the firm to achieve its objectives and
increases the value to shareholders
• Classification:
–
Portfolio Restructuring
–
Financial Restructuring
–
Organizational Restructuring
What Is Corporate Restructuring?
Introduction
Why Companies Undertake Restructuring Practices?
• Regulatory and political change
• Technological change
• Financial change
• Management Ego

Introduction
Types of Corporate Restructuring
• Mergers & Acquisitions
• Joint Ventures
• Leveraged Buy-Outs (LBO)
• Asset Sale
• Spin-Off
• Split-Up
• Equity Carve Out
• Tracking Stocks
• Liquidation
• Leveraged Re-capitalization
• Dual Class Re-capitalization
• Share Repurchase
• Exchange Offers
• Bankruptcy

Introduction
Impact Of Restructuring On Corporate Performance
• A study that covers some data from 5000 firms over the 1980s has
attempted to investigate restructuring impact on market & economic
performance.
• The study reveals that LBOs result in greatest performance
improvement
• Spin off has a high probability of improving performance, but likely to be
much more modest than LBO
• Aggressive M&A activities, yielded returns slightly below the returns
realized from no transactions

Mergers & Acquisitions
Merger Motivations
• Synergy
• Tax considerations
• Purchase of assets below their replacement cost
• Diversification
• Managers’ personal incentives
Types Of Mergers
• Horizontal
• Vertical
• Congeneric
• Conglomerate

Mergers Waves
Buyer Target Completion Date Value ($ billion)
Vodafone Air Touch Mannesmann 12-Apr-00 161
Pfizer Warner-Lambert 19-Jun-00 116
America Online Time Warner 11-Jan-01 106
Exxon Mobil 30-Nov-99 81
Glaxo Wellcome Smithkline Beecham 27-Dec-00 74
SBC Communications Ameritech 8-Oct-99 72
Vodafone Group Airtouch 30-Jun-99 69
Bell Atlantic GTE 30-May-00 60
Pfizer Pharmacia 16-Apr-03 60
Total Fina Elf Aquitaine 9-Feb-00 54
• 1800s • 1960s• 1920s • 1980s • Today

Hostile Vs. Friendly Takeover
• Acquiring company identifies a possible target
• Acquiring firm’s managers decide how to approach the target firm:
• Friendly takeover: management of target firm accepts merger
• Hostile takeover: management of target firm does not accept
merger
• In friendly takeover, the target firm’s management recommends the
merger to its stockholders
• In hostile takeover, the acquiring firm makes a direct appeal to the
target firm’s stockholders
• In both cases, the stockholders are asked to tender their shares to a
designated financial institution that transfers ownership of the shares to
the acquiring firm

• Market multiple analysis
• Corporate valuation model
Vop =
• Equity residual model
Vequity =
• Adjusted Present Value (APV)
Vop = ,
rsU
= rrf
+ MRP*bU
bU
=bL
/ [1 + (D/S)(1-T)]
Merger Analysis: Valuing The Target Firm
∑
∞
= +1 )1(t
t
t
WACC
FCF
∑
∞
= +1 )1(t
t
s
t
r
FCFE
N
sU
N
t
sU
tt
N
t r
HV
r
TSFCF
)1()1(1 +
+
+
+
∑= gWACC
gFCF
HV N
N
−
+
=
)1(

Merger Analysis: Setting The Bid Price
• The ceiling price is the target firm’s post merger value as estimated
earlier
• The minimum price is the target firm’s pre-merger value of equity as an
independent operating company
• The gap between the post merger value and the value of equity
represents the synergistic benefits expected from the merger
• The actual price will be set somewhere in the gap, depending on many
factors

Financial Reporting: Purchase Accounting
Post Merger Firm A
Firm A
(1)
Firm B
(2)
$20 Paid
(3)
$30 Paid
(4)
$50 Paid
(5)
Current Assets 50 25 75 75 75
Fixed Assets 50 25 65 75 85
Goodwill 0 0 0 0 10
Total Assets 100 50 140 150 170
Debt 40 20 60 60 60
Equity 60 30 80 90 110
Total Claims 100 50 140 150 170

Financial Reporting: Income Statement Effects
Post Merger Firm A
Firm A
(1)
Firm B
(2)
Merged
(3)
Sales 100 50 150
Operating Costs 72 36 109
EBIT 28 14 41
Interest (10%) 4 2 6
Taxable Income 24 12 35
Taxes 9.6 4.8 14
Net Income 14.4 7.2 21
EPS 2.4 2.4 2.33

Divestiture
• Divestiture is the distribution of a company's assets or a
business segment by sale, liquidation or other acquisition
arrangement .
• Asset sale
– The sale of an entire division or unit.
• Spin-off
– Existing stockholders are given new stock representing
separate ownership rights in the division that was divested.
• Crave-out
– Minority interest in a corporate subsidiary is sold to new
shareholders .
• Liquidation
– Assets of a division are sold off piecemeal, rather than as an
operating entity.

Reasons for Divestiture
• Dismantling segments which had higher values as independent
operations .
• Sale of original business due to changing opportunities.
• Divestiture to finance major acquisitions .
• Divestiture of unrelated divisions to focus on core businesses.
• Discarding unwanted businesses from prior acquisitions.
• Divestiture used as a takeover defence.
• Divestiture of low margin product lines to improve margins and
profitability .

Examples of Divestitures
• PEPSI
– Spinning-off its fast-food business, which included Pizza
Hut, Taco Bell, and Kentucky fried chicken.
– To focus on its core business.
– Signing long-term contracts that ensure that Pepsi products
will be sold exclusively in each of the three spun-off chains.
• United Airlines
– Selling Hilton international hotels subsidiary and Hertz rental
car unit .
– To maintain the company’s focus in the highly competitive
airline industry .

Financial Restructure
• Financial restructuring relates to improvements in the capital
structure of the firm. An example of financial restructuring would be
to add debt to lower the corporation's overall cost of capital.
• Leveraged Recapitalizations
– Additional debt to pay a large dividend or repurchasing shares .
• Dual-class recapitalization
– A second class of common stock that has limited voting rights in
the form of a higher dividend.
– Securing liquidity without sacrificing control.
• Exchange offers
– Giving one or more classes of claimholders the option to trade
their holdings for a different class of securities of the firm .

Bankruptcy
• Bankruptcy is a legally declared inability or impairment of ability of
an individual or organization to pay their creditors.
• Financial distress:
– Temporary and permanent cash problem.
– Agreement with creditors to recover.
– Is the company “worth more dead than alive”?
– Should the firm file for protection under chapter 11 of the
bankruptcy.
– should it try to use informal procedures?
– Who should control the firm while it is being liquidated or
rehabilitated?

Bankruptcy
• Informal reorganization
– For temporary financial difficulties.
– Workouts to restructure the firm the debt.
– Extension, creditors postpone the date of required interest or
principal payments.
– Composition, creditors voluntarily reduce their fixed claims on
the debtor or equity in exchange for debt.
– Simple, and also relatively inexpensive because legal and
administrative expenses are held at minimum.
– Result in the largest return to creditors.

Bankruptcy
• Informal Liquidation
– Firm is more valuable dead than alive.
– Assignment, an informal procedure for liquidating a firm .
– An assignment calls for title to the debtor’s assets to be
transferred to a third party, known as an assignee.
– The assignee is instructed to liquidate the assets through a
private sale or public auction and then to distribute the proceeds
among the creditors on a pro rata basis.
– Assignments are feasible only if the firm is small.

Bankruptcy
• Federal Bankruptcy
– Company to be filed for court protection under chapter 11.
– Attempting to reorganize under the supervision of a bankruptcy
court.
– Formal bankruptcy proceedings are designed to protect both the
firm and its creditors .
– Creditors can use bankruptcy procedures to stop the firms’
managers from continuing to operate & loose more money.
– A trustee will be appointed to take over the company.
– If no feasible reorganization can be worked out, the bankruptcy
judge will order that the firm be liquidated under procedures
spelled out in chapter 7 .
– Fraud and holdout problem.

Bankruptcy
• Criticisms of Bankruptcy laws
– Large public corporations with the ability to hire high-priced legal
help can avoid, or at least delay, liquidation, often at the
expense of creditors and shareholders.
– Critics believe that bankruptcy is great especially for consultants,
lawyers, and investment bankers, who gain fees during
bankruptcy proceedings, and for managers, who continue to
collect their salaries and bonuses as long as the business is kept
alive.
– Companies operating under the protection of chapter 11 can
damage or even bankrupt their otherwise healthy competitors.

Leveraged Buyouts (LBO)
• It is the takeover of a company, financed by borrowed funds.
• The investors group usually include current management.
• The target company's assets are used as security for the loans
acquired to finance the purchase.
• The acquiring company or group then repays the loans from the target
company's profits or by selling its assets.
• Generally the acquiring group plans to run the acquired company for a
number of years, boost its sales and profit, and then take it public
again as a stronger company.

Leveraged Buyouts (LBO)
• In a LBO, there is usually a ratio of 90% debt to 10% equity.
• Due to this high debt/equity ratio, the bonds are usually not
investment grade and are referred to as junk bonds.
• Leveraged buyouts have had a notorious history, especially in the
1980's when several buyouts led to the eventual bankruptcy of an
acquired company.
• This was mainly due to the fact that the leverage ratio was nearly
100% and the interest payments were so large that the company's
operating cash flows were unable to meet the obligation.
• As of 2005, the largest LBO to date was the acquisition of RJR
Nabisco in 1989 by Kohlberg Kravis Roberts & Co. (KKR).
• Depending on the source cited, KKR paid between $25 billion
and $31 billion for the acquisition.
• LBOs activities increased from 99 transactions worth $3 billion in
1981 to peak 338 transactions worth over $61 billion in 1989.

Role of Equity in LBOs

Valuing Corporate Restructuring
Process
We have Three methods for valuing the process
• Comparables Approaches
 Comparable companies analysis
 Comparable transactions analysis
• The DCF Spreadsheet Approach
• Formula Approach

Summary of the valuation process
• All valuation methods have strengths and weaknesses
• Valuation uses historical data as starting point
• Valuation depends on forecasts
• Reliability of forecasts depends on
 Analysis of changes in world and national economies.
 Understanding of business economics and financial
characteristics of the industry
 Analysis of competitive strategies and tactics.
• Ultimately valuation judgments must be made
 Precision is not possible.
 Valuations require periodic reassessments.

Summary of the valuation process
• Role of valuation
 Valuable planning framework for sound strategies and
improved efficiencies.
 Valuable framework to help identify value drivers important
to the future value of the firm.
 Sensitivity studies identify critical factors for the future.
 Valuable as a tool to develop a business model with
effective information feedback system.
 Valuable tool for flexible long range planning processes.
 Critical in M&As — major cause of acquisition failure is that
bidder overpays .

Industry Characteristics & Merger Motivations
Case Study: Exxon-Mobil Merger
• Impact of OPEC
• Oil price instability
• Early Restructuring Activities in the U.S. Oil industry
• The combined company would be in a stronger position to invest in
programs involving large outlays with high prospective risks and returns
• Exxon’s experience in deepwater exploration in West Africa would
combine with Mobil’s production and exploration acreage in Nigeria and
Equatorial Guinea
• Exxon’s strong presence in Azerbaijan would combine with Mobil’s
similar position in Kazakhstan
• Near term operating synergies of $2.8 billion were predicted. Two-thirds
of the benefits would come from eliminating duplicate facilities and
excess capacity

Deal Terms & Event Returns
Exxon Mobil
Pre-Merger
Share Price $72.00 $75.25
Shares Outstanding (million) 2,431 780
Market Value (billion) $175.00 $58.70
Book Value (billion) $43.70 $19.00
P/E Ratio 23.60 17.90
Exchange Terms
Total Paid (billion) $74.20
Stock Exchanged 1.32 for 1
Premium Over Market (billion) $15.50
Premium Over Market % 26.40%
Premium Over Book (billion) $55.20
Premium Over Book % 290.50%
Post-Merger
Number of Shares 2,431 1,030

Deal Terms & Event Returns
Date MOB
MOB
Returns
Cumulative
Returns
XON XON Returns
Cumulative
Returns
13-Nov-1998 73.44 72.88
16-Nov-1998 72.63 -1.11% -1.11% 71.44 -1.97% -1.97%
17-Nov-1998 71.94 -0.95% -2.05% 70.56 -1.23% -3.20%
18-Nov-1998 73.63 2.35% 0.29% 70.69 0.18% -3.02%
19-Nov-1998 73.5 -0.17% 0.12% 69.88 -1.15% -4.17%
20-Nov-1998 75.25 2.38% 2.50% 72 3.04% -1.13%
23-Nov-1998 76.19 1.25% 3.75% 72.06 0.09% -1.04%
24-Nov-1998 74.94 -1.64% 2.11% 72.69 0.87% -0.17%
25-Nov-1998 78.38 4.59% 6.70% 72.69 0.00% -0.17%
27-Nov-1998 86 9.73% 16.42% 74.38 2.32% 2.15%
30-Nov-1998 86 0.00% 16.42% 75 0.84% 2.99%
1-Dec-1998 83.75 -2.62% 13.81% 71.63 -4.50% -1.51%
2-Dec-1998 84.19 0.52% 14.33% 71.25 -0.52% -2.04%
3-Dec-1998 84.5 0.37% 14.70% 70.56 -0.97% -3.00%
4-Dec-1998 86 1.78% 16.48% 71.5 1.33% -1.67%
7-Dec-1998 87.38 1.60% 18.08% 73 2.10% 0.43%
8-Dec-1998 87.94 0.64% 18.72% 73.19 0.26% 0.68%
9-Dec-1998 88.25 0.36% 19.08% 73.94 1.03% 1.71%
10-Dec-1998 88.25 0.00% 19.08% 73.75 -0.25% 1.45%
11-Dec-1998 88.88 0.71% 19.78% 74.63 1.19% 2.64%
14-Dec-1998 89.38 0.56% 20.35% 74.44 -0.25% 2.39%
15-Dec-1998 88.44 -1.05% 19.30% 74 -0.59% 1.80%

Valuation Analysis
• Cost of Capital Calculation
ke
= rrf
+ MRP*b
Exxon: ke = 5.6% + 7%(0.85) = 11.55%
Mobil: ke = 5.6% + 7%(0.75) = 10.85%
WACC = (S/VL) ke + (D/VL) kb (1–T)
Exxon: WACC = 0.7 (0.1155) + (0.3)(0.072)(0.65) = 9.49%
Mobil: WACC = 0.7 (0.1085) + (0.3)(0.075)(0.60) = 8.95%
Combined WACC = 0.70(0.112) + 0.30(0.072)(0.62) = 9.18%

Valuation Analysis
• Free Cash Flow Projections

Valuation Analysis
• Valuation Calculation
PV of cash flows, 2000-2010 $130,331
PV of terminal value $171,757
Marketable securities $73
Total value of the firm $302,161
Value of debt ($18,972)
Value of equity $283,189
Shares outstanding 3,477
Intrinsic share price $81.45

Tests of Merger Performance
Market Caps Ownership
Pre merger
Exxon $175.00 74.90%
Mobil $58.70 25.10%
Total $233.70 100.00%
Post merger
Combined Value $283.30
Paid to Mobil $74.20
Remainder $209.10
Exxon Pre merger $175.00
Gain from Merger $34.10
Portion to Exxon 70% $23.90
Portion to Mobil 30% $10.20
Plus Premium to Mobil $15.50
Mobil Total Gain $25.70

Anti-Trust Considerations
• Antitrust agencies place great emphasis on market concentration effects using
the Herfindahl-Hirschman Index (HHI or H index) Oil price instability
• The H index is measured by the sum of the squares of the market shares of all
of the firms in the industry
• The critical H index specified in the Guidelines is 1,000
• Below 1,000 concentration is considered sufficiently low, so that no further
investigation is required
• If a post-merger H index is between 1,000 and 1,800 and the index was
increased by 100 or more, the merger would be investigated
• If the industry H index is more than 1,800 and it was increased by at least 50,
the merger is likely to be challenged.
• With 9 mergers among the largest petroleum companies during 1998-2001, the
HHI for the petroleum industry rose from 389 points to 583 points

Corporate Restructuring - A Financial Perspective

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