Corporate Restructuring

y Restructuring is a process by which a firm does an analysis of

itself at a point of time and alters what it owes and owns, refocuses itself to specific task of performance improvements.y Restructuring would radically alter a firms

o capital structure, o asset mix and o organization

so as to enhance the firm value.

Definitiony Corporate restructuring can be defined as

- any change in business capacity or portfolio that is carried out by an inorganic route - any change in the capital structure of the company that is not in the ordinary course of business - any change of ownership of a company or control over its management or a combination of any two or all of the above.

y Any change in business capacity or portfolio carried out by inorganic route.

- merger - acquisitiony Change in the business portfolio could also be in the nature of reduction of

businesses handled by a company.y Any change in the capital structure of a company that is not in the ordinary course of

its business - significant change in the debt equity ratioy Any change in the ownership of a company or control over its management

- merger of two companies belonging to different promoters - demerger of a company into two or more with control of the resulting company passing on to other promoters - acquisition of a company - sell-off of a company or its substantial assets - delisting of the company

The activities or changes which are not termed as Corporate Restructuring1. Initial creation of a corporate structure y Its various examples are - incorporation of a limited company - conversion of a proprietary concern into a company - conversion of a partnership firm into a company - conversion of a private company into a public company. 2. Change in internal command structure or hierarchy 3. Change in business process 4. Downsizing Other activities outsourcing, enterprise resource planning, TQM,

Broad Areas of Restructuringy Financial: mergers, acquisition, joint ventures etc. It

also deals with restructuring the capital basey Technological: investment in R& D, alliances with

overseas companies.y Marketing: product market segments y Manpower: internal

structures and process for improving the capability of people

Motives for Restructuring

Strategic motivesy Expansion and growth y y y y y y y y y y y y y y y

Dealing with the entry of MNCs Economies of scale Synergy Market penetration Market leadership Backward/forward integration New product entry New market entry Surplus resource Minimum size Risk reduction Balancing product cycle. Arresting downward trend Growth and diversification strategy Re-fashioning

Financial MotivesDeployment of surplus funds Fund raising capacity Market capitalization Tax planning Operating economies Tax benefits Revival of sick units Undervaluation of target company Creation of shareholder value

Organizational Motivey Superior management y Ego satisfaction y Retention of managerial talent y Removal of inefficient management.

Gains from Corporate Restructuringy Synergistic benefits y Sharper focus y Better corporate governance y Improvement in managerial incentives and motivation y Greater disciplining power of debt y Elimination of cross subsidies.

Types of Restructuring

Techniques of Corporate RestructuringCorporate restructuring technique

Expansion technique

Divestment techniques

Other techniques

Mergers Acquisition Takeovers Joint venture Strategic alliance Franchising IPRs

demerger sell-off management buy out leveraged buy out liquidation

going private share repurchase management buy in reverse merger equity carve out

Mergers

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Mergers may take two forms

Merger through absorptionAbsorption is a combination of two or more companies into an existing company. All companies except one lose their identity in a Merger through absorption. Tata Fertilizer Ltd was absorbed by Tata Chemical Ltd. TCL survived But TFL ceased to exist.

Merger through consolidationConsolidation is a combination of Companies two or more into a new company. In this form of merger companies are legally dissolved and a new entity is created. Hindustan Computers Ltd, Hindustan Instrument Ltd, Indian Software Company Ltd and Indian Reprographic Ltd in 1986 merged to form a new Company called HCL Ltd.

Classifications of mergers` Horizontal merger - Horizontal mergers are those

mergers where the companies manufacturing similar kinds of commodities or running similar type of businesses merge with each other.` Examples of Horizontal Mergers` The merger of ACC (erstwhile Associated Cement Companies

Ltd.) with Damodar Cement. ` The formation of Brook Bond Lipton India Ltd. through the merger of Lipton India and Brook Bond.

Classifications of mergers Vertical mergers : A situation where a product manufacturer

merges with the supplier of inputs or raw materials or a product manufacturer merges with the product's distributor. Example:

A cone supplier merging with an ice cream maker.

Classifications of mergersy Conglomerate merger : A type of merger whereby the two

companies that merge with each other are involved in different sorts of businesses.

y Example: Voltas limited.

Classifications of mergersy Market-extension merger - Two companies that sell the

same products in different markets.

y Product-extension merger - Two companies selling

different but related products in the same market.

AcquisitionPurchase of one company by another

Types

NatureFriendly Hostile

PatternStock Assets

There are many ways in which control over a company can be acquired1.

By acquiring i.e purchasing a substantial percentage of the voting capital of the target company.

2.

By acquiring voting rights of the target company through a power of attorney or through a proxy voting arrangement.

3.

By acquiring control over an investment or holding company, whether listed or unlisted that in turn holds controlling interest in the target company.

4.

By simply acquiring management control through a formal or informal understanding or agreement with the existing persons in control of the target company.

Types of Controly Absolute control y Practically absolute control y General control over a company

Case StudyHindalcoHindalco-Novelis

Company OverviewHindalcoo Aditya Birla Group o Largest aluminium producer

Noveliso World leader o Aluminum beverage cans

Why the Deal?o Gain sheet mills o Strong presence in recycling of aluminium business

o All cash transaction o Debt-equity ratio of 7.23:1$3.6B

Total $6B

$Debt 2.4B

$2.85B

$300M

$450M

Joint Venture

What is a Joint Venture?A Joint Venture (JV) is a cooperative enterprise entered into by two or more business entities. The parties in the JV agree to create a new entity by both contributing equity. They share the revenues, expenses, and control of the enterprise according to a joint venture agreement (contract). The venture can be for one specific project only, or a continuing business relationship. The phrase generally refers to the purpose of the entity and not to a type of entity.

Some of the JV S in India

Basic elements of a Joint VentureContractual Agreement

Specific Limited Purpose and Duration

Joint Property Interest Common Financial and Intangible Goals and Objectives Shared Profits, Losses, Management and Control

Developing Joint VenturesPartner search Evaluating Options Negotiation Business Valuation Business Planning

COMPANY ALegal Procedures ( MOU, JV Agreement, Regulatory Approvals)

COMPANY B

JOINT VENTURE (Formation & Management)

Key FactorsEarly considerations Regulatory Licences & approvals Employee Issues

Understanding FDI rules

Company formation

Taxation and Duties

Due Diligence

Structuring the JV vehicle

Joint Venture Documents

Case Study: Hero Honda

What Was Hero Before JV.y Hero Cycles manufactured Over 16000 bicycles a day. y They had nurtured an excellent network of dealers to

serve India s expansive markets.y Over the years Hero Group had entered multiple

business areas.

Some Facts About Honda.y HMC initial plans called for both two-wheeler market

and the electric generator market.y HMC first chose Kinetic Engineering Ltd. and formed

Kinetic Honda Motors Ltd. But this JV would work in field of Scooters Manufacturing.y HMC came to Hero Group as the last compromise

choice for its motorcycle venture.

Honda selected the Hero Group for a variety of reasons, which included:y Its engineering capability y Relevance and salience of HERO brand. y Distribution network. y Commitment to Quality. y Know-how and experience in handling large volume

production and distribution. y Tight focus on financial and raw material processes. y Cordial Industrial Relations.

The Deal Is Done.(June 1984)y Honda agreed to provide tech. know-how to HHM

and setting up manufacturing facilities. This included the future R & D efforts.y Honda agreed for a lump sum fee of $500,000 & 4%

royalty on SP.y Both Partners held 26% of the equity with other

26% sold to the public and the rest held to financial institutions.

Success Storyy HHM had grown consistently, earning the title of the world s

largest motorcycle manufacturer after having churned out 1.3 million vehicles in 2001.

y World s largest two-wheeler manufacturer with annual sales

volume of over 2 million motorcycles.y Owns world s biggest selling motorcycle brand

Splendor.y Over 9 million motorcycles on Indian roads. y Deep market penetration with 5000 outlets.

Hero Honda

Success Story (Contd.)MARKET SHARE (%)

21 OTHER S HEROHO NDA 63 52 79 37 97-98 48 03-04 08-09

Reasons for successy The deep penetration network of hero largely benefited the

sales.y Absence of major competitors in initial years. y Sound and proven technical capabilities of Honda and the

reliability of Hero.

y Increased market for motorcycles:y Better Fuel efficiency. y Change in people s perception. y Decrease in price difference with scooters.

Strategic Alliance

y A strategic alliance is when two or more businesses join together

for a set period of time. Characteristics y May or may not be a contractual arrangement but this is always recommended. y Long Term Relationship y High Level of Trust y Win/Win (Mutual Advantage) y Top Management Interchange y Continuous Exchange of Ideas y Business Process Re-engineering

Characteristics Conty Focus on Significant Value-Added y Mutual Dependency y Strategic Framework in Place y High Level of Commitment y Increased Capabilities/Capacities y Enhanced Business Opportunities y Improving Shareowner Value

How to create Strategic Alliances

Alliance Operation Contract Negotiation Partner Assessment Strategy Development

Alliance Termination

Horizontal and Vertical AllianceSuppliers Vertical Alliances Customers

Organization

Horizontal Alliances

Competitors

Forms of alliancesIndustry consortium Technical training Supplier agreement Technology licensing Franchising Distribution agreement D cooperation Equity joint venture

Exit from Strategic AlliancesAll alliances need an exit strategy It is important to agree in advance on how the alliance will be unwound when. To have such a strategy is commercial best practice. There are contractual mechanisms for doing this, such as by including a Savoy clause in the contract. As in the case of partner selection, exit options and actions are well described in the literature.

JV and Strategic Alliance-Difference

C A A B B

A

B

Joint Venture

Strategic Alliance

Joint Venture Contractual Separate legal entity Significant matters of operating and financial policy are predetermined and owned by the JV Exist for a specific time Exist for a specific project or purpose Limited with respect to future expectations

Strategic Alliance May or may not be contractual Generally, not a separate legal entity Significant matters of operating and financial policy may or may not be predetermined but are owned by the individual participants Indefinite life or a specific time Fluid and allows for greater amounts of ambiguity

Franchising

FRANCHISING

Franchising is an arrangement whereby one party which has developed a proven way of running and managing a business, licenses another party and gives him the rights to operate in the same business format, a trade or trade name.

Components of Franchising The three components of the franchise are : stipulated way of operating the business distinctive trademark or service mark payment of fees :- joining fee & on-going fee and/or royalty payment

The Proprietary Marks in Franchising Trade Name Trade Mark Patent Logo

Emblem Motto Other Proprietary Marks / copyrights

How to set up a franchise?Company has successful franchise concept

Develop franchise package

Recruit franchisees

Set up model Franchise outlet

Benefits Of Franchising

Franchising allows the franchisor to : expand rapidly enhance business image save operating costs have access to greater geographical location

Advantage to the franchisor

No Investment in Immovable Property Large Scale Turnover Sales Staff Brand loyalty is developed Goodwill of trademark is secured

Benefits to Franchisee higher chances of success shorter learning curve established trade mark or service mark economies of scale in bulk purchasing joint advertising and promotion transfer of management expertise training support services from the franchisor

The Two Formats of Franchising

(a) Product Format Franchising (b) Business Format Franchising

(a) Product Format Franchising Franchisor is Typically a Manufacturer License covers Proprietary Marks only Franchisee may or may not use same marketing efforts as Franchisor Example : Ford, GM, Coca-Cola

(b) Business Format Franchising Franchisor may or may not be a Manufacturer License covers system + Proprietary Marks Franchisee Follows strict & uniform way to operate & promote Franchise Example : Mc-Donalds, Pizza Hut, Starbucks.

CASE STUDY 1

Case Study 70% business Franchising Support in terms of operations, training, advertising, marketing, real estate, construction, purchasing and equipment. Franchisees to Individuals only Completion of a 9 month training programme essential Site evaluation, Property acquired, construction done by McDonalds Franchisees are responsible for all normal business functions No financing

Case StudyAgreement is for 25 years ( Mc holds head-lease) Franchisees to maintain the restaurant dcor and building fabric to a high standard, repairing lease Franchisees may only sell approved McDonald's products through their restaurants. On Going Fees For the use of the Real Estate, McDonald's charge a monthly rent. This is based on the level of monthly net sales (Total sales less v.a.t.), and currently ranges from 5.65% to 18.4% (of monthly net sales). McDonald's charges a monthly royalty of 5% of monthly net sales. All McDonald's restaurants make an agreed contribution to a separately managed marketing fund. The contribution rate is currently 4.5% of monthly net sales.

Divestment

DIVESTMENTy The process of selling an asset , also known

as divestiture, it is made for either financial or social goals.y Realizing the market value of an asset by selling,

liquidating, or exchanging it.y Sale of all or majority of voting stock (voting

shares) of a firm.

TYPES OF DIVESTMENTy Straight sale y Spin-off y Equity carve-out y Outsourcing y Tracking stock y Demerger

Motives for Divestmenty Market Share Too Small y Availability Of Better Alternatives. y Need For Increased Investment. y Lack Of Strategic Fit. y Legal Pressures To Divest. y Curtailment Of Losses

Sell-off: A sell off is a sale of a part of the organization to a third party in the following circumstances.y To come out of shortage of cash y To protect the firm from takeover activity by selling off desirable division

to the bidder. y To improve profitability by selling loss making unit. y To reduce business risk by selling off high risk activities.

Demerger

Spin-OffsSTRUCTURE

X

Transfer of undertaking Y Y

Y

Company A

Consideration in cash Company B or issue of shares

Consideration is usually shares of Company B but maybe cash. Process may or may not be Court sanctioned. Salora spinning off Panasonic to Matsushita under s. 391 Scheme. Consideration in cash.78

y

Tracking Stock A tracking stock is a special type of stock issued by a publicly held company to track the value of one segment of that company. The stock allows the different segments of the company to be valued differently by investors. Let's say a slow-growth company trading at a low price-earnings ratio (P/E ratio) happens to have a fast growing business unit. The company might issue a tracking stock so the market can value the new business separately from the old one and at a significantly higher P/E rating. Why would a firm issue a tracking stock rather than spinning-off or carving-out its fast growth business for shareholders? The company retains control over the subsidiary; the two businesses can continue to enjoy synergies and share marketing, administrative support functions, a headquarters and so on. Finally, and most importantly, if the tracking stock climbs in value, the parent company can use the tracking stock it owns to make acquisitions. Still, shareholders need to remember that tracking stocks are class B, meaning they don't grant shareholders the same voting rights as those of the main stock. Each share of tracking stock may have only a half or a quarter of a vote. In rare cases, holders of tracking stock have no vote at all

Share Buy Back

y Share buyback helps a company by giving a better use of its

funds than reinvesting these funds in the same business at below average rates of return or going in for unnecessary diversification or buying growth through costly acquisition.y It leads to reduction in paid up capital and higher earning

and book value per share.y The market price of equity goes up y It strengthens promoters control and enhances equity value

of shareholders

Reasons for Buy-Backy To improve shareholders value. Surplus funds of the company are

utilized, EPS improves.y It provides a safeguard against hostile takeovers by increasing

promoters holdingy It enables corporate to shrink their equity base. y It is a method of financial engineering. y It improves intrinsic value of shares by reducing the level of floating

stocks

Financing of Buy-Back y Internal sourcesy Sufficient cash position y Selling of temporary investment with least possible loss y Raising cash by issuing fixed deposits y Cash credit from commercial bank

Methods of Buybacky Tender Method y Open market purchase through stock exchanges y Open market purchase through book building:

Repurchase price can be calculated as follows P = (S*M)/(S-N)y Where y P = Equilibrium purchase price y M = current market price of shares y S = No. of shares outstanding y N = No. of Shares to be repurchased.

Impact of buyback on shareholding pattern

Company A Promoters group Widely scattered Financial institution Total

Share % s 40 40 30 30 100 30 30 100

Company B Foreign shareholder Indian company

Share % s 50 50 50 50

100

100

There is a buyback from the two companies to their respective shareholders. 25 shares are offered by public shareholders of company A and 20 shares are offered by Indian shareholders of Company B. the other shareholders are not accepting the buyback. The resulting shareholding pattern would be as under.

Company A Promoters group Widely scattered Financial institution Total

Shares 40

% 53.3

5 30 75

6.7 40 100

Company Shares B Foreign 50 sharehold er Indian 30 company

% 62.5

37.5

80

100

Particulars

Before buy back

After buy back

Paid up equity share capital(Rs 10 each) No. of equity shares

1,00,00,000

60,00,000

10,00,000

6,00,000

PAT Dividend paid EPS Dividend payout ratio

60,00,000 15,00,000 6 25%

60,00,000 15,00,000 10 25%

Particulars

Before buy back

After buy back

Dividend per share

1.50

2.50

P/E Ratio of the industry

12

12

Theoretical market price of shares (EPS *P/E ratio) Market capitalization

72 720 lakh

120 720 lakh

Benefits:y Firms whose profitability was below their industry average enjoy

greater share price growth after shares are repurchased than firms whose profitability was above their industry average.y Firms whose sales growth was below their industry average enjoy

greater share price growth after shares are repurchased than firms whose profitability was above their industry average.y Profitable and growing firms that repurchase share provide a clear

indication to investor about the strength of the company.

Drawbacksy This enables unscrupulous promoters to use companys

money to raise their personal stakes.y It opens up possibility for share price manipulation y It could divert away companys fund from product