linklaters (corporate restructuring - shrink to grow

Corporate Restructuring Shrink to Grow

CONTENTS

Executive Summary 1

1. Understanding Corporate Restructuring in Japan 2

1.1 Regulatory Reforms 2

1.2 Trends in M&A Transactions in Japan 4

1.3 The Corporate Restructuring Survey 7

1.4 Summary 10

2. Creating Value through Divestitures 11

2.1 The Pattern of a Typical Corporate Restructuring Process 11

2.2 Alternative Divestiture Structures 13

2.3 Spin-Ins 14

2.4 Corporate Splits 16

2.5 Sell-Offs 19

2.6 Equity Carve-Outs 20

2.7 Spin-Offs 21

2.8 Tracking Stocks 23

2.9 Joint Ventures 24

2.10 Summary 26

3. Achieving Value-Building Growth 27

3.1 Common Obstacles to Restructuring 27

3.2 Future of Corporate Restructuring 28

3.3 Key Factors for Successful Restructuring 29

3.4 Managing Balanced Business Portfolios 30

3.5 Pruning the Portfolios through Proactive Divestitures 31

3.6 Summary 34

Glossary 35

List of CASE STUDIES

Case Study 1: Nissan's Dramatic Turnaround 12

Case Study 2: Matsushita's Spin-Ins to Implement Groupwide Restructuring 14

Case Study 3: Thermo Electron's "De-Conglomerating" through Spin-Ins 15

Case Study 4: NEC's Restructuring through Corporate Splits 17

Case Study 5: Sumitomo Rubber's Splitting of its Non-Tires Businesses 17

Case Study 6: Osaka Gas's Corporate Splits followed by Sell-Offs 18

Case Study 7: Japan Telecom's Use of a Holding Company as a Restructuring Vehicle 18

Case Study 8: Chugai's Reactive Spin-Off to Avoid Anti-Trust Issues 22

Case Study 9: Sony's Issuing of the First Tracking Stock 24

Case Study 10: Tomen's Formation of a Joint Venture to Foster Growth 25

Case Study 11: Takeda's Sell-Offs of Non-Core Businesses through Joint Ventures 25

Case Study 12: Hitachi's Difficulty in Finding Buyers 32

Case Study 13: GM's Preparing for a Successful Spin-Off of Delphi 33

ABeam Research & Linklaters Corporate Restructuring

1

Executive Summary

Since 1997, there has been a series of legislative and tax changes

in Japan with the aim of facilitating corporate restructuring. In

particular, the introduction of procedures such as share exchanges,

share transfers and corporate splits has provided companies with

greater flexibility in pursuing corporate restructuring. Although

corporate restructuring is not facilitated by legislative and tax

changes alone, the increased level of M&A activities over the

same period is evidence that the recent reforms have, to some

extent, achieved their aims. See Chapter 1.

A typical corporate restructuring process comprises three phases.

Faced with debt and cash flow problems, companies should

execute financial restructuring immediately to stabilize their

financial situation. Once the situation is stabilized, companies

need to start business rebuilding to strengthen their core

businesses. Finally, companies can shift their focus to long-term

value-building growth. Across the three phases of the restructuring

process, divestitures play an increasingly crucial role in Japan.

Divestitures may take several different forms: corporate splits,

sell-offs, equity carve-outs, spin-offs, tracking stocks and joint

ventures.

Corporate splits, minority carve-outs and joint ventures are often

used as interim solutions toward an eventual exit. In Japan the

most common exit alternatives are sell-offs and full or majority

carve-outs. We believe spin-offs would also be popular in Japan

(as they are in the U.S. and Europe) if the tax disadvantages were

removed. Some of the most successful corporate restructurings

have been where parent companies have prepared exit strategies

at the start of the corporate restructuring process and have used

interim solutions as a means to develop stronger subsidiaries

before a full exit at a later date. See Chapter 2.

We conducted a survey to determine the current and future

trends in restructuring activities. Our findings revealed that many

companies rated planning growth strategies prior to restructuring

as very important, but assessed their own performance as less

satisfactory. To achieve value-building growth, companies must

develop and maintain balanced business portfolios. The key

challenge is to nurture growth options while proactively divesting

underperforming or non-core businesses. Success in proactive

divestitures is likely when companies deliberately use interim

solutions before an eventual exit and lay the groundwork for

creating a stand-alone entity. See Chapter 3.

We include in this report a number of case studies. One of the

lessons that these demonstrate is:

The more extensive the restructuring, the greater

the growth prospects; the stronger the growth, the

greater the need for restructuring. Shrink to grow

and vice versa.


2

1. Understanding Corporate Restructuring in Japan

This first chapter presents an overview of the recent regulatory

reforms in Japan related to corporate restructuring and recent

trends in M&A transactions in Japan.

This chapter also sets out certain results of our survey on corporate

restructuring which we conducted in March 2003. The results

1.1 Regulatory Reforms

1.1.1 Overview

Over the past several years, many of the obstacles to corporate

restructuring contained in the Commercial Code of Japan (the

"Code") have been amended or removed, beginning in 1997 with

the introduction of simplified mergers. This was followed by the

introduction of equity redeployment procedures such as share

exchanges (Kabushiki Koukan), share transfers (Kabushiki Iten)

and corporate splits (Kaisha Bunkatsu). Consequently, examples

of corporate restructuring, including divestitures, have become

more commonplace in Japan.

The Japanese tax rules have also been amended to provide

incentives to companies to take advantage of the new restructuring

measures. The corporate reorganization tax reforms have been

effective since April 1, 2001 and allow for tax-free restructuring

under certain circumstances.

The following presents a brief list of recent changes to the Code

and other legislation and the taxation rules that are relevant to

corporate restructuring in Japan.

In October 1997, the Code was amended to simplify and ratio-

nalize merger procedures.

In December 1997, the Anti-Monopoly Law was amended to

allow pure holding companies to be established in Japan.

In October 1999, the Code was amended to introduce the share

exchange and share transfer procedures.

In April 2000, the Composition Law was abolished and the

Civil Rehabilitation Law was introduced to facilitate corpo-

rate workouts.

In April 2001, the Code was amended to introduce the corpo-

rate split procedure.

In April 2001, the corporate reorganization rules were intro-

duced under the 2001 tax reform.

In October 2001, the treasury stock system was introduced.

This system allows companies to buy back their shares and

hold them for unspecified purposes, including later use in

M&A transactions through share exchanges.

In August 2002, the consolidated taxation system was enacted.

In April 2003, the Industrial Revitalization Law was revised

to facilitate corporate restructuring. Under this law, companies

whose restructuring plans receive approval from the relevant

authorities are eligible for tax incentives and governmental

financial assistance. They may also take advantage of a less

restrictive corporate law regime.

As part of the revision of the Industrial Revitalization Law, there

are measures designed to encourage inward investment by non-

Japanese companies. For example, in a statutory merger, the

revisions to the law allow shares in a third company to be issued to

the shareholders of the extinguishing company (whereas normally

they could only receive shares in the surviving company). What

is more, the third company issuing shares can be a non-Japanese

company, which makes this new law a potentially significant

additional tool to facilitate inward investment and corporate

restructuring in Japan.

of this survey illustrate the recent trends in M&A transactions

in Japan and give an insight into how Japanese companies are

conducting (or intending to conduct) corporate restructurings in

the future, in particular how Japanese companies are starting to

make use of alternative methods to conduct such restructurings (see

Chapter 3).

New sharesShareholder Shareholder

Y Co. shares

X Co. Y Co. X Co. Y Co. X Co.

Y Co.

100%Share exchange

agreements

Figure 1.1 Share Exchanges

Source:ABeam Research

Figure 1.2 Share Transfers


New shares

Shareholder

X Co. shares

100%

X Co.

X Co. X Co.

New Co.New Co.

Figure 1.3 Types of Corporate Splits


New shares

Transferring a business toan existing company

X Co.

A

Y Co.

C

X Co.

A

Y Co.

B

X Co.

A

Y Co.

C

X Co.

A

Y Co.

B

B

C

B C

New shares

X Co.

A

New shares

New shares

Shareholder

Transferring a business toa new company

Allo

tting

new

sha

res

toa

tran

sfer

or c

ompa

nyA

llotti

ng n

ew s

hare

s to

the

shar

ehol

ders

B

A

B

X Co.

A

Shareholder

B

X Co.

A

New Co.

B

New shares

A B2

A

B1

B1

B2

C

C

A B2 A B1B1 B2C C

New Co.X Co. Y Co.X Co.

Y Co.

New shares

New Co.

X Co.

Y Co.

X Co.

Y Co.

X Co.

New Co.

Transferring a business to a newly created joint venture company

Figure 1.3


3

1.1.2 Share Exchanges

The share exchange procedure, which was introduced in October

1999, allows companies to make other companies both within the

group and outside the group wholly-owned subsidiaries (Figure

1.1). X Co. acquires all of Y Co.'s outstanding shares in exchange

for new shares issued by X Co. at a predetermined exchange

ratio. As a result of the completion of the share exchange, Y Co.

becomes a wholly-owned subsidiary of X Co. and shareholders of

Y Co. become shareholders of X Co.

1.1.3 Share Transfers

The share transfer procedure, which was introduced along with

the share exchange procedure in October 1999, allows companies

to create a new holding company (Figure 1.2). X Co. incorporates

a new company. New Co. acquires the entire shares of X Co. in

exchange for new shares issued by New Co. Subsequently, X Co.

becomes a wholly-owned subsidiary of New Co. and shareholders

of X Co. become shareholders of New Co.

1.1.4 Corporate Splits

The corporate split procedure was introduced in April 2001.

Under the Code, corporate splits are classified into two types:

(i) where a business is transferred into a new company; and (ii)

where a business is transferred to an existing company, in each

case, in exchange for shares in the transferee company. It is also

possible to transfer a business to a newly established joint venture

company in exchange for shares in the JV company.

For tax purposes, corporate splits are further classified according

to whether the new shares as consideration are distributed to the

transferor company or directly to the shareholders of the transferor

company. Accordingly, there are the following types of corporate

splits (Figure 1.3).

Figure 1.4 Number of Japanese Company Related M&A Transactions

Source:Nomura Securities

In-Out

In-In

0

400

800

1,200

1,600

2,000

Out-In

Increased numberof In-In M&As

1,881

1,344

968

636525

394354382454

1,442

Note: In-In M&As mean M&As between Japanese companies.In-Out M&As mean M&As of non-Japanese companies by Japanese companies.Out-In M&As mean M&As of Japanese companies by non-Japanese companies.

Number of Transactions

93 94 95 96 97 98 99 00 01 02Year

Figure 1.5 Total Value of Japanese Company Related M&As


In-Out

In-In

Out-In

Note : The total value of transactions is based only on cases for which data is available. Data availability differs widely depending on transaction types.

While the value of In-In deals remain flat, the value of both In-Out and Out-In

deals collapsed

0

500

1,000

1,500

2,000

2,500

3,000

3,500bn

93 94 95 96 97 98 99 00 01 02Year

Figure 1.6 Number of In-In M&A Transactions by Type

Source:Nomura Securities Year

389281

489

74

37

608

62

395

0

100

200

300

400

500

600

700

800

Assetacquisitions

Equityparticipations

Mergers

Equity acquisitions

Increased diversity in M&A transaction type

93 94 95 96 97 98 99 00 01 02


Mergers

Equity participations

Equity acquisitions

Asset acquisitions

62%16%

8%

14% 21%

26%32%

21%


4

1.2 Trends in M&A Transactions in Japan1.2.1 General Trends

In the following pages, we describe the trends in M&A

transactions up to the end of 2002. The total number of Japanese

company related M&A transactions announced in 2002 increased

to 2,244. The number of M&A transactions between Japanese

companies ("In-In deals") constituted 84% of all deals in 2002. It

is interesting to note the significant increase in the number of In-In

deals in the five-year period from 19972002 (Figure 1.4).

In this paper, we have only included data for the number of M&A

transactions completed; complete data showing the value of these

transactions is not available. Data was available for 931 out of

2,244 M&A transactions announced in 2002 (i.e., 41% of all

M&A transactions). The value of these 931 cases was 3.42 trillion

yen. While the value of In-In deals remained roughly flat for the

period from 2000 to 2002, the value of M&A transactions of non-

Japanese companies by Japanese companies ("In-Out deals")

and M&A transactions of Japanese companies by non-Japanese

companies ("Out-In deals") fell dramatically during the same

period (Figure 1.5). This data suggests the following trends:

there are fewer high profile (i.e., big value) transactions now

than two or three years ago; and

Japanese rather than foreign companies are driving an increase

in M&A transactions but such Japanese companies are pre-

dominantly active in Japan rather than abroad.

M&A transactions can be categorized into four types:

(1) mergers;

(2) equity acquisitions (controlling over 50% of the voting

shares in a company);

(3) asset acquisitions (whether an entire business or a collection

of assets); and

(4) equity participations (controlling up to 50% of the voting

shares in a company).

Mergers constituted the majority of In-In deals in the 1990s. While

the number of equity acquisitions, asset acquisitions and equity

participations increased during the 2000 to 2002 period, the number

of mergers remained flat during the same period and consequently

accounted for only 21% of In-In deals in 2002 (Figure 1.6).

Significantly, asset acquisitions rose by 70% in 2002 over 2001.

This sharp rise in asset acquisitions reflected the increasing

number of business divestitures and sell-offs of assets as part of

corporate restructuring.

Figure 1.7 Number of Inter- and Intra-group M&A Transactions


594 617

808

825

500

316248

213

175

199279

750

1,073

320277

468

181

179

183175

0

200

400

600

800

1,000

1,200

Inter-group M&As

Intra-group M&As

Increased numberof inter-group M&As

93 94 95 96 97 98 99 00 01 02Year


Figure 1.8 Number of Inter-group M&A Transactions by Type


Mergers35

367

377

294

Inter-group mergers have leveled out but other

inter-group M&A transactions have

increased significantly

0

50

100

150

200

250

300

350

400Number of Transactions

Equity participation

Equity acquisitions

Asset acquisitions

93 94 95 96 97 98 99 00 01 02Year

Figure 1.9 Number of Intra-group M&A Transactions by Type


0

50

100

150

200

250

300

350

400

93 94 95 96 97 98 99 00 01 02

Equityacquisitions

Mergers

18

241

354

195Asset

acquisitions

Equityparticipations

Intra-group acquisitions of assets and equity have increased significantly


Year


5

M&A transactions are often categorized as either inter-group

or intra-group. An inter-group M&A transaction is when

companies from two different groups are involved. An intra-group

M&A transaction is when all of the companies involved in the

transaction belong to the same group.

Inter-group and intra-group M&A transactions increased in

parallel from 1995 to 1999. Thereafter, the number of inter-

group M&A transactions surpassed that of intra-group M&A

transactions, reflecting the increased level of restructuring in

Japan generally (Figure 1.7).

The mix of inter-group M&A transactions underwent significant

changes during the 20002002 period. Equity participations

tripled in number to 377 in 2002. Asset acquisitions showed a

2.5-fold increase (Figure 1.8).

Although mergers are still the most popular form of transaction

in intra-group M&A transactions, asset acquisitions and equity

acquisitions have grown in popularity in recent years (Figure 1.9).

The growth in asset acquisitions has been fueled by the increase

in the number of business transfers as part of reorganizations and

consolidations within groups.

The number of equity acquisitions has risen as the review of

capital policy became prominent in business trends. Major

companies are increasingly turning majority-owned subsidiaries

into wholly-owned subsidiaries. Such transactions are sometimes

referred to as spin-ins. According to the Tokyo Stock Exchange,

48 publicly listed companies were spun in by their parent

companies and consequently were delisted in 2002, up from 30 in

the previous year.

Figure 1.11 Number of Corporate Splits by Objective

2002

2001

Growing use of the corporate split

procedure

Split of business unit into a wholly-owned subsidiary

Reorganization into a holding

company

Intra-group M&A

M&A Total

29

68

46

8

151

33

9284

15

224

0

50

100

150

200

250Number of Transactions

Source:Recof

Figure 1.10 Number of Share Exchanges/Share Transfers and Corporate Splits

Growing use of the share exchange

procedure within the group

Note: Share exchanges include both intra- and inter-group share exchanges.

20

45

51

81

4 6

159

23

0

20

40

60

80

100

99 00 01 02

Share exchanges

Intra-group share

exchanges

3432

61

12

Share transfers

26

Corporate splits


Year



6

1.2.2 Use of New Procedures for Equity Redeployment

The introduction of equity redeployment procedures such as share

exchanges and share transfers (in October 1999) and corporate

splits (in April 2001) gave companies greater flexibility with

regard to corporate restructuring.

The number of M&A transactions using share exchanges

increased 59% from 51 in 2001 to 81 in 2002. Among these,

75% were effected to make majority-owned subsidiaries into

wholly-owned subsidiaries. The number of share transfers to

create holding companies decreased to 9 in 2002 from 15 in

2001 and the number of corporate splits increased to 26 in 2002

from 23 in 2001 (Figure 1.10).

These figures for corporate splits, however, do not include deals

between parents and subsidiaries. If such deals are included, the

number of corporate splits increased to 224 in 2002, an increase of

nearly 50% on 2001 (Figure 1.11).

Figure 1.12 Profile of the Survey Respondents


27.7%59.6%

4.3%

8.5%

Less than 3,000

70.2%

6.4%6.4%

6.4%

10.6%

Utility & Others

Number of Employees Type of Industry

Wholesaling & Retailing

Financial Services

Transportation & Services

Construction & Manufacturing

3,000~ 5,000

10,000 and over

5,000~10,000

Figure 1.13 Organizational Structure


55.3%31.9%

4.3%

8.5%

Other system

Divisional unit system

In-house company system

Holding company system

Figure 1.14 Performance Metrics


76.6%

44.7%

21.3%

10.6%

0% 20% 40% 60% 80% 100%

Sales and profits

Cash flows and return on assets

Value metrics (e.g, EVA)

Balanced Score Card


7

1.3 The Corporate Restructuring Survey

We conducted a survey on corporate restructuring in March 2003

to determine:

current and expected levels of restructuring activities in Japan;

motives for engaging in restructuring activities;

restructuring methods that are used today and will be used in

the future; and

key factors for successful corporate restructuring.

Questionnaires were sent to executives of 250 listed companies

with more than 1,000 employees on a consolidated basis. A total

of 47 companies responded to the survey. 60% of our respondent

companies have 10,000 or more employees and 70% are

manufacturers (Figure 1.12).

1.3.1 Organizational Structures

55% of our respondents adopt a divisional unit system. 32%

have gone one step further, creating quasi-companies within

themselves (Figure 1.13). This divisional company or in-house

company system is designed to increase management efficiency

through swift decision-making and clearly defined responsibility

and authority. 9% of our respondents have established holding

companies.

1.3.2 Increased Focus on Shareholder Value

The results of our survey indicate that Japanese companies are

beginning to focus more on shareholder value. Though 77% of

our respondents use sales and profits as key metrics, 21% use such

performance metrics as economic value added (EVA) to measure

shareholder value creation (Figure 1.14).

Figure 1.15 Present Situation in Corporate Restructuring


59.6%12.8%

14.9%10.6%

2.1%No M&As

Focusing on inter-group M&As

Focusing on intra-group M&As

Wrapping up M&As

Conducting intra-group and

inter-group M&As simultaneously

Figure 1.17 Degree of Attainment of Objectives


21.3%

34.0%

27.7%

0.0%2.1%

4.3%

10.6%

Fully achieved

Nearly achieved

Partially achieved

Unable to assess

No answer

Moderately achievedUnachieved

Figure 1.16 Motives for Corporate Restructuring


55.3%

42.6%

40.4%

31.9%

27.7%

23.4%

21.3%

21.3%

4.3%

Increasing shareholder

value

Achieving growth

Improving financial position

Pursuing group synergy

Eliminating duplication of

businessesDivestiture of less

profitable businesses

Divestiture of non-core

businesses

Strengthening core businesses

Unlocking intrinsic value

50%40%30%20%10%0% 60%


8

1.3.3 Current Corporate Restructuring Activities and Motives

60% of our respondents are currently pursuing corporate

restructuring through intra-group and inter-group M&A

transactions simultaneously. More than 72% are conducting

inter-group M&A transactions (Figure 1.15). These statistics

are consistent with the increased level of inter-group M&A

transactions over the past three years (Figure 1.7).

The results of our survey revealed that strengthening core

businesses, increasing shareholder value and achieving growth are

the three main motives for corporate restructuring (Figure 1.16).

We asked respondents to assess the degree to which they had

achieved their objectives on a scale of one to five. 28% of

our respondents say it is too early to assess the results of their

restructuring efforts. No respondents say that their objectives have

been fully achieved. 55% say that their objectives were nearly or

moderately achieved (Figure 1.17).

Figure 1.18 Restructuring Methods Used Over the Past Three Years


91.5%

80.9%

55.3%

55.3%

44.7%

42.6%

40.4%

36.2%

34.0%

23.4%

21.3%

14.9%

12.8%

10.6%

6.4%

6.4%

2.1%

0% 20% 40% 60% 80% 100%

Reorganization of business units/subsidiaries through corporate split procedure

Creation of a holding company through share exchange/share transfer procedures

Acquisition of companies outside the group through share exchange procedure

Split of business units into subsidiaries through corporate split procedure

Closure of unprofitable businesses

Sale of businesses/subsidiaries through MBO

Sale of businesses/subsidiaries to buyout funds

Merger with companies outside the group

Carve-outs of subsidiaries as publicly traded businesses

Spin-ins of subsidiaries through share exchange

Dissolution of a JV with companies outside the group

Purchase of businesses from companies outside the group

Cash acquisition of companies outside the group

Sale of businesses to companies outside the group

Sale of subsidiaries to companies outside the group

Increase in the size of controlling stakes in subsidiaries

Creation of a JV with companies outside the group


9

1.3.4 Restructuring Methods

There is a wide range of options available for companies to

implement restructuring. The results of our survey indicate that

91% of our respondents have closed unprofitable businesses

over the past three years (Figure 1.18). Creation of joint ventures

(81%) is the second most popular method. Other widely

used methods for restructuring include: increasing the size of

controlling stakes in subsidiaries (55%), selling off subsidiaries

to companies outside the group (55%), selling off businesses

to companies outside the group (45%), acquiring companies

outside the group for cash (43%) and acquiring businesses from

companies outside the group (40%).

Many companies executed restructurings using the new

methods available to companies, including share exchanges and

corporate splits. 34% of our respondents have made majority-

owned subsidiaries into wholly-owned subsidiaries through

share exchanges. 23% have reorganized their business units and

subsidiaries by way of corporate splits. 21% have established

new subsidiaries, again using the corporate split procedure.


10

1.4 Summary

Since 1997, there has been a series of legislative and tax changes

in Japan with the aim of facilitating corporate restructuring. In

particular, the introduction of procedures such as share exchanges,

share transfers and corporate splits has provided companies

with greater flexibility in pursuing corporate restructuring. The

number (and, to the extent data is available, value) of M&A

transactions has increased over the same period. In particular, the

number of M&A transactions using new procedures has increased

significantly. This seems to indicate that, at least on a superficial

level, the recent changes in legislation and taxation have achieved

or begun to achieve their aims.

The results of our survey provide anecdotal evidence for the

increased level of corporate restructuring and, more importantly,

suggest that a high proportion of large companies continue

to engage in restructuring activities with the objectives of

strengthening core businesses and increasing shareholder value,

among others. Almost every large company has been engaged

in some form of corporate restructuring. Most of them have

closed unprofitable businesses and created joint ventures and

approximately half of them have made divestitures and/or

acquisitions.

Figure 2.1 Shrink to Grow


Value-Building

Growth

FinancialRestructuring

ROE < Keg > 0

ROE > Keg > 0

ROE > Keg < 0

ROE < Keg < 0

BusinessRebuilding

0

- +

-

+A

sset

Gro

wth

(g)

Return (ROE Ke)

0

ROE: return on equity Ke: cost of capital


11

2. Creating Value through Divestitures

engaged in divestitures of underperforming business units or

subsidiaries. In this chapter, we will describe the pattern of a

typical corporate restructuring process and examine in depth

various alternative divestiture structures. This chapter will also

explore many case studies, which demonstrate specific examples

of how companies put various divestiture structures into practice.

Recent changes in the Code and taxation rules allow Japanese

companies to use a wide range of restructuring options. Many

companies have executed restructurings using the new options

available to companies. Large companies are coming under more

pressure to create shareholder value. We believe that this trend

will continue and that large companies will become increasingly

2.1 The Pattern of a Typical Corporate Restructuring Process

The pattern (as illustrated in Figure 2.1 below) of a typical

corporate restructuring process calls for a company to stabilize

its financial situation, return to profit and then focus on growth.

If companies incur excessive debts and suffer from deteriorating

cash flows, short-term measures will need to be taken immediately

to generate cash for debt payments and stabilize the financial

situation. To release cash (and thus reduce debts), companies can

sell off fixed assets or underperforming businesses and rationalize

working capital (e.g., accelerate debtor collections, extend creditor

payments or reduce inventories). The priority in this phase, called

financial restructuring, is to stabilize financial situations.

Once the financial restructuring phase is over, companies will

need to strengthen their core businesses so that they can generate

enough cash to finance subsequent growth initiatives. No growth

initiatives can commence without having strong core businesses.

To improve profitability in core businesses, companies can

redesign and streamline business processes. Such efforts can be

extended to the entire supply chain. We refer to this phase as

business rebuilding.

When companies have improved the efficiency of their core

businesses sufficiently, they are poised to shift emphasis from

short-term profitability to long-term profitable growth. To sustain

growth, companies need to launch new products and develop

new markets. This phase is called value-building growth.

Growth initiatives usually take several years to yield results.

Consequently, companies will need to consider front-loading of

growth initiatives. In many cases, business rebuilding and value-

building growth take place simultaneously rather than one after

the other (see the Nissan case study 1 below).

Figure 2.2 Nissan: Automotive Cash Flow

Source:Nissan

Cash generated

Cash used

Cashgenerated

Cash used

FY00 FY01

Cashgenerated

Cash used

FY02

296.6195.7

629.2

293.1

169.7

45.4

106.3

287.4

98.7

108.9

40.4

38.2

31.0

0

100

200

300

400

500

600

700

800

900

1,000

Others

Others

Billion yen

302.0

*PPE: Property, plant and equipment

797.3

376.4

39.8

80.2

94.8

15.6

491.0

395.1

Proceeds from sales

of PPE*

Proceeds from sales

of securities

Operating cash flow

Proceeds from sales of operations

Capital investment

134.6

215.2

308.7

Figure 2.3 Nissan: Purchasing Cost Reduction

Source:Nissan

80

100

90

FY00 FY01 FY02

NRP Target

-8%

-14.5%

-20%

-20%

-11%

Actual

Plan

Nissan beat its own purchasing costreduction targets

Figure 2.4 Nissan: Net Automotive Debt

Source:Nissan

2,100

1,349

953

432

-8.60

500

1,000

1,500

2,000

2,500

3/99 3/00 3/01 3/02 3/03

-751

-396

-521

-440

Billion yen

Nissan eliminated its automotive debt


12

Case Study 1: Nissan's Dramatic Turnaround

Nissan Motor faced serious problems in the early 1990s. Nissan, led

by Yoshifumi Tsuji, announced in 1993 a restructuring plan including

the closure of its major assembly plant. Although the plan aimed

to return to profitability by 1997, Nissan continued to suffer a loss.

Yoshikazu Hanawa, who succeeded Tsuji in 1996, announced a new

restructuring plan in 1998. However, Nissan was still saddled with

more than 2 trillion yen in debt and needed a capital injection to

accelerate its debt reduction.

The Renault-Nissan Alliance was formed in 1999 and Carlos Ghosn

was named Nissan's COO in that year. Ghosn's aggressive Nissan

Revival Plan (NRP) was announced in October 1999. Although he

had earned the nickname "le cost killer" in France, Ghosn understood

that Nissan would not achieve lasting profitable growth by cost

reductions alone. The NRP focused on building the foundations

for long-term growth whilst simultaneously undergoing systematic

financial reform.

The first phase of the NRP was financial restructuring. For two years

up to the end of March 2002, Nissan sold off fixed assets and non-

core businesses and raised cash worth 524 billion yen to pay down

interest-bearing debt (Figure 2.2). The second phase was business

rebuilding. Nissan implemented the "3-3-3" initiative to reduce

purchasing costs by 20%. The "3-3-3" initiative means: 3 partners

(suppliers, purchasing and engineering) working together in 3 regions

over 3 years. Nissan achieved a 20% reduction in purchasing costs

by March 2002, one year ahead of schedule (Figure 2.3). Lower

purchasing costs increased operating cash flow to 629 billion yen for

the fiscal year 2001 and thus further reduced interest-bearing debt to

432 billion yen at the end of the fiscal year 2001 (Figure 2.4).

The third phase of value-building growth was started with the launch

of the three-year Nissan 180 plan in April 2002. Nissan 180 plan

means one million additional unit sales by the end of fiscal 2004

compared with fiscal 2001, 8% operating profit margin and zero net

automotive debt at the end of fiscal 2004. Nissan also continued the

"3-3-3" initiative to further reduce costs by 15% over three years.

The first year of Nissan 180 marked net sales of 6.85 trillion yen, up

10.6% from the fiscal year 2001, and net income of 495 billion yen,

up 33.1% (Figure 2.5).

Figure 2.5 Nissan: Net Sales and Net Income

Source:Nissan

NRP 180

Billion yen Billion yen

3/99 3/00 3/01 3/02 3/033/94 3/95 3/96 3/973/93

Net sales

Net income

3/98

-56 -87-166

-88

78

-14 -28

-684

331372

4956,198

5,834

6,039

6,580

5,801

6,6596,565

5,977

6,0906,196

6,829

-800

-600

-400

-200

0

200

400

600

800

1,000

4,000

4,500

5,000

5,500

6,000

6,500

7,000

With NISSAN 180, Nissan took a step toward value-

building growth

Figure 2.6 Options to Implement Corporate Restructurings


Mergers

Acquisitions

Divestitures

M&As

2.5 Sell-Offs

2.7 Spin-Offs

2.4 Corporate Splits

2.8 Tracking Stocks

Inter-Group Acquisitions

2.6 Equity Carve-Outs

2.3 Spin-Ins

2.9 Joint Ventures


13

While the foundation is being laid in business rebuilding, Nissan

180 also focuses on growth. This demonstrates that the business

rebuilding phase and value-building growth phase may take place

simultaneously rather than one after the other.

Nissan's growth initiatives include launching new models and

developing new markets. Nissan introduced 12 new models in the

fiscal year 2002, to be followed by 16 new models during fiscal years

2003 and 2004. In addition, Nissan and China's DongFeng Motor

established a new joint venture, which commenced operations in July

2003. This paved the way for Nissan's first entry into the Chinese

market. The new company aims to sell 550,000 units by 2006.

2.2 Alternative Divestiture Structures

Whereas section 2.1 focused on the general principles of corporate

restructurings, in this section we describe alternative divestiture

structures, other than the closure of unprofitable businesses.

Divestitures play a major role in corporate restructuring in the U.S.

and Europe. There are three basic ways to divest a subsidiary: sell-

off, equity carve-out and spin-off (Figure 2.6). Other methods

of divesting a subsidiary include corporate splits and tracking

stocks. Corporate splits are commonly used to effect intra-group

corporate restructurings and to prepare a business for divestiture.

A tracking stock is a specialized option for a parent company

to realize hidden value in a business unit or subsidiary while

retaining control of the unit or subsidiary concerned.

We also describe spin-ins and joint ventures. A spin-in is the

acquisition of minority shares in majority-owned subsidiaries.

Consequently, majority-owned subsidiaries become wholly-owned

subsidiaries. In many cases spin-ins are executed with the aim of

implementing groupwide restructuring and are followed by further

divestitures (see the Matsushita case study 2 and the Thermo

Electron case study 3 below). A joint venture can be used as a

means of acquiring or exiting a business in two stages. In the first

stage, a parent company and its partner company create a joint

venture company. In the second stage, the parent company sells its

remaining shares of the joint venture to the partner after a certain

period of time (see the Takeda case study 11 below).

Figure 2.7 Matsushita: Spin-Ins to Implement Groupwide Restructuring


Matsushita Kotobuki

Electronics

Matsushita Electric Industrial Co. (MEI)

FADiv.

Carnavi -

gation

Systemsolu -tions

Auto.multi -media

MobileComm.

PanasonicComm. &Imaging

PanasonicMobileComm.

PanasonicAutomotive

Systems

PanasonicSystemsSolutions

MatsushitaEcologySystems

PanasonicFactory

Solutions

Merger


MEI made five majority-owned subsidiaries into wholly-owned subsidiaries by way of share exchanges

67.8% 51.5% 56.3% 57.6% 57.6%

Listed on the Tokyo Stock Exchange

100% 100% 100% 100% 100%

Then, MEI implemented groupwide restructuring

Oct. 1, 2002

- -

MatsushitaKotobuki

Electronics

Jan. 1, 2003

Matsushita Kotobuki

Electronics

Matsushita Graphic Comm.

Kyushu Matsushita

Electric

Matsushita Communication

Industrial

Matsushita Seiko


Matsushita Kotobuki

Electronics


Kyushu Matsushita

Electric

Kyushu Matsushita

Electric


Industrial


Industrial

Matsushita Seiko

Matsushita Seiko

Corporate systems related

divisions

FA Company

Corporate Info. & Comm.

Sales Div.

Automotive electronics

related divisions


In-house company In-house company

Env. systems related

divisions


14

between Kyushu Matsushita Electric and Matsushita Graphic Communications Systems. MEI also split its environmental systems sales unit into Matsushita Seiko and the company was renamed Matsushita Ecology Systems. Finally, by combining the FA Company, an in-house company of MEI, and the FA division of Kyushu Matsushita Electric, Panasonic Factory Solutions was newly established. These transactions are examples of the use of the corporate split procedure described in section 1.1.4 (corporate splits are described in more detail in section 2.4).

In line with the restructuring initiatives, MEI also made two other group companies, Matsushita Electronic Components and Matsushita Battery Industrial, into wholly-owned subsidiaries through share exchanges in April 2003.

As part of its restructuring program, in October 2002, Matsushita Electric Industrial (MEI) made five majority-owned subsidiaries

into wholly-owned subsidiaries by way of the share exchange procedure described in section 1.1.2. The five group companies were Matsushita Communications Industrial, Kyushu Matsushita Electric, Matsushita Seiko, Matsushita Kotobuki Electronics Industries and Matsushita Graphic Communications Systems. Four of these companies had been publicly listed companies and consequently were delisted (Figure 2.7).

Thereafter, MEI implemented its groupwide restructuring in January 2003. MEI split its sales unit of mobile communication equipments into Matsushita Communications Industrial and the company was renamed Panasonic Mobile Communications. Panasonic Communications was established through a merger

2.3 Spin-Ins

Increasingly, companies are making majority-owned subsidiaries

into wholly-owned subsidiaries. Such transactions are referred

to as spin-ins. Often spin-ins are implemented through the share

exchange procedure. Spin-ins allow a parent company to implement

Case Study 2: Matsushita's Spin-Ins to Implement Groupwide Restructuring

groupwide restructuring by streamlining overlapping businesses and

redeploying assets and capabilities within the group. Consequently,

spin-ins will often lead to divestitures (see the Matsushita case

study 2 and the Thermo Electron case study 3 below).

Figure 2.8 Thermo Electron: Increased Complexity of the Company Structures

Source:Thermo Electron 10K, ABeam Research

ThermoElectron

ThermoEcotek

ThermoFibertek

ThermoPower

MetrikaSystems

ThermedicsDetections

The RandersKillam Group

ThermoLase

ThermoFibergen

ONIXSystems

ThermoCardiosystems

ThermoTerraTech

TrexMedical

ThermoBioAnalysis

ThermoSentron

ThermoVision

ThermoOptek

ThermoVoltek

ThermoQuest

ThermoSpectra

85% 74% 86% 64% 94% 91% 79%

73%

ThermoElectron

Kadant * ViasysHealthcare

Shareholders

Shareholders

Sell-offSell-off

Note: % reflects combined ownership by direct parent company and Thermo Electron as of year end 1998.

*former Thermo Fibertek

76%

81%

84%

95%

90%

92%

80%

88%

60%

86%

69%

96%

71%

80%

77%

Spin-Ins

Sell-off

ThermoInstrument

Thermedics ThermoTerraTech

ThermoTrex


15

Case Study 3: Thermo Electron's "De-Conglomerating" through Spin-Ins

Kadant (former Thermo Fibertek) and Thermo Fibergen. Spectra-

Physics was spun into the company in 2002. These acquisitions

enabled Thermo to undertake groupwide restructuring.

After the acquisition of minority interests, Thermo implemented

a groupwide restructuring. Thermo split into three independent

publicly listed entities. The company spun off as a dividend to its

shareholders Kadant and Viasys Healthcare in 2001 (spin-offs are

described in more detail in section 2.7). In addition, Thermo sold

several non-core businesses. As part of the sell-offs, the company

sold its interest in Thermo Cardiosystems in 2001. As a result of

the completion of spin-offs and sell-offs, Thermo's continuing

operations consist solely of its instruments businesses.

This case study highlights some of the disadvantages of minority

carve-outs and the fact that minority carve-outs are perhaps

better thought of as an interim solution (minority carve-outs are

described in more detail in section 2.6).

In the early 1980s, the founder of U.S.-based Thermo Electron,

George Hatsopoulos, began to carve out subsidiaries as publicly

listed businesses. Using carve-outs, he hoped to increase the

overall valuation of the group and inspire entrepreneurship.

Thermo completed 24 minority carve-outs between 1983 and

1998. The initial success of Thermo's carve-outs became an

appealing model for other companies. Subsequently, however,

the company structures became too complex and unmanageable

(Figure 2.8).

A new management team led by Richard Syron started the process

of "de-conglomerating." The goal was to consolidate Thermo

into one publicly traded entity focused on its core business of

measurement and detection instruments. In January 2000, Thermo

announced a major reorganization plan. During 2000, Thermo

acquired the minority interest in all of its formerly publicly held

subsidiaries other than Spectra-Physics, Thermo Cardiosystems,


16

2.4 Corporate Splits

The corporate split procedure makes it easier for companies to

split business units into new companies (or existing companies).

Prior to the introduction of the corporate split procedure, it

was possible for a company to split a business unit into a new

subsidiary through either an investment-in-kind or a post-

establishment transfer of business. However, the traditional

methods to complete such transactions were expensive and time-

consuming procedures. For example, an asset valuation by a court-

appointed inspector was required. We call this type of corporate

split Bunsha-type splits.

In addition, the corporate split procedure makes it possible for the

first time for a transferee company to distribute its shares directly

to the shareholders of a transferor company. This type of corporate

split is broadly equivalent to the concept of a spin-off in the U.S.

or the concept of a demerger in the European market (spin-offs

are described in more detail in section 2.7).

The Matsushita case study 2 above and the NEC case study 4

below show examples of restructurings that made use of different

types of corporate splits.

Bunsha-type splits (whether in the traditional method or by a

corporate split which does not involve the distribution of shares

directly to the shareholders of a transferor company) enable a

parent company to:

focus on core businesses (see the Sumitomo Rubber case

study 5 below);

improve the control span of the parents management team by

reducing parental involvement; and

accommodate differing personnel and compensation systems.

At the same time, such Bunsha-type splits enable a parent

company to unlock the value of a business unit by:

clarifying the business units responsibility and authority;

providing a certain degree of autonomy to foster an indepen-

dent culture;

expediting the business units decision-making to improve

business performance; and

enhancing visibility for customers, suppliers and potential alli-

ance partners or buyers.

More significantly, Bunsha-type splits facilitate the participation

of strategic partners who can provide necessary capabilities (e.g.,

by way of joint ventures, see section 2.9 and the Tomen case

study 10 below). Alternatively, Bunsha-type splits are commonly

used to prepare a business for divestiture. The Osaka Gas case

study 6 below illustrates how corporate splits may be used to

divest selected assets into a subsidiary in preparation for a sell-

off. Bunsha-type splits may be also used to establish a holding

company (i.e., a parent company splits its business units into new

companies and the parent becomes a holding company). In many

cases, a parent company establishes a holding company to manage

its business portfolio more efficiently (see the Japan Telecom case

study 7 below). These examples show that Bunsha-type splits are

often interim solutions leading to more strategic transactions.

Figure 2.9 NEC: Restructuring through Various Corporate Splits


Split its Compound Semiconductor Device Division and transferred it to NEC Compound Semiconductor Devices, a new subsidiary, in October 2001.

Split its microwave tube business and transferred it to NEC Microwave Tube, a new subsidiary, in October 2002.

Split its color PDP business and transferred it to NEC Plasma Display Corporation, a new subsidiary, in October 2002.

Splits its semiconductor business (except for DRAMs) and transferred it to NEC Electronics Corporation, a new subsidiary, in November 2002.

Split its liquid crystal display (LCD) business and transferred it to NEC LCD Technologies, a new subsidiary, in April 2003.

Split capacitors, batteries and relays business from NEC Electron Devices, an in-house company of NEC, and transferred it to Tokin Corporation in April 2002. Tokin allotted new shares to NEC in exchange for the business. As a result, NEC increased its stake in Tokin from 40.6% to 66.6% and Tokin was renamed NEC Tokin Corporation.

Established NEC Toppan Circuit Solutions, a new joint venture company with 55% contributed by Toppan Printing and 45% by NEC, and transferred its printing wiring business in October 2002.

Transferring a business to a new company

Transferring a business to a new JV company

Transferring a business to an existing company

Examples of Corporate SplitsType

Figure 2.10 Sumitomo Rubber: Corporate Splits to Focus on Core Business


MergerOhtsu Tire

SRI

SumitomoRubber

Sportinggood

business

Tirebusiness

51%

SRIHybrid

July 1, 2003

Industrialproductsbusiness

Sumitomo Rubber (SRI)

Sports


17

Case Study 4: NEC's Restructuring through Corporate Splits

NEC recorded a 151 billion yen net loss in the fiscal year 1998

and since that time has been implementing a restructuring. NEC

set the short-term goal of returning to profitability and the long-

term goal of transforming NEC into a solutions provider. As part

of the restructuring efforts, Packard Bell NEC was liquidated in

November 1999, Elpida Memory, a DRAM joint venture with

Hitachi, was established in December 1999 and NEC Home

Electronics was dismantled in January 2000.

In April 2000, NEC formed three in-house companies (NEC

Solutions, NEC Networks and NEC Electron Devices) to focus on

solutions businesses. NEC has also completed many splits of non-

core businesses through the corporate split procedure described

in section 2.4. Some of these splits are described below; these

splits include examples of transfers of business to new companies,

newly created JV companies and existing companies both inside

and outside the NEC group.

Case Study 5: Sumitomo Rubber's Splitting of its Non-Tires BusinessesSumitomo Rubber Industries is Japan's third largest tire maker and

a major manufacturer of sporting goods and industrial products.

While the tire business posted operating income of 28.1 billion

yen and the sporting goods business 6.4 billion yen in the fiscal

year 2002, the industrial products business caused an operating

loss of 2.8 billion yen in the same year. Sumitomo Rubber

announced a restructuring plan in December 2002.

As part of its restructuring initiatives, Sumitomo Rubber merged

with its 51% controlled subsidiary, Ohtsu Tire & Rubber, in July

2003. At the same time, using the corporate split procedure,

Sumitomo Rubber split its sporting goods and industrial products

businesses into new subsidiaries, SRI Sports and SRI Hybrid,

respectively (Figure 2.10). This reorganization will enable the

parent company to focus on its tire business and promote further

restructuring in its non-tire businesses.

Figure 2.11 Osaka Gas: Corporate Splits for Later Sell-Offs


100% 65.3%

6.4%

28.3%

100% 65.3%

6.4%

28.3%

65.3% 65.3%

Osaka Gas

Osaka Gas

Osaka Gas

Osaka Gas

Harman Co.

OG Capital

OG Housing

OG Capital

Mfg Sales

100% 65.3%

6.4%

28.3%

60% 10%

OG Capital

OG Housing 40%

90%

Harman

Harman Pro

Noritz

100% 65.3%

6.4%

28.3%

10% 10%

OG Capital

OG Housing 90%

90%

Harman

Harman Pro

Noritz

Sep. 1, 2001

Oct. 1, 2001

Apr. 1, 2003

..........

.....

.....

OG Housing

Harman Planning

Harman Planning

Harman Harman ProHarman Planning

Figure 2.12 Japan Telecom: Restructuring Under the Holding Company Structure

Source:Japan Telecom Holdings

Japan Telecom Holdings Co.

JENS

J-Phone

Absorption into JT

Japan System Solution

Japan Telecom

JT Information

Services

JTSingapore

JTUK

JTAmerica

JTNetworks

JTData

Telecom Services

JT Network Information

Services

JT Create

Sale of telemarketing business to JT Max

& Transfer to JT

Sale to TohoElectrical

Construction

Sale toMoshi MoshiHotline Co.

Sale toRipplewood

Sale of assets to Toppan Forms &

liquidation

Sale ofassets to JT& liquidation

JT Engineering

Asahi TelecomJT MAX

Telecom Express


18

Case Study 6: Osaka Gas's Corporate Splits followed by Sell-Offs In September 2001, Osaka Gas split its kitchen appliance

business subsidiary, Harman, into three companies through the

corporate split procedure (Figure 2.11). The three companies

are: Harman Pro (manufacturing), Harman (sales) and Harman

Planning (real estate).

In October 2001, Osaka Gas sold 90% of its shares in Harman

Pro and 40% of its shares in Harman to Noritz, a leader in gas

water heaters. One and a half years later, Osaka Gas sold its 50%

stake in Harman to Noritz. Noritz now controls a 90% stake in

both companies.

Case Study 7: Japan Telecom's Use of a Holding Company as a Restructuring VehicleIn December 2001, Japan Telecom initiated its "Project V"

restructuring plan to improve profits of its fixed-line business. In

August 2002, Japan Telecom established a new holding company

structure under which it operates fixed-line, mobile and other

businesses as separate subsidiaries (Figure 2.12). In March 2003,

Japan Telecom Holdings announced that, with the sale of Japan

Telecom Max, it has completed its program to dispose of all of its

non-core assets. In August 2003, Japan Telecom Holdings further

announced that it had reached agreement to sell its wholly-owned

fixed-line subsidiary, Japan Telecom, to Ripplewood Holdings.

Figure 2.13 Nissan's Sell-Offs of Subsidiaries to Buyout Firms


Target Company Buyout Firms Form Date

Vantec 3i Group 66.7% MBO Jan.'01

Niles Parts Ripplewood Holdings 40.0% Buyout Apr.'01Nissan Transport

AIG Japan Partners; Tokyo Marine Capital

100.0% MBO May'01

Nissan Altia Fuji Management 86.9% MBO Oct.'01

IID Inc. 100.0% MBO Nov.'01

KIRIU Unison Capital 36.7% MBO Dec.'01

Rhythm J.P. Morgan Partners 51.0% MBO Aug.'02

Nissan's Stake

NIF Ventures; Fuji Capital Markets (now Mizuho Capital); New Business Investment

Figure 2.14 Buyout Firms in Japan

Source: ABeam Research

Transformation Turnaround

Traditional Venture Capitals Traditional Buyout Firms

Extended Venture Capitals (e.g., JAFCO)

Turnaround Funds

Transformation

TurnaroundStart-Up

Start-Up

Corporate Life Cycle

Extended Buyout Firmse.g., Advantage Partners, Unison Capital, MKS Partners, Ripplewood Holdings, Carlyle Japan Partners

Principal Investment Firmse.g., Nomura Principal Finance, Daiwa Securities SMBC Principal Investments, Mizuho Capital, Tokio Marine Capital, Goldman Sachs, BNP Paribas, J.P. Morgan Partners


19

2.5 Sell-Offs

A sell-off is the sale of a business or subsidiary of the parent company

to another firm outside the group, generally resulting in a payment

of cash to the parent. In theory, sell-offs are the least complex of

restructuring structures.

Acquirers can usually be divided into two groups: strategic buyers

and financial buyers. Strategic buyers are those who are interested

in acquiring a business for strategic purposes (e.g., increasing

market share, creating economies of scale or exploiting synergies).

Strategic buyers are typically companies engaged in the same

business as, and therefore competing with, the business or company

under consideration. In contrast, financial buyers are those who

are interested in acquiring a business to secure a financial return in

the short- to medium-term before selling the business or otherwise

exiting the investment. Financial buyers are likely to be buyout firms.

Buyout firms raise funds in order to be able to take equity stakes

in companies though funding and assisting with management

buyouts (MBOs) and leveraged buyouts (LBOs). Buyout firms

generally focus on established companies with potential to grow

after transformation. Non-core divisions and subsidiaries of large

public companies are their typical targets. For example, as part of

its restructuring efforts, Nissan Motor sold its shares in at least 24

subsidiaries from 2000 to 2002. 17 were sold to strategic buyers

and the remaining 7 were sold to buyout firms (Figure 2.13). It was

expected that, like Nissan, large companies would sell off non-core

divisions and subsidiaries as they pursued restructuring initiatives.

Fueled by expectations, the number of new buyout firms rose

significantly. However, some buyout firms have been unable to find

places to invest, as evidenced by the withdrawal of some such firms

(e.g., 3i) from Japan.

Due to the pressure for banks to dispose of non-performing loans, it is

expected that turnaround deals will increase dramatically over years

to come. Consequently, the number of corporate turnaround funds

has increased sharply and is expected to increase even further. For

buyout firms, corporate turnarounds provide an important source of

investment opportunities. Accordingly, most buyout firms have been

expanding their activities into corporate turnarounds.

There are several types of buyout firms in Japan (Figure 2.14):

venture capital-affiliated buyout firms (e.g., JAFCOs Structured

Investment Group);

domestic independent buyout firms (e.g., Advantage Partners,

Unison Capital, MKS Partners);

foreign independent buyout firms (e.g., Ripplewood Holdings,

Carlyle Japan Partners);

domestic principal investment firms (e.g., Nomura Principal

Finance, Daiwa Securities SMBC Principal Investments, Mizuho

Capital, Tokio Marine Capital); and

foreign principal investment firms (e.g., Goldman Sachs, BNP

Paribas, J.P. Morgan Partners).


20

2.6 Equity Carve-Outs

An equity carve-out is the sale of an equity interest in a subsidiary

to public investors in an IPO or to professional investors in a

private placement.

Equity carve-outs come in two forms: minority carve-outs and

majority carve-outs. A minority carve-out occurs when a parent

company sells a minority interest in a wholly-owned or majority-

owned subsidiary to investors while retaining the majority interest.

A majority carve-out involves the sale of a majority interest in a

wholly-owned or majority-owned subsidiary to investors. It should be

noted that the preparation for either an IPO or a private placement to

professional investors takes longer than that for a sell-off. In addition,

a parent company will have to ensure that a carved-out subsidiary

should be a viable independent company. This is often the most

difficult part of the preparation for an equity carve-out.

Minority carve-outs have the following benefits, among others:

after a minority carve-out, the parent company continues to remain

in control of the subsidiary;

a minority carve-out allows the parent company to take advantage

of a high valuation of part of its operations and provides opportu-

nities to raise capital on advantageous terms;

if the minority carve-out unlocks value and a higher-rated or

higher value stock is created (in aggregate), the stock of the

parent company (or subsidiary) has more value as an acquisi-

tion currency;

a minority carve-out gives the subsidiary time to become a stron-

ger company before a sale or majority or full carve-out;

a minority carve-out may create business opportunities for the

subsidiary by demonstrating that the subsidiary will be an inde-

pendent business; and

a minority carve-out IPO allows the subsidiary to offer market-

linked or other equity incentives to management.

Minority carve-outs also have disadvantages. These include:

the parent company maintains control of the subsidiary, which

may cause a potential conflict of interests with the minority share-

holders of the subsidiary;

if the initial public float (i.e., the value of shares available for

public investors in the IPO) is too small, it may fail to attract insti-

tutional investors;

small public floats may increase the volatility of the stock;

in difficult markets, a minority carve-out may impede a selling

strategy by setting a price for the shares of the subsidiary which is

below their "real" value; and

a minority carve-out may reduce the flexibility with which the

parent and subsidiary can cooperate to capture synergies.

The parent should anticipate that a minority carve-out is often an

interim solution. In most cases, a minority carve-out is later followed

by another transaction, such as a sell-off, follow-on public offering or

spin-off. In practice, a minority carve-out is likely to lead to complete

separation over time because the carved-out subsidiary tends to drift

away from and interact less with the parent due to its independence.

In addition, the carved-out subsidiary, if it becomes a publicly listed

company, will issue its own financial statements and establish a

public market value, resulting in the increased possibility of a merger

(or takeover) offer. A minority carve-out IPO may be combined with

a later spin-off (such two-stage spin-offs, which are particularly

popular in the U.S., are described in more detail in section 2.7).

If unsuccessful, the minority carve-out may be followed by a

spin-in, i.e., the parent company acquires the shares held by minority

shareholders and turns the majority-owned subsidiary into a wholly-

owned subsidiary (see the Thermo Electron case study 3 above).

When a substantial or complete separation is desired, a majority carve-

out may be implemented (again usually by way of an IPO or private

placement). A majority carve-out is beneficial in the following ways:

a majority carve-out may generate substantial cash for the parent

and/or the subsidiary;

a majority carve-out may allow the parent to terminate its respon-

sibility toward the subsidiary;

a majority carve-out means that there will be fewer potential con-

flicts of interests between the parent and the subsidiary after the

carve-out than is the case with a minority carve-out;

notwithstanding that it will only be a minority shareholder, the

parent may maintain a significant influence on the subsidiary after

the carve-out; and

a majority carve-out allows continued financial participation by

the parent.

Disadvantages of a majority carve-out include:

neither the parent nor its shareholders will participate fully in the

upside of the subsidiary; and

the parent will lose control over the subsidiary after the carve-out.

Figure 2.15 Potential Advantages of Spin-Offs


Spin-offs provide a valid IPO alternative in difficult market

Spin-offs enable the parent's shareholders to retain the value of a subsidiary

Spin-offs separate a subsidiary from the parent's balance sheet

Spin-offs have no advantages over alternatives

Spin-offs create a focused parent and a fully independent subsidiary

0.0%

16.3%

11.6%

11.6%

60.5%


21

2.7 Spin-Offs

A spin-off (or demerger) often consists of the distribution of a

subsidiary's stock to the parent company's existing shareholders

by way of a dividend. A spin-off has become an increasingly

popular way of undertaking corporate restructuring in the U.S.

and Europe (see the Thermo Electron case study 3 and the GM

case study 13). The main reason for the popularity of spin-offs in

the U.S. and Europe is that the distribution can often be made tax-

free for both the parent corporation and the receiving shareholder.

This can represent significant savings to the parent company.

In Japan, the corporate split procedure allows a transferee

company to distribute new shares as consideration directly to

the shareholders of the transferor company. However, spin-offs

have been rarely executed to date. This may be because spin-offs

are only tax-free for Japanese companies if they are executed as

part of reorganization within the group or reorganization for the

purpose of a joint venture. Otherwise, spin-offs are taxable and

hence have been executed only in special cases (see the Chugai

case study 8 below).

Spin-offs are a means to unlock the value of a subsidiary and

transfer that value directly to the parent company's shareholders.

It is especially useful for a subsidiary that does not completely

fit with the parent company's core activities or would otherwise

benefit from being a stand-alone public company. Spin-offs

are also a means to obtain full value for the parent company's

shareholders when a spun-off subsidiary is viable but will not

command a reasonable price in a cash divestiture because of

market conditions.

Where the shares of the parent company are publicly listed, in

order to ensure that the parent company's shareholders can realize

the value of the distribution, the shares of the subsidiary generally

need to be (or become) publicly listed to give the shareholders

the same liquidity in the shares in the subsidiary as they have in

the shares of the parent, i.e., the parent will need to seek a public

listing for the new shares.

As is the case with equity carve-outs, the spun-off subsidiary must

be a viable stand-alone entity to create shareholder value. This

means that it must have a strong capital structure and a viable

business model. This poses a major challenge for all spin-offs. In

addition, spin-offs have disadvantages, including the following:

unlike an equity carve-out or a sale for cash, neither the parent

company nor the subsidiary receives any cash in the transac-

tion itself;

the parent company loses the income and cash flow of the sub-

sidiary without receiving any cash in return;

unlike a carve-out IPO, the shares are distributed to the parent's

shareholders as a dividend and therefore the parent company

may not work hard to create investor interest in the stock as

much as in a carve-out IPO; and

if the spun-off subsidiary fails to meet their investment criteria

(e.g., minimum size of market capitalization or portfolio hold-

ings), institutional investors of the parent company may sell

the shares distributed to them in the spin-off.

Although spin-offs are currently rare in Japan, the results of our

survey revealed that many companies found potential merits

in spin-offs (see Figure 2.15). 84% of our respondents believe

that spin-offs are a unique measure offering several advantages

over alternatives. 60% of our respondents believe that, unlike

Bunsha-type splits, spin-offs enable a parent to focus more

completely on core businesses and allow a subsidiary to become

fully independent from the parent company and develop its own

business strategy. Where spin-offs can be structured so that they

incur no tax, we expect them to become a more widely accepted

method of implementing corporate restructurings in Japan.

Figure 2.16 Chugai Pharmaceutical: Gen-Probe Spin-Off


100%

Chugai

Gen-Probe

Chugai

Gen-Probe was spun-off from Chugai on September 16, 2002.

Gen-Probe began trading on the NASDAQ

on Sept. 16, 2002

Gen-Probe

Chugai shareholders

Chugai shareholders

Gen-Probe shares


22

A carve-out IPO may be combined with a later spin-off. Such two-

stage transactions have become a common means of implementing

a spin-off in the U.S. (see the GM case study 13 below).

The advantages of such two-stage transactions include the

following:

the IPO establishes a public market for the subsidiarys stock

in advance of the spin-off;

the scrutiny which comes with being a publicly listed company

should make the subsidiary a stronger company; and

the IPO generates cash for either the parent company or sub-

sidiary or both.

The disadvantages of these two-stage transactions are similar to

those of minority carve-outs, including:

the IPO is dependent on equity market conditions;

preparing for and implementing the IPO is time consuming;

companies with small public floats are less attractive to institu-

tional investors; and

a depressed stock price may prevent the parent from undertak-

ing the subsequent spin-off.

A split-off is a variant of a spin-off. In a split-off, a parent

company distributes shares it owns in a subsidiary to its

shareholders in exchange for their shares of the parent. A split-off

is a way to create value for the parent's shareholders by reducing

the parent's outstanding shares. Reducing the parent's shares

outstanding increases the earnings and cash flow per share and,

thereby, the value of the remaining shares.

A split-up is a form of split-off where a parent company is

broken up into two or more independent companies. In the

split-up, a parent company is often liquidated and the parent

company's shareholders become shareholders of each of the new

independent companies.

Case Study 8: Chugai's Reactive Spin-Off to Avoid Anti-Trust IssuesChugai Pharmaceutical merged with Nippon Roche, a wholly-

owned subsidiary of Roche Pharmholding, so that Roche became

Chugai's parent company, in October 2002. Prior to the merger,

Chugai resolved to spin off its wholly-owned U.S. subsidiary,

Gen-Probe, and completed the distribution of Gen-Probe shares

to Chugai's shareholders in September 2002 (Figure 2.16). The

purpose of the spin-off was to avoid anti-trust problems over

Chugai's merger with Nippon Roche.

Chugai decided on a spin-off through capital reduction with

compensation. Upon the capital reduction, each of Chugai's

shareholders was allotted 0.086 shares in Gen-Probe for each

Chugai share. The spin-off was taxable at the parent level.

The distribution was also taxable as a deemed dividend for the

Japanese shareholders of Chugai receiving the shares. Chugai paid

a cash distribution to cover Japanese withholding taxes.

This case study provides an example of using the spin-off method

to address regulatory issues.

Figure 2.17 Tracking Stocks


Providing stock incentives to management of the subsidiary

68.9%

31.1%

50.0%

32.5%

5.0%

5.0%

7.5%

Others

Interest in Tracking Stocks

Potential Merits

Raising capital without losing control over the subsidiary

Using the tracking stocks as acquisition currency

Unlocking the value in the underlying subsidiary

Feel no need to issue tracking stocks

Examine the possibility of issuing tracking stocks in the future


23

2.8 Tracking Stocks

Tracking stock is a class of parent company common stock that

provides a return to investors linked to the performance of a

particular business unit within the parent company. Under the

Code, prior to the amendment in April 2002, it was possible for

Japanese companies to issue tracking stocks. For example, in June

2001, Sony issued the first tracking stock in Japan (see the Sony

case study 9 below). However, the amendments in April 2002 now

allow Japanese companies to issue stocks with various dividend

payments and voting rights. Although the April 2002 amendment

has made it easier for a company to issue tracking stocks, no other

Japanese company has yet followed Sony's lead.

Tracking stocks are a very different solution to the others

discussed in this paper. In theory, it can create many benefits for

both the parent company and the subsidiary. A tracking stock does

not require the parent company to make the tax, legal, governance

and organizational changes required for an equity carve-out or

spin-off (e.g., no separate board of directors is required). This

provides the main appeal to the parent company over other

alternatives.

There are other advantages to using tracking stocks, including

the following:

the parent company continues to control the business unit and

maintain ownership of its assets;

a tracking stock can raise capital on attractive terms;

a publicly listed tracking stock establishes a market value for

the business to which management compensation programs

can be tied;

a tracking stock preserves the operating benefits of a single,

integrated corporation; and

the parent company may use the tracking stock as acquisi-

tion currency.

The disadvantages of a tracking stock include the following:

the parent company issuing a tracking stock must create financial

"firewalls" between the business and the rest of its operations;

the parent company will shoulder the administrative burden in

connection with a tracking stock;

a company that issues a tracking stock creates the potential for

a conflict at the board level between the interests of the two

sets of shareholders; and

investors may not give as much value to the tracking stock as

if shares represented a direct ownership interest in the assets of

the tracked business.

Tracking stocks are often terminated when the circumstances and

objectives of the business and/or parent company change and

consequently the parent company decides to sell, spin off or spin

in the tracked business.

According to the results of our survey, 31% of respondents say

they intend to examine the possibility of issuing tracking stocks

in the future (Figure 2.17). Our study also identified the perceived

merits of issuing tracking stocks. Half of our survey respondents

believe that a tracking stock would enable them to raise capital

without losing control over the subsidiary.

Figure 2.18 Sony: Stock Performance

Source:Yahoo! Finance

Sony

SCN

+100

+50

0

-50

1999/1 2000/1 2001/1 2002/1 2003/1

The SCN tracking stock has not

outperformed Sony


24

2.9 Joint Ventures

When well crafted, joint ventures can achieve many of the same

objectives for the parent company as an acquisition of the other

company, including access to the resources and capabilities of the

joint venture partner, but at a lower cost and without many of the

risks associated with an acquisition (see the Tomen case study

10 below). Consequently, the parent can increase the value of a

subsidiary by way of a joint venture. Successful joint ventures are

often followed by IPOs.

Joint ventures may be also used as a means of divesting a business

(see the Takeda case study 11 below). The first step is the creation

of a joint venture with a strategic partner. Often the strategic

partner controls a major stake (i.e., over 50%) in the joint venture

company. The second step is the acquisition of the minority shares

of the joint venture company by the strategic partner.

Such two-stage transactions provide the acquiring partner with

benefits, including the following:

a means to encourage the partner to assist in building the business;

a means to get to know the business before a subsequent acqui-

sition; and

a means to lay the groundwork for smooth integration after a

later acquisition.

As mentioned in section 2.5, buyout firms are active buyers of

non-core subsidiaries of large public companies. Although joint

ventures are not their traditional business model, buyout firms

today may be interested in forming joint ventures. Such buyout

partnerships can be used as a means of divesting non-core

businesses when a cash sale is unavailable or undesired.

The advantages of a buyout partnership for the parent company

and the subsidiary include:

experienced buyout firms can greatly assist in building the sub-

sidiary, recruiting a management team, forming relationships

with customers and setting business strategy;

buyout firms invest cash into the subsidiary and assist in fund-

ing key business initiatives; and

the involvement of experienced and respected buyout firms

may be a significant asset to the subsidiary in a later IPO.

The challenges of a buyout partnership for the parent company

and the subsidiary include:

most subsidiaries will not meet the criteria for a buyout invest-

ment; in particular, a buyout firm may not invest in an entity

when the parent company controls its strategic direction; and

buyout firms are usually interested in executing an exit strategy

within a reasonable time frame.

Case Study 9: Sony's Issuing of the First Tracking Stock

In November 2000, Sony Corporation announced that the

company had begun preparations to issue a new class of stock

linked to the performance of Sony Communication Network

(SCN). SCN is a wholly-owned subsidiary of Sony, engaged in

internet-related businesses. Sony believed that a tracking stock

would enable the company to realize the value of SCN while

maintaining full parent ownership.

Though the company planned to issue the tracking stock by the

end of March 2001, Sony postponed the issuance because of the

depressed stock market. In June 2001, Japan's first tracking stock

was listed on the first section of the Tokyo Stock Exchange. There

was, however, a lack of enthusiasm amongst investors. Figure

2.18 demonstrates the performance of SCN tracking stock against

that of Sony itself. As can be seen, the SCN tracking stock has not

outperformed the parent company. Issuing the first tracking stock

resulted in disappointment to both Sony and shareholders.

Figure 2.20 Takeda Chemical: Joint Ventures to Be Followed by Sell-Offs


Sale of shares

40% 60% 100%

New Co.Takeda's agrochemical business has been transferred to a new JV company

The JV company will be made a wholly-owned subsidiary of Sumitomo Chemical

Takeda Chemical

Agro-Chemical business

Sumitomo Chemical Takeda Agro Company

Sumitomo Chemical

Takeda Chemical

Sumitomo Chemical

Takeda Chemical

Sumitomo Chemical

Nov. 1, 2002 5 years later Takeda will sell the remaining 40%

to Sumitomo after 5 years

Figure 2.19 Tomen: A Corporate Split to Facilitate the Formation of a Joint Venture


Tomen Tomen Tomen

Sale of TPHC shares

*Tokyo Electric Power Company

100% 50%

TEPCO*

50%

Tomen Power Holdings Corp

(TPHC)

Eurus Energy Holdings Corp.

Power & Utility

Projects Division

Nov. 1, 2001 Sep. 30, 2002


25

Case Study 11: Takeda's Sell-Offs of Non-Core Businesses through Joint VenturesTakeda Chemicals have established three joint venture companies

with the intention of leading to a later divestiture of these non-

core businesses. In April 2001, Takeda established Mitsui Takeda

Chemicals, a urethane chemicals joint venture company, with

Mitsui Chemicals. Mitsui acquired 51% and Takeda 49%. Mitsui

is scheduled to purchase Takeda's shares in the joint venture five

years after start-up.

Takeda entered into similar joint venture agreements with Kirin

Brewery and Sumitomo Chemical.

In April 2002, Takeda and Kirin established Takeda Kirin Foods

in the food business, producing mainly seasonings and flavor

enhancers. Kirin has a 51% stake in the new company and

Takeda 49%. Kirin plans eventually to acquire all of the shares.

In November 2002, Take

linklaters (corporate restructuring - shrink to grow

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