chapter20 corporate restructuring
TRANSCRIPT
INTRODUCTION
This chapter focuses on forms of corporate restructuring, including external expansion (mergers) and business failure (bankruptcy).
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TYPES OF COMBINATIONS
Merger (or Acquisition) Vertical Horizontal Conglomerate
Geographic market Product extension Pure
Consolidation Holding company Joint venture
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LEVERAGED BUYOUT (LBO)
Buyer borrows most of the purchase price
Purchased assets used as collateral
Buyers frequently are the managers
Anticipated cash flows to service debt
Reasonable ROI
Sell assets to pay off debt
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TYPES OF MERGERS
Share Purchase
Acquiring company buys the stock of the target company. Assumes liabilities of the acquired firm
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TYPES OF MERGERS
Asset Purchase
Acquiring company buys assets of target company NO assumption of liabilities
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TYPES OF MERGERS
Tender Offer/Hostile Takeover
Purchase the common stock of the target company Offering price is greater than the market price
Induce shareholders to sell
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WHAT HAPPENS AFTER A MERGER? Divestitures
Part of the company sold for cash Spin-off Equity carve-out
Restructurings Operational Financial
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POPULARITY OF RESTRUCTURING
Failure of internal control mechanisms Unproductive investment Organizational inefficiencies
Large active investors
Available financing
Long economic expansion Increased revenues Increased asset values
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ANTI-TAKEOVER MEASURES
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Staggering board
Golden parachutes
Supermajority rule
Poison pills
White knight
Standstill agreement
“Pacman” defense
Litigation
Asset/Liability restructuring
BOARDMAIL Institutional investors use it to fight
anti-takeover devices
Requires the board of directors to adopt weaker anti-takeover measures
In exchange for voting support from institutional owners
Vote in sympathetic board members
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WHY FIRMS SEEK EXTERNAL GROWTH Less Expensive
Achieve economies of scale
Vertical merger
Rapid growth
Diversification
Tax-loss carryforward
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TAXES ON MERGERS Cash or debt securities
Gains are usually taxable at the time of the merger
Equity securities Usually tax-free
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ACCOUNTING FOR MERGERS
Section 1581 of the CICA handbook requires that all business combinations after 2001 be accounted for under the purchase method.
Total value paid recorded on books Tangible assets at fair market value Excess as goodwill
Must be amortized Deducted from net income after taxes
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VALUATION OF A MERGER CANDIDATE
Comparative P/E Ratio Method Examines prices and P/E ratios of similar companies
Adjusted Book Value Method Determine market value of the company’s assets
Discounted Cash Flow Method Uses capital budgeting techniques to find the Present value of
the free cash flows
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EPS OF THE SURVIVING COMPANY
( )1 2 1,2
C1 2
EAT + EAT + EATEPS =
NS + NS ER
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EPSc = Earnings per share (combined companies)EAT1 = Earnings after taxes (acquiring company)EAT2 = Earnings after taxes (target company)EAT1,2 = Synergistic earnings from mergerNS1 = Shares outstanding (acquiring company)NS2 = Shares outstanding (target company)ER = Exchange ratio
Post-merger common share price and P/E ratio determined by the financial markets
BUSINESS FAILURE
Two federal laws govern business failure:
The Bankruptcy and Insolvency Act (BA) Companies’ Creditors Arrangement Act (CCAA)
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FAILURES Technically insolvent
Unable to meet current obligations
Legally insolvent Assets are less than liabilities
Bankrupt Unable to pay debts Files for protection under federal bankruptcy laws
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REASONS WHY FIRMS FAIL
Business risk
Industry downturns Over expansion Inadequate sales Increased competition Technological change
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REASONS WHY FIRMS FAIL
Financial risk
Excessive leverage Too much short-term debt Poor management of accounts receivable Poor management of accounts payable Incompetent management
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ALTERNATIVES FOR FAILING BUSINESSES
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Resolve itsDifficulties(informally) Declare
Bankruptcy(formally)
REORGANIZATION VS LIQUIDATION Legal bankruptcy proceedings focus on whether the failing
firm should be reorganized or liquidated
Reorganize if going-concern value exceeds its liquidation value
Liquidate if liquidation value is more than its going-concern value
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ALTERNATIVES FOR CASH FLOW PROBLEMS
Negotiate accounts payable deferrals
Restructure debt Extension Composition
Sell off assets Real estate/operating divisions
Sale and leaseback
Creditors’ committee
Assignment23
FAILURE UNDER BANKRUPTCY LAWS Voluntary petition
Debtor company files for bankruptcy.
Involuntary petition Unsecured creditors file the claim for bankruptcy asserting that the
debtor company is not paying its present debts as they come due.
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PRIORITIES Administration expenses Wages owed six months prior to bankruptcy (maximum
$2000) Municipal taxes owed within 2 years preceding bankruptcy Rent for preceding 3-month period General/unsecured claims, including taxes due the Crown Preferred shareholders Common share holders
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MAJOR POINTS
Mergers and acquisitions are a method of growing more quickly than through internal growth.
Firms must use the Purchase Method of accounting for acquisitions.
A leveraged buyout allows a buyer to acquire a target using mainly debt financing.
Failing firms are said to be insolvent.
A failing firm may be liquidated or reorganized.26