Reading 18: Corporate Restructuring

No. 167Date//Reading 8Corporate RestaracturingOwerviewLarge Corp often have diverse lines of biz under aCommon corp umbrella+ve ( or -ve) Sy nergies may results from these diverse holdingsManagers may alter the fdie of company reduce biz inresponse to a changing biz environment toinefficiencies & & Sy nergiesTypes of Corporate TransactionInvest: Increases biz size and/or scopeTo increase revenues and improve marginsDivestment: Decreases size orlor scope of bizShedding slow growing , low - profit higher risk segmentsRestructuring: Improve performance with same scopeIncrease growth T improve profitability or reduce risksMotivations for Invest" ActionsCreating Synergies : Firms are more valuable combinedIncreasing growth : eg Form a faster - grawing companyImprove Capabilities : eg Vertical Integration Page No 168Date//Improve access to resources : Talent manifacturing etcPursuing undervalued invest Relative burgainsMotivations for Corporate ResturingActionInvestDisinvest"Realize SynergiesFocus operations &Improve return onRestructuringIncrease growthbiz linesIssuer-speafieCapitalImprove CapabilitiesValuation (overValue)motivationsFinancial challenges,or Secure resourcesLiquidity needsOpportunity toincluding bankruptcy andRegulatory legliquidationacquire an under-valued targetTop - Down Drivers of Corporates ResturcutringThere are two top - down drivers of all three Kinds ofactions: industry shocks & higher Sec princes overall1Industry Shocks.Corporate restructuring tends to have industry - specific waves ;ThisIndustry mergers are often followed by more mergersphenomenon of industry shocks suggests a reactionarymotive for some Corporate transactions2High Security pricesPotential explaination for the economic cyclicality ofCorport transactions. Page No. 169Date//Greater CEO Confidence :- CEO confidenence lvl rate rise inrising market when Sec prices are highLower cost of Capital :- when stock & bond prices arehigher , cost of Capital (& dilution and int cost) is low.Over valued stock:- Using an overpriced Sec to finance anacquisition is attractiveYet, transaction in a week eco create more valueTypes of Investment ActionsEquity InvestPurchase a material (<50%) Stake in another firm equityThe two companies maintain their independence.May have representation on investee board of directorsOften made for one of several reasons :-- Establishing a strategic partnership beth firms- Taking an initial step toward on eventual ac quisition- Invest In a company it believes 18 undervaluedJoint VentureTwo or more Companies form a new Seperate company.Each firm contributes assets, employees Know - Know howThe participants share in the JVS profits or lossesTechnically just a laige equity invest"Commonly used to enter a new (often foreign ) market Page No. 170Date //Acquisition:Acquirer purchase a target share to gain control of an entireCompany, a segment , or specific assets-In exchange for Cash stock or assumption of liabilitiesAfterward target only exists as a subsidariary of acquirerAcquirer - then reports a singles set of financial statements ConsoliEach financial statn linel revenue exp , Cash + 6005 (FO) isaggregated.Divestment ActionsDivest action such asSalesSpin offsare made by issuers seeking toincrease growthIncrease profitability orreduce risk-by Shedding certain divisions & assetsSale (also Known as a divestiture) :Selling a Company, + segment , or a group of assetsControl of the target is transferred to the acquirer for Cashseller is no longer exposed to divested bizCapital Can then be reallocated to a better use- Or returned to shareholders or creditorsSeller & acquirer can then both focus on their strengths. Page No.171Date / /Spin -offSeperatingpart of a firm into a new independent Company.Goal is toincreasemang"&employeefocusby- Seperating distinct biz- Awarding employees relevant Compensation- Removing incompatibility bet parent&spin-offFirms are then independent T in terms of debt & equitySecurities , financial reporting mang" etcMotivation for RestructuringRestructuring actions, including1. Cost Restucturing2. B/S restructuring3. Reorganizationsdo not change the size or scope of issuersBut are aimed at improving retuins on capital to historicalor peer Ivl.Types of Corporate RestructuringsCost RestructingReducedcosts by improving operational efficiencyRaise margins / profits to historical lul or industry peerOutstandingSending Specific, Standardized biz processes CIT HR etc )tospecializedthird - party companies Page No. 172Date//Off Shoring :operations within the corp.Relocating operations to another Country while maintainingOutstanding and off sharing are often combinedB/s RestructuringsAlters the Composition of the B/S by shifting the assetCommon Bls restrict transact Includes lease backs & divCompositions or changing the Capital structurerecapitalizat1 Sale leasebackAsset owner sells an asset to a lessor for Cash & immediatelysigns a lease agreement for its use@Div RecapitalizationReducing WACC by increasing debt through debt-financingdiv or share repurchasesReorganizationsBankruptcy court assumes Control of the insolvent Company &overseas an orderly negotiationFirm's biz operations typically Continueou as normalCompany seeks agreement with creditors on a [eorg planUpon court approval , firm exits with lighter debt burdenReorganizations is diff from liquidation (in which the courtdivests assets & distribution proceeds to credits) Page No. 173Date / /Evaluation of a Corporate RestructuringEvaluation of a Comporate resturingiscomprised of :IInitial evaluationtext of ComponaryPR2Preliminary valuationeg Acq3ModelingFinancial Stat Post Restructuring4Updatingthe invest thesisFull evaluation is usually reserved for material restructuringsInitial Evaluation of Corp RestructuringWhat is happening ?Is it material ?bywhen is it happening!Why is it Shoppening ?Initial Evaluation - MaturidityMateriality is defined by both size & fitSize : : One rule of thumb defines a large actions as onethat is greater than 10% of an issuer enterprise valueeg for an acq t consideration in exceeds of 10% of theacq preannouncement enterprise valueFit : Refers to the aligment bet" the action & existingCompany strategyDeg a small acq in a different industry could be interpretedas management changing its strategy Page No. 75Date/Valuation Methods for Corp RestructuringsCommon valuation methods for Co involved in Corp restruc( during the preliminary valuation phase of the evaluation)includes :1Comparable Co.2Comparable trans"3] Disc CFComparable Company AnalysisUses the valuation multiples of similar , + listed 6. to valuea target.Valuation multiples and metrics based on the Currentmarket prices of the Comparable Co are used.- EV+ EV 1 1 EV , etcEBITDA Sales E I FCFFUsed more for valuing spin-offs than acq or salesAdvantageProvides a similar value to similar Co in the marketMost of the leg data is readily availableThe est of value are derived directly from the marketDisddvantageComparable Co Can be hard or impossible to findSensitive to market mispricing Covervalued compurables) Page No. 175Date / /Comparable Transaction AnalysislegClosely related to Comparable Company Analysis-but uses multiples from historicalacquistionValuation multiples are used to est a targetvalueUnlike comparable Co. valuation multiples in Comparabletransactions include takeover premAdvantages :Value est Come from actual transaction pricesIts unnecessary to est to seperate takeover premDisadvantages :There many be few or no Comparable transactionsMacroeco conditions influence historictransactionsThere is a risk that past acq over or underpaid-*Prem Paid AnalysisEst takeover prem is the amt by which the per - sharetakeover price exceeds the unaffected price.Expressed as a % of the unaffected priceReflects the price of control or the control premFor historical transaction the prem is calc asPRM = CDP - UP)UPPRM = Y. takeover premup = unaffected stock price of the Fargot-DP= deal price per share Page No. 176Date/ICaveats :-Be careful to exclude any pre - announcementin the pricethat may have occured because of rumors- Use a share price from one week prior to ann oun cement-Or a volume - -weighted avg over a week of monthPrem paid will vary by the same factors responsibleforvariation in valuation multiples targets outlook & risk.Avg prem paid 1990 - 2018 is 30% (20% - -40% range)Effects of Corp ResturturingPro forma financial stat" include restructuring effectsImportantinputs for equity & credit evaluation include:RevNet debt to EBITDAEPSFCFI measuresPro Forma Income Statn ModelingStep for creating pro forma financial stat" (acq) :RevCombine acq & target revAdd rev synerg ies Lor subtract for incompatibilites)Operating ExpCombine acq and target operating expSubtract Cost synergies ( or add cost of incompatibilites) Page No. 177Date / /Dep & AmortCombine acq & target dep & amortAdd amort of acq intangible assetsOther exp or incomeCombine acq & target other exp or incomeInt rate expStart with current acqint expAddint from debtissuance&revised int rateIncome taxesEBT- - weighted avg of tax rates of acq & targetest usually provided by issuersShare OutstandingStart with Current acq shares outstandingAdd sharefromanyshareissuancePro Forma WACCThe WACC for an issuer is determined by :1. The Weight of different capital types2. The consitituent Costs of CapitalIssuer's WACCCost of debtCost of preferred EquityCost of EquityWdid (1-t)WplpWere Page No. 178Date/Corporate Restucturing & WACECorporate bottom restucturings affects the cost of Capital by affecting-up drivers of the cost of capital + includingProfitabilityEBITDAorEBITRisk PremSalesSalesLeverage (debt to EBITDA)Stability (Stanard dev of Tev or EBITDA) VolatilityPrevailing int rate (ref rates, 'spread)Collateral assets (specificity , liquidity etc)Example : Evaluating an Equity Invest"Alpha Inc a large mature movie studio , is Concerned about newcompetition eroding its market share.Beta LLC is a digital distribution Co that provides proplietaryentertainment content to its subscriber baseBeta has had high organic growth over the past threeyr, but needs a Capital infusion for continued growthBeta has zero debt & one class of Common sharesSelected financials of the 6 (TTM) followAlpha makes a $1 billion Cash invest to acq 25% ofthe equity in betaAlpha financial the equity invest by issueing seriorunsecured debenturesThe two Company enter into an agreement to distributethe content library of alfa based on 50-50 Rev sharing Page No. 179Date//An analyst gather the following info related to the preersof beta LLC:ComparableEVNetRevenue (ITM)P1431311Q1019112R1994391S769157Evaluate the implied valuation of Beta & the transactionseffect on alpha SolvencyQuel : What other Corporate actions could alpha haveundertaken?Alpha alternatively Could have secured a controlling int in bet a(i.e an aq)Alpha could also have entered into an agreement to setup a third seperate Co as a joint venture- However because beta needs an infusion of Cash, betais more motivated to find an investor than to Committoa new invest"Que 2: What are the primary motivations for the Companiesto enter into the announced tran saction?Alpha will obtain entry into a fast -growing biz segment as wellas gain a mechanism to monetize its assets (i.e itsContent library)growthBeta will obtain the necessary infusion of Cash to finance its Page No.180Date//Oue 3 : Evaluate the valuation of Beta implied by the transactionGiven that Alpha acq a 25% stake for $ I billion , Beta'simplied market cap is est at $4B > GBGiven that beta has no debt, beta implied Ev is also$4BEVPQR5Rev4.69.15.14.9Median - 5Mean - 5.925Using the mean EV/Rev multiple of 5.925 t the EV of betawould be est to be 720 X 5.925 = $4.27 BUsing the median multiple t the EV of Beta would be estto be 720 x 5 = $36 BThe median multiple may be more representative because the meanis sly skewed by comparable Q, which apprears to be anoutlierAt a justified value of $ 3.6B the $4B purchase price apprearsto be at a prem of 11%other things to take into accounts are risk & growth ratediff among the peer companies . Page No. (8)Date / /Evaluating a IVJ.VThe process of evaluating a JV announcement is similarQue to consider include:-- What are the gains to the two firms involved ?- What impact will the transaction have on the variousratios of the two Companies ?Accounting for a IV is similar to equity invest"The two partners in the JV will report their stakein the venture using the equity method, reporting theirshare of income in their respective income stat"Any Capital raised by the two partners will be accountedfor in their own financial stat"Evaluating an AcqAcquisitionsWe cover acq a/c in detail in the financial Stat,analysis topic areaThe acq method calls for line-by-line consolidation of theinvestor financial stat" with the financial stat" of thesubsidiary f with a recognition of non - controlling int in theConsolidated financial statEvaluating an ocy should include determining the impact ofest synergies on the profitability ratios Page No. 182Date/The Impact of Consolidation on leverage ratios ( DIE or GDLEBITshould also be analyzed to determine the potential for achange in the parents Company debt ratings ( & hence, in itsCost of Capital)The evaluation should consider the impact of the transact" on thediluted EPS of the parent & whether the transaction priceapprears to be reasonable using Comparable transactionanalysis and the piem - paid analysis discussed earlierEvaluating Corporate Divestment ActionsEvaluation of divestment actions typicallyinvolves :1. Valuation of biz segments2. Impact on ratiosFor the sale of a biz segment, analysts should form an opiniumon whether the valuation of the segment is reasonablesOne approach is to use a multiple such as EV - to - EBITDAor EV -to- - sales to value the various segment of a biz- The sum of the parts should equal the Conglomerate EV,Sale proceeds (i.e Cash, stack) should be accounted for properlyinThen ratio such as debt -to EBITDA Can be prepared to assesspreparing pro-forma financial stat"Unlike sales, spin-offs do not generation sale proceeds & hencethe impact of the sale on the Company debt ratingsare easier to model Page No. 183Date / /Cost & B/5 RestructuringsMany external factor can initiate a Corp restructuring- -eg activist shareholder actions, a failed acq, etcEvaluation of a restructuring annoucement involves preparing pro formafinancial stat" that reflect- -Our expectations about cost Saving- The likelihood of achieving the restructurings goalsKnown how to appy assumptions to generate pro forma financialstat (& Calc rdevant ratio)