Corporate Financial Strategy 4 th edition Dr Ruth

Corporate Financial Strategy 4 th edition Dr Ruth Bender Chapter 17 Restructuring a company Corporate Financial Strategy

Restructuring a company: contents § Learning objectives § Reasons for restructuring, and possible approaches § Some warning signs § Debt equity swap § Determining the shortfall for creditors § Stakeholders have choices § Tips for those planning a distressed acquisition § Spin-offs § Carve-outs § Some reasons why demergers can add value Corporate Financial Strategy 2

Learning objectives 1. Diagnose when a company is in trouble, and identify ways in which its cash flow can be improved to stave off a cash crisis. 2. Identify potential sources of finance for a troubled company, and evaluate how appropriate they are. 3. Understand some of the regulatory mechanisms underlying company rescue or liquidation. 4. Explain what spin-offs and carve-outs are, and how they differ. Corporate Financial Strategy 3

Reasons for a restructuring, and possible approaches Wrong financial strategy Wrong business strategy Too little debt Too much debt Pay a special dividend Improve operating efficiency Undertake a buyback Invest Change strategy Sell assets Raise new finance Restructure existing debt Corporate Financial Strategy 4

Some warning signs § The company is trading close to the limit on its bank facilities. § Monthly management accounts continually show negative variances on sales and profits. § There are no monthly management accounts, or they arrive late, with inadequate explanation. § Several key people leave the company in a short period of time. § Loss of several customers. § Poor relationships with suppliers. Corporate Financial Strategy 5

Debt –equity swap After Before Debt Equity held by previous Debt holders Equity Corporate Financial Strategy 6

Determining the shortfall for creditors Assets are insufficient to meet all claims Claims on the company Unsecured creditors Shortfall to creditors Shortfall on charged assets Amounts loaned under a floating charge (value restricted to the value of those charged assets) Realizable value of business / assets (whichever is greater) VALUE BREAK Amounts loaned under a fixed charge (value restricted to the value of those charged assets) Costs of restructuring (professional fees) Based on: ICAEW Corporate Finance Faculty, Best-practice Guideline – Turnarounds Corporate Financial Strategy 7

Stakeholders have choices § Creditors (unsecured) § Ordinary shares − Put in more money − Accept dilution − Write off part of the debt − Negotiate payment terms − Take equity § Debt − − Put in more money Swap to equity Write-offs Note that all the different lenders will have different views on what should happen § Employees − Trade-off between jobs and pay § Management − Fight to be part of the deal? Payoff? § Other stakeholders? ? Corporate Financial Strategy Page 8

Tips for those planning a distressed acquisition § Use advisers with previous experience of distressed acquisitions § Be prepared to undertake an accelerated due-diligence exercise, but on limited information § Clarify and resolve the legal position regarding charges on the company’s assets, and retention of title clauses § Determine which contracts with customers, suppliers, and landlords include an automatic termination clause in the event of insolvency, and resolve this § Ensure you have the funding in place so that you can move quickly § Incorporate the new business to ring-fence the assets and make sure that if things don’t work out it doesn’t threaten your existing business. When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact. Warren Buffett Corporate Financial Strategy 9

Spin-offs Owned by existing shareholders Company A Pre-transaction Corporate Financial Strategy Owned by existing shareholders Company A Post-transaction Company B spun off division of Company A 10

Carve-outs Owned by existing shareholders Company A Pre-transaction Owned by existing shareholders Owned by new shareholders and by Company A Company C spun off division of Company A Post-transaction Corporate Financial Strategy 11

Some reasons why demergers can add value § Separation into clearly defined business segments leads to market transparency and greater understanding. § Raise money by taking advantage of the market pricing one particular sector very highly. § The different businesses can follow financial strategies more appropriate to their activities. § Improvements in corporate governance and efficiencies arise in companies which were subsidiaries but are now separately accountable to the markets. § Incentive structures can be put in place that link management performance directly to the unit’s share price. § Removal of the ‘conglomerate discount’. Corporate Financial Strategy 12