Alternative Restructuring Strategies

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Alternative Restructuring Strategies
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Learning Objectives

• Primary Learning Objective To provide students
  with an understanding of alternative exit and
  restructuring strategies.
• Secondary Learning Objectives To provide
  students with an understanding of
• Divestiture, spin-off, split-up, equity
  carve-out, split-off, and tracking stock
  strategies
• Criteria for choosing strategy for viable firms
• Criteria for choosing strategy for failing firms
• Process for filing for bankruptcy, voluntary and
  involuntary settlements inside and outside of
  court, and voluntary and involuntary liquidation

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Divestitures

• Sale of a portion of the firm to an outside party
  generally resulting in a cash infusion to the
  parent
• Motives
• De-conglomeration
• Moving away from the core business
• Assets are worth more to the buyer than to the
  seller
• Satisfying government requirements
• Correcting past mistakes
• Assets have been interfering with profitable
  operation of other businesses

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Deciding When to Sell Financial Evaluation of
Divestitures

• Estimate units after-tax cash flows viewed on a
  standalone basis, carefully considering
  dependencies with other operating divisions
• Determine appropriate discount rate
• Calculate the units PV to estimate market value
• Calculate the equity value of the unit as part of
  the parent by deducting the market value of
  liabilities
• Decide to sell or retain the division by
  comparing the market value of the division (step
  3) minus its operating liabilities (step 4) with
  the after-tax proceeds from the sale of the
  division.

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Spin-Offs Split-Ups

• Spin-Offs New legal subsidiary created by parent
  with new subsidiary shares distributed to parent
  shareholders on pro-rata basis (e.g., Medco by
  Merck in 2004)
• Shareholder base in new company is same as parent
• Subsidiary becomes a publicly traded company
• No cash infusion to parent
• Tax-free to shareholders if properly structured
• Split-Ups (e.g., ATT in 1985)
• A new class of stock is created for each of the
  parents subsidiaries
• Current parent shareholders receive a dividend of
  each new class of stock,
• Sometimes the remaining corporate shell is
  dissolved

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Equity Carve-outs

• Two forms Initial public offering (IPO) and
  subsidiary equity carve-out
• IPOs represent the first offering of stock to the
  public of all or a portion of the equity of a
  formerly privately held firm (e.g., UPS sells 9
  of its shares in 1999)
• The cash may be retained by the parent or
  returned to shareholders
• Subsidiary equity carve-out is a transaction in
  which the parent sells a portion of the stock of
  a wholly-owned subsidiary to the public. (e.g.,
  Phillip Morris 2001 sale of 15 of its Kraft
  subsidiary)
• The cash may be invested in the subsidiary,
  retained by the parent, or returned to the
  parents shareholders
• Although the parent generally sells less than 20
  of the subs equity, the subs shareholder base
  may be different than that of the parent

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Tracking Stocks

• Separate classes of common stock created by the
  parent for one or more of its operating units
  (e.g., USX creates Marathon Oil stock in 1991)
• Each class of stock links the shareholders
  return to the performance of the individual
  operating unit
• For the investor, such shares enable investment
  in a single operating unit rather than in the
  parent
• For the parent and the operating unit, such
  shares
• Give the parent another means of raising capital,
  
• Represent an acquisition currency for the unit,
  and
• Provide an equity-based incentive plan to attract
  and maintain key managers

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Split-Offs

• A variation of a spin-off in which some parent
  company shareholders receive shares in a
  subsidiary in return for their parent shares.
  (e.g., ATT spun-off its wireless operations in
  2001 to its shareholders for their ATT shares)
• Frequently used when a parent owns a less than
  100 investment stake in a subsidiary in order
  to
• Reduce pressure on the spun-off firms share
  price, because shareholders who exchange their
  stock are less likely to sell the new stock and
• Increase the parents EPS by reducing the number
  of its shares outstanding

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Voluntary Liquidations or Bust-Ups

• Involves the sale of all of a firms individual
  operating units
• After paying off any remaining outstanding
  liabilities, after-tax proceeds are returned to
  the parents shareholders and the corporate shell
  is dissolved
• This option may be pursued if management views
  the growth prospects of the consolidated firm as
  limited

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Bankruptcy

• Applicable to failing firms
• A firm is technically insolvent if it is unable
  to pay its liabilities as they come due
• A firm is legally insolvent if a firms
  liabilities exceed the fair market value of its
  assets
• Designed to protect failing firms from lawsuits
  by its creditors until decision made to shut-down
  or to continue operating the firm
• A firm not considered bankrupt until it or its
  creditors petition the federal bankruptcy court

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Voluntary Reorganization Outside of Bankruptcy
Court

• Generally offers best chance for owners to
  recover a portion of their investment
• Usually, initiated by debtor firm by requesting
  relief from creditors
• Such relief often consists of the following
• An extension Creditors agree to lengthen period
  during which debtor firm can repay its debt. May
  also include a temporary suspension of both
  interest and principal repayments
• A composition Creditors agree to settle for less
  than the full amount they are owed
• Debt for equity swap Creditors surrender a
  portion of their claims in exchange for an
  ownership position in the firm

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Voluntary Liquidation Outside of Bankruptcy Court

• If creditors conclude insolvent firms situation
  cannot be reorganized, liquidation may be only
  course of action
• If insolvent firm is willing to accept
  liquidation and all creditors agree, legal
  proceedings not necessary
• Creditors normally prefer liquidations to avoid
  lengthy and costly litigation

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Reorganization and Liquidation in Bankruptcy

• In absence of out-of-court voluntary settlement,
  debtor firm may
• seek protection from creditors by petitioning the
  bankruptcy court or
• be forced into bankruptcy by its creditors
• Bankruptcy allows creditor firm to stop all
  principal and interest payments and prevents
  secured creditors from taking possession of their
  collateral
• U.S. Bankruptcy Code
• Chapter 11 deals with reorganization and provides
  for the debtor to remain in possession, unless
  court rules otherwise
• Chapter 7 deals with liquidation and defines
  priority in which creditors will be paid

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Procedures for Reorganizing in Bankruptcy
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Liquidation in Bankruptcy

• If the bankruptcy court determines reorganization
  not feasible, failing firm may be forced to
  liquidate
• Priority in which claims are paid (per Chapter 7
  of U.S. Bankruptcy Code)
• Past due property taxes
• Secured creditors up to proceeds of the sale of
  pledged assets
• Legal fees
• Expenses incurred after involuntary case begun
  but before trustee appointed
• Wages not to exceed 2000 per worker
• Unpaid employee benefit plan contributions up to
  2000
• Unsecured customer deposits of 900 or less
• Income taxes owed federal, state, or local
  governments
• Under-funded pension liabilities up to 30 of the
  firms book value
• Unsecured creditors
• Preferred shareholders, up to par value of their
  stock
• Common shareholders, paid out of remaining funds

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Choosing Appropriate Restructuring Strategy
Viable Firms

• Choice heavily influenced by the following
• Parents need for cash
• Degree of operating units synergy with parent
• Potential selling price of operating unity
• Implications
• Parent firms needing cash more likely to divest
  or engage in equity carve-out for operations
  exhibiting high selling prices relative to their
  synergy value
• Parent firms not needing cash more likely to
  spin-off units exhibiting low selling prices and
  synergy with parent
• Parent firms with moderate cash needs likely to
  engage in equity carve-out when units selling
  price is low relative to synergy

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Choosing Appropriate Restructuring Strategy
Failing Firms

• Choice heavily influenced by the following
• Going concern value of debtor firm
• Sale value of debtor firm
• Liquidation value of debtor firm
• Implications
• If sale value gt going concern or liquidation
  value, sell firm
• If going concern value gt sale or liquidation
  value, reach out of court settlement with
  creditors or seek bankruptcy protection under
  Chapter 11
• If liquidation value gt sale or going concern
  value, reach out of court settlement with
  creditors and liquidate or liquidate under
  Chapter 7

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Things to Remember

• Divestitures, spin-offs, equity carve-outs,
  split-ups, split-offs, and tracking stock are
  common restructuring strategies to enhance
  shareholder value
• Divestitures and equity carve-outs are more
  likely for operating units whose selling price is
  much higher than its perceived synergy with
  parent and whose parents need cash
• Spin-offs are more likely for operating units
  whose selling price and synergy are low and whose
  parent firm does not need cash
• A failing firms options are to merge with
  another firm, reach an out-of-court voluntary
  settlement with creditors, or file for Chapter 11
  bankruptcy protection