Corporate Restructuring: Combinations and Divestitures

Corporate Restructuring:
1960s - Mergers of unrelated firms formed huge conglomerates.
1980s - Investors purchased conglomerates and sold off the pieces as independent companies.
1990s - Strategic mergers of related firms to create synergies.

Possible Benefits of Mergers
• Economies of Scale
   Ex: reduce administrative expenses as a percentage of sales.
• Tax Benefits
   Ex: target firm has tax credits from operating losses, and lacks the income to use the credits.
• Unused Debt Potential
   Ex: merging with a firm that has little debt increases debt capacity.
• Complementarity in Financial Slack
   Ex: a cash-poor firm merging with a cash-rich firm will be able to accept more positive NPV projects.
• Removal of Ineffective Managers
   Ex: ineffective target firm managers may be replaced, increasing the value of the target firm.
• Increased Market Power
   Ex: merging may increase monopoly power, but too much may be illegal.
• Reduction in Bankruptcy Costs
   Ex: merger may improve financial condition of the combined firm,
   reducing direct and indirect costs of financial distress.


Determination of Firm Value
Book value: assets minus liabilities on the balance sheet. Book value is based on historical cost minus accumulated depreciation.
Appraisal value: firm value is estimated by an independent appraiser. This estimate is often based on the firm’s replacement cost.
Chop-shop or Break-up value: determines if multi-industry firms would be worth more if separated into their parts. Firms are valued by their business segments.

Free Cash Flow or “Going Concern” value steps:
• Estimate the target firm’s free cash flows.
• Estimate the target firm’s after-tax risk-adjusted discount rate.
• Calculate the present value of the target firm’s free cash flows.
• Estimate the initial outflow of the acquisition.
• Calculate the NPV of the acquisition.

Divestitures
Divestiture - Eliminating a division or subsidiary that does not fit strategically with the rest of the company.
Sell-off: selling a firm’s subsidiary or division to another company.
Spin-off: separating a subsidiary from its parent company, with no change in equity ownership. The parent firm no longer has control over the subsidiary.
Liquidation: Selling assets to another company and distributing the proceeds from the sale to shareholders.
Going Private: A group of private investors buys all of a firm’s publicly-traded stock. The firm is now private, and its shares are no longer traded in the secondary market.
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