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

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

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

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

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.

Equity held by previous Debt holders Debt –equity swap Before After Debt Debt Equity held by previous Debt holders Equity Equity

Determining the shortfall for creditors Shortfall to creditors Assets are insufficient to meet all claims Claims on the company Unsecured creditors Shortfall on charged assets Amounts loaned under a floating charge (value restricted to the value of those charged assets) Value break Realizable value of business / assets (whichever is greater) 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

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

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

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

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

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’.