Corporate Restructuring EMP 51 Timothy A. Thompson

What is restructuring? 1980’s: corporate restructuring identified with leveraged buyouts, LBO’s, LCO’s More generally, however, divestitures, carve out IPO’s, spin offs, etc. Early 1990’s: corporate restructuring identified with troubled debt restructuring: workouts and reorganization In the 1980’s, corporate restructuring was usually taken to mean acquisitions, usually highly levered acquisitions, by corporate raiders financed with Michael Milliken’s Drexel Burnham Lambert’s junk bonds. Usually referred to buying long-standing diversified conglomerates and to break up the pieces and sell them off to pay off the enormous levels of debt. Often referred to defensive restructurings, MBO’s of divisions, divestitures, LCO’s undertaken to avoid the hostile acquisition by a raider. In the early 1990’s, a substantial recession, coupled by the collapse of DBL and indictments (and convictions) of several of the era’s leverage kings (Milliken, Icahn, etc.) led HLT’s into substantial trouble. Restructuring took on a different connotation: troubled debt restructuring. A cottage industry sprung up to help distressed companies with workouts, renegotiating contracts, and go through Chapter 11 reorganizations. We will take a much more general approach to restructuring. Restructuring decisions are decisions concerning the definition of the firm (what businesses the corporation will be in), ownership structure (debt vs. equity), ownership structure (equity ownership structure), control structure (power of board of directors/management/stockholders/unions/community/etc.). Course is really what is currently being called organizational architecture. Restructuring decisions are decisions involving changes (usually large changes) in the organizational architecture of the firm.

Impetus for restructuring Stock market Activist shareholders Pension funds Increasing competition Global Technological Change in regulation

Restructuring hexagon Information gap Slightly modified from the McKinsey book. Current Market Value Optimized firm value Value status quo Operating improvement Incentives management with VBM Value with financial restructuring Value with internal improvements Value with improvements Financial engineering: leverage, dual class stock, carve outs, tracking stock, employee ownership, debt restructuring Divestiture activity, spin offs and disposals

Dimensions of restructurings Asset restructuring Acquisitions Divestitures Spin offs Corporate downsizing Outsourcing Asset restructuring has to do with what activities are going to be done within the legal structure of the firm. Could entail the details of the corporate structure: divisions, subsidiaries, etc. In particular, acquisitions that are diversification oriented are moving the corporation into new industries, etc. Divestitures/spin off/split ups of divisions of a corporation alter the different businesses the firm owns and operates in. Corporate downsizing and outsourcing are catch-all phrases, but are often connected with the activities in the work flow that go into the production of finished products and services that can either be done within the corporation or can be contracted with third parties. Examples: franchising vs. ownership, outsourcing HR, licensing arrangements, etc. We will not focus as much on the mergers and acquisitions side of restructuring, because these decisions are treated in many other courses.

Dimensions of restructuring, II Restructuring ownership structure, leverage Exchange offers Share repurchases LBO’s, LCO’s Restructuring equity claims (next slide) Ownership restructuring: changes in the ownership structure of the corporation. This could be as basic as significant capital structure changes, such as large scales stock repurchases or leveraged recapitalizing dividends. Again, we will not focus much on simple stock repurchase plans or leveraged recapitalizations because these receive enough attention in Financial Decisions.

Restructuring equity claims Inside vs. outside equity ownership MBO’s, LCO’s ESOP’s, Employee buyouts Active investors, institutional blockholders Restructuring equity claims IPO Spin off, carve out IPO, letter stock Restructuring the equity claims of the corporation: how much of the firm should be owned by managers, employees, public shareholders, institutional shareholders, activist shareholders. How should management/board make decisions about changing the composition of the shareholder base?

Dimensions of restructuring, III Ownership vs. control Limited partnerships Leasing Joint ventures Securitization Project finance Incentive restructuring Value based management programs (EVA, etc.) An huge range of organizational structures have been developed in the last twenty years associated with the idea that the ownership of the assets need not have the control or discretion over the use of the assets. Marriott manages hotel chains, but sells the ownership of the real estate and hotel properties to limited partnerships which sign long term management agreements to use Marriott to operate the hotel properties. Airlines can decide to lease their fleets rather than own the airplanes. Companies can decide to sell the claims to future cash flows on certain assets to the capital market in securitized paper. Often a large scale investment (the Eurotunnel, EuroDisney, etc.) necessitates investments by several corporations, construction companies, and the okay of communities and several governments. Most of the restructuring alternatives we look at involve selling off pieces of the business, issuing new equity/debt claims against the business, etc. Perhaps the challenge of the organization is that the planning, performance measurement and compensation systems of the firm are not designed appropriately to reward value creating decisions on the part of management, both top level and divisional managements. Value based management programs (EVA, CFROI, SVA, MVA, CVA, etc.) based on performance metrics listed are designed to induce decisions that create value. Can this internal approach be sufficient and sidestep the need for more drastic (and expensive) measures?

Dimensions of restructuring, IV Corporate control Antitakeover amendments Dual-class recapitalizations Greenmail/Standstill agreements Poison pills/Charter amendments Defensive asset/ownership restructurings Restructurings can involve changing the fabric of the control of the corporation: changing the corporate charter. Antitakeover amendments such as poison pills, supermajority provisions, etc., can be used to insulate managers from threat of hostile takeover. Other defensive restructurings can involve more than the corporate charter: dual class recapitalizations change the voting structure of the equity of the firm, which requires a change in the corporate charter, but also involves sale of equity or an exchange offer. Greenmail is usually motivated by entrenchment, but involves the repurchase of shares of a particular shareholder or aligned group, usually with borrowed funds. Other defensive restructurings could be LCO’s, MBO’s, divestitures, etc., which are not different in substance than those discussed earlier, but the motivation of the deal may be control related.

Distress related restructuring Troubled debt restructuring Workouts Pre-packaged Chapter 11 Chapter 11 reorganizations Liquidations The last three weeks of the course are dedicated to distress related restructurings, which are the restructuring of the ownership and liability structure, and perhaps the asset structure, necessitated by financial distress of the corporation. The different channels of renegotiating terms, cancelling old contracts and writing new ones, are workouts (outside of a bankruptcy court), chapter 11 reorganizations and liquidations (in and outside of bankruptcy court).