Corporate Restructuring

CORPORATE RESTRUCTURING

What is restructuring? It is a complex and multi-dimensional task. It can be re-assignment of  human resources, downsizing, redrawing of systems & rules, selling off  assets / businesses or changing the finance portfolio or a combination of  all. The objective is to reorient or tune the organisation to make it more efficient and effective. Examples:

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AT&T had its share prices shoot up with an announcement of 40,000 cut in its workforce when faced with pressure on profits.

Daewoo during early 90s experienced difficulties difficulties with its large diversified empire. By amputating unprofitable parts, restructuring and downsizing, it rewrote its success story. Subsequently it again got into trouble.

Some Indian cases:

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Tata Steel had taken the services of 3 international consultants namely McKinsey & Co, Arthur D Little and Booz Allen & Hamilton to enable it to become it globally competitive. It sold of its cements division, had VRS & modernised its plants and thereafter became became the lowest cost producer of steel in the world.

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Asian Paints has restructured its manufacturing operations into 3 SBU’s: Deco Decora rati tive ve Indi India, a, Deco Decora rati tive ve Inte Intern rnat atio iona nall and and anot anothe herr made made up of  chemi chemical cal busine businesse ssess along along with with indust industri rial al paints paints to ensure ensure focus focus and greater accountability. accountability. Driving force being global operations.

Dabur with P/E ratio of 20 and operating profit margin of 12% was not satisfied. With assistance from McKinsey it initiated steps to lower its inventory costs, shorten delivery schedules and sharpen response time to market needs.

THER THERE E IS NO SET FORM ORMULA ULA OR STANDARD DARD MODEL FOR  FOR  REST RESTRU RUCT CTUR URIN ING. G. HOWE HOWEVE VER R IT SHOU SHOULD LD BE A CONS CONSTA TANT NT PROCESS WITH PERIODIC DOSES TO FINE-TUNE THE ORGANISATION.

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Why restructure?

Restructuring has caught up with Indian companies. In the US companies have have un unde dert rtak aken en a wide wide rang rangee of rest restru ruct ctur urin ing g tran transa sact ctio ions ns incl includ udin ing g acquisition, divestiture, spin-off, split-off, leveraged buyout, etc.

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The major objective of restructuring is to enhance shareholder value. Besides other reasons as:

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Changes in competitive co mpetitive situation : Because of foreign competition, accelerated rate of technological change & competitive pressures faced globally. To focus on core competencies by divesting non-core businesses; these disinvestments can have attractive valuations.

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Changes in capital markets : [has triggered financial restructuring res tructuring]] Abolition of Controller of Capital Issues, empowering SEBI, freedom to FIIs to invest in new issues and existing stocks, access to capital globally at chea cheap p rate rates, s, scop scopee for for priv privat atee plac placem emen ent, t, scop scopee for for deli delist stin ing, g, the the emergence of angel investors as well as venture funds, etc, are forcing companies to rethink their capital structure.

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Changes Cha nges in i n Govt. Gov t. polici po licies es: Major changes in MRTP Act, FEMA, Industrial licensing, setting up of  Competition Commission of India, etc; Size no longer is a constraint; growth strategy is based on competencies and not govt. licenses; 3

MNCs can gain control of operations in India. A classic example is HUL. From associate companies to subsidiaries to 100% ownership

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To avoid avo id unsolicited un solicited take-overs : As bidders believe that the stock prices of some companies do not reflect true values achievable via restructuring of businesses (after acquisition). Goi Going con onccern ern value alue may be lowe ower than han brea breakk-up up market ket valu valuee. Therefore, some firms increase debt considerably to become unattractive. unattractive.

5. To gain long term competitive advantage: advantage: Honda Motors India broke up with Kinetic Engineering to set up HMSI Private Limited. HUL restructured itself via project millennium in 2000. Now after loosing market share to competitors in 2008-09 it is trying to reinvent itself.

6. To enter international international markets markets: This is especially in the face of quota & other restrictions besides the effects of globalisation. Ranbaxi acquired firms’ abroad to penetrate foreign markets. Infosys reorganised itself as per demands of international stock exchanges and investors. Tata’s acquired Tetley, Chorus and Jaguar Land rover to enter global  business in tea, steel and automobiles. 4

7. To achieve achieve operationa operationall & market relate related d benefits benefits: Restructuring of the appropriate kind can lead to improved competitive   pos posit itio ion n (say (say via via vert vertic ical al inte integr grat atio ion) n),, gain gainss in mark market et shar sharee (by (by  business combinations) and increased productivity (via modernisation and retraining)

8. To reduce cost: Reducing the cost structure via a host of organisational, portfolio and finan financi cial al restr restruct ucturi uring ng is essent essentia iall to make make firm firmss cost cost compet competiti itive/ ve/  profitable.

9. To increase increase management management control: By merger of investment companies, increasing share holding pattern, etc.

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Types of Restructuri Restructuring ng

1.

Organisational Res Restructuring:

Here, changes are aimed largely at corporate culture, processes & systems, number of employees, levels of managers (especially middle managers &  professionals) or a combination of the aforesaid.

2.

Portfolio Restructuring:

It refers to changes in the sets of businesses comprising the corporation to create create a more more effec effectiv tivee confi configur gurati ation on of busine businesse sses. s. Effec Effectiv tivene eness ss is enhanced by combining lines of businesses in areas where the firm has competitive advantage, and by shedding lines of business where it cannot obtain higher returns than its competitors.

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Financial Restructuring:

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It mainly involves changes in the capital structure of the firm.

It has meant different things at different times. Increase in debt when it is attractive (trading on equity), greater reliance on equity when it proves to be cheap, going in for GDR issues, etc. •

It also also invo involv lves es chan change ge in the the stru struct ctur uree of debt debt & equi equity ty –  convertible bonds – as well as improved treasury management, intercorporate deposits and commercial paper/ corporate bond.

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All of these intended to reduce cost of financing, passing on these  benefits to shareholders & having a more flexible finance portfolio. •

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FORMS OF BUSINESS RESTRUCTURING IN INDIA (Based on article by Prof. N Venkiteswaran 1997, Vikalpa)

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Portfolio Restructuring Acquisitions: Various considerations (few are given below) have driven firms to acquire companies in India. Generally, instead of 100% acquisitions only controlling blocks of shares have been acquired.

Acquisit Acqu isition ion for fo r Market entry e ntry :

# Vodafone’s acquisition of 67% stake in Hutchison Essar from Li Ka Shing in February 2007.

# NTT DoCoMo’s 26% acquisition of Tata Tele Services in Nov 08

# Daiichi Sankyo’s acquisition of >50% stake in Ranbaxy Ltd in 2008

Acquisition Acquisitio n for Diversification Diversificat ion: (By acquiring) acq uiring)

# Torrents group’s acquisition of the controlling interest in Ahmedabad Electric Co. Ltd. and Surat Electricity Co. Ltd

# Acquisition of the erstwhile Union Carbide India Ltd. by Khaitans/ Mcleod Russell group in a court-mandated court-mandated auction

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Acquisition Acquisitio n for market mark et share & industry in dustry consolida c onsolidation tion:

# Hindalco’s acquisition of Novelis a Canadian company in Feb 2007 for $ 6 billion

# Merger of Centurian Bank of Punjab with HDFC Bank in Feb 2008 at $ 2.4 billion

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Mergers Merge rs and an d Amalgamati Amalg amations ons :

Consolidation Consoli dation at the business bu siness / group level le vel:

This is do This done ne to gain gain crit critic ical al mass mass,, redu reduce ce cost costs, s, gain gain focu focuss and and eliminate intra-group competition.

# RPL merger with RIL in March 2008 at $ 1.68 billion; the swap ratio was 16:1. # Series of mergers involving Unilever group of companies in India.

Financial and tax ta x considerations cons iderations :

# Merger with sick firms (for tax benefit), asset stripping, etc E.g. Mcleod Russel (India) merging with Eveready Industries India Ltd

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3.

Dive Di vest stit itur ures es:: (Fo (Forr li liqu quid idit ity, y, fo focu cus, s, et etc. c.)) Tata Steel’s divestment of Cement division to Lafarge of France

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Joint Ventures & Strategic Alliances Hero Groups joint venture with Honda Motors to enter  motorcycles market

ICIC ICICII conv conver erti ting ng its its inve invest stme ment nt bank bankin ing g bu busi sine ness ss into into a JV company ICICI Securities Securities with JP Morgan as the JV partner 

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Demerger or spin-off: (increase business unit value)

Demerger of Aptech from Apple Industries Ltd.

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Financial restructur restructuring ing

Debt Restructuring Res tructuring : (when debt level lev el is high) h igh)

Can be done through fresh issue of equity and / or divestment and asset sale to retire debt

Converting debt to equity; FI loans are converted to equity to free the firm from interest and repayment repayment burden when it is passing through a very difficult financial situation. 9

Capi Capita tall Redu Reduct ctio ion n: Can Can be do done ne by redu reduci cing ng equi equity ty by part part conversion into preference capital/ debentures. (EPS increases and stock prices too)  Now share buy back has made the process less cumbersome.

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Ownership Restructuring:

A situation wherein, the shareholding structure undergoes changes even as the management remains the same.

Tar Targete geted d sha share issu issues es: Com Compani paniees issui ssuing ng sha shares to the management management or the promoter groups essentially to beef up the latter’s holdings (e.g. private placement, etc).

Indian Indian affiliat affiliates es of MNC’s were the first to do so when government government relaxed ceiling on foreign holding of 40%

The pricing of shares for increasing stake by MNC’s were in many cases low / unfair. Now it can be issued only at market prices.

Shareh Sharehold olding ing by FII’s FII’s: The entry entry of FII’s FII’s as shareh sharehold older erss of  Indian firms is affecting the quality of governance (positively)

This is refl This reflec ecte ted d in comp compan any y focu focus, s, info inform rmat atio ion n diss dissem emin inat atio ion n  practices, etc.

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Restructuring Conglomerates in Emerging Markets

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Tarun Tarun Khann Khannaa and Krish Krishna na Palepu Palepu have have raise raised d a releva relevant nt questi question on whether it is desirable to dismantle the diversified business groups that dominate emerging markets?

 These conglomerates in developing countries provide the services that

are necessary for proper functioning of an efficient market (e.g. capital market, market for labour, management, management, technology, etc.)

 In western countries independent institutions exist to provide these

services like investment banks, venture capital firms, well developed capital markets, stock exchanges, B-schools, technical institutes, R&D labs, etc.

What the Business Groups provide? [Add value]

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They substitute for intermediaries by providing funds needed for  diversification diversification / growth for group businesses.

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Substitute for labour market institutions.

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Develop a common brand name, which group companies can leverage nationally or world-wide. 11

 Therefore, if dismantling the business groups is not the best option,

what needs to be done?

The BG’s should be encouraged in the short term to make proper  reforms to substitute for market institutions.

Governments in these countries should focus on building these institutions in the long run.

Dismantling of BG’s will happen naturally once these institutions are in place.

Incr Increa easi sing ng comp compet etit itio ion n will will forc forcee thes thesee BG’s BG’s to rest restru ruct ctur uree themselves.

How should the BG’s improve their functioning?

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Reform Refo rm busines bus inesss practice prac ticess:

They have to shift from ‘growth now, profitability profitability later’ to ‘profitable ‘profitable growth now’ by:

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inve invest stin ing g in int inter erna nall info inform rmat atio ion n and and ince incent ntiv ivee syst system emss

ii) ii)

shou should ld lear learn n how how to exit exit a bu busi sine ness ss;; and and

iii) iii)

need need to to chan change ge financ financial ial strate strategy gy from from debt debt to to equi equity ty 12

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Investing in institutiona inst itutionall value added:

i)

improving fi financial ma management by by:

distinguishing between financing new ventures and financing ongoing operations

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 behaving like a Venture capital firm

Providing only risk capital  Never transfer funds from one venture to another  Rarely interfere in day-to-day operations

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superior ro role in in MD MDP; an and

iii) iii)

Promo Promote te stan standar dards ds in qualit quality, y, cust custom omer er serv service ice and ethics ethics..

Assu Assume me lead leader ersh ship ip role role in co-o co-ord rdin inat atin ing g the the desi design gn and and dissemination of best business practices.

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Lay Lay the the foun founda dati tion on for for long long term term chan change ge by prom promot otin ing g transparency transparency and sound corporate governance. •

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