Topic 6.

Corporate Restructuring,
Mergers and Acquisitions
What is Corporate
Restructuring?
• Corporate Restructuring refers to the
changes in ownership, business mix
and alliances with a view to enhance
shareholders value.
 What is Corporate
Restructuring?

Any change in a company’s:

1. Ownership
2. Operations, or
3. Capital structure,
that is outside its ordinary course of
business.

So where is the value coming

from (why restructure)?
 Corporate Restructuring And
Business Combination
• Ownership restructuring – through M&As,
leveraged buy-outs, spin-offs, joint ventures,
strategic alliances, buyback shares etc.
• Business restructuring – it involves the
reorganization of business units or division. It
includes diversification into new business,
outsourcing, divestment, brand acquisitions etc
• Assets restructuring – acquisition or sales of
assets and their ownership structure. Through
sale and leaseback, securitization of debt etc.
4
 Types of Corporate
restructuring
Corporate restructuring includes;
Mergers and acquisitions (M&As),
 Amalgamation,
Takeovers,
Spin-offs,
Leveraged buy-outs,
Buyback of shares,
Capital reorganisation etc.

M&As are the most popular means of corporate

restructuring or business combinations.
 Objectives
 Discuss the form of mergers and acquisitions
 Highlight the real motives of mergers and acquisitions
 Show how mergers and acquisitions could help in
creating value
 Illustrate the methodology for valuing mergers and
acquisitions
 Focus on the considerations that are important in the
mergers and acquisitions negotiations
 Consider the issues involved in post-merger integration

6
 Types of Business Combination:
1: Merger
• Merger or Amalgamation
A merger is said to occur when two or more
companies combine into one company.
One or more companies may merge with an
existing company or they may merge to form a
new company.
 Types of Business Combination:
1: Merger
• Merger or Amalgamation
– Merger or amalgamation may take two forms:
• Absorption is a combination of two or more companies
into an existing company, usually the larger company. All
they companies except one lose their identity through
merger by acquisition.
• Consolidation is a combination of two or more
companies into a new company. Here, all companies
are legally dissolved and a new entity is created.
– In merger, there is complete amalgamation of the assets
and liabilities as well as shareholders’ interests and
businesses of the merging companies. There is yet another
mode of merger. Here one company may purchase another
company without giving proportionate ownership to the
shareholders’ of the acquired company or without
 Forms of Merger
• Forms of Merger:
– Horizontal merger -
• Combinations of two or more firms in similar type of
production, distribution or area of business.
• Examples; Nike and Puma merge, CFC stanbic
– Vertical merger
• Combinations of two or more firms in different stages of
production or distribution.
• Examples; Distributor merge with the production company
e.g. a bicycle manufacturing company merges with a
bicycle advertising firm.
• Vertical mergers may take the form of forward or backward
merger. When a company combines with a supplier it is
called backward merger and when its combines with the
customer, it is known as forward merger.
– Conglomerate merger
• Combinations of two or more firms in unrelated business
activity.
• Example: KCB merge with Utalii company
 Types of Business Combination:
Merger Waves
 Horizontal Consolidation (The First Wave) 1897-1904
- After 1883 depression
- Horizontal mergers
- Create monopolies
 Increasing Concentration (The Second Wave) 1916-
1929
- Oligopolies
- The Clayton Act of 1914
 The Conglomerate Era (The Third Wave) 1965-1969
- Conglomerate Mergers
- Booming Economy
 The Retrenchment Era (The Fourth Wave) 1981-1989
- Hostile Takeovers
- Mega-mergers
 Age of the Strategic Megamerger (after 1990’s
- Strategic mega-mergers
 Horizontal Consolidation
(1897-1904)
• Spurred by
– Drive for efficiency,
– Lax enforcement of antitrust laws
– Westward migration, and
– Technological change
• Resulted in concentration in metals,
transportation, and mining industry
• M&A boom ended by 1904 stock market
crash and fraudulent financing
 Increasing Concentration
(1916-1929)
• Spurred by
– Entry of U.S. into WWI
– Post-war boom
• Boom ended with
– 1929 stock market crash
– Passage of Clayton Act which more
clearly defined monopolistic practices
 The Conglomerate Era
(1965-1969)
• Conglomerates employ financial engineering to boost
their share price
– High P/E firms acquired lower P/E target firms
– Combined firms’ share price increased if investors
applied the higher P/E to the combined firms’ EPS
– Number of high-growth, low P/E firms declined as
conglomerates bid up their prices
– Higher purchase price for target firms and increasing
leverage of conglomerates brought era to a close
 The Retrenchment Era
(1981-1989)
• Strategic U.S. buyers and foreign
multinationals dominated first half of decade
• Second half dominated by financial buyers
– Buyouts often financed by junk bonds
– Drexel Burnham provided market liquidity
• Era ended with bankruptcy of several large
LBOs and demise of Drexel Burnham
Age of the Strategic Megamerger
(1992-2000)

• Dollar volume of transactions reached record in

each year between 1995 and 2000
• Purchase prices reached record levels due to
– Soaring stock market
– Consolidation in many industries
– Technological innovation
– Benign antitrust policies
• Period ended with the collapse in global stock
markets and worldwide recession
 Types of Business
Combination: 2. Acquisition
• Acquisition may be defined as an act of acquiring
effective control over assets or management of a
company by another company without any
combination of businesses or companies.
• A substantial acquisition occurs when an
acquiring firm acquires substantial quantity of
shares or voting rights of the target company.
• Thus, in an acquisition, two or more companies
may remain independent, separate legal entity, but
there may be change in control of companies.
 Motives of Mergers and
Acquisitions
 Mergers and Acquisition are intended to:
Limit competition.
Utilise under-utilised market power.
Overcome the problem of slow growth and profitability in one’s
own industry.
Achieve diversification.
Synergy
Tax considerations
Gain economies of scale and increase income with
proportionately less investment.
Establish a transnational bridgehead without excessive start-up
costs to gain access to a foreign market.
Fund raising
Increased technology
 Motives of Mergers and Acquisitions
– Utilise under-utilised resources–human and physical
and managerial skills.
– Displace existing management.
– Circumvent government regulations.
– Reap speculative gains attendant upon new security
issue or change in P/E ratio.
– Defence against takeover
– Create an image of aggressiveness and strategic
opportunism, empire building and to amass vast
economic powers of the company.
– Managerial self-interest and hubris are the primary,
though unstated, reasons for many takeovers.
 Benefits of Mergers
and Acquisitions
• The most common advantages of M&A
are:
1. Accelerated Growth
2. Enhanced Profitability
• Economies of scale
• Operating economies
• Synergy
3. Diversification of Risk
 Benefits of Mergers and
Acquisitions
4. Reduction in Tax Liability
5. Financial Benefits
• Financing constraint
• Surplus cash
• Debt capacity
• Financing cost
6. Increased Market Power
 1. Accelerated Growth

• A company may expand its markets internally or

externally. If the company cannot grow internally due to
lack of physical and managerial resources, it can grow
externally by combining its operations with other
companies through mergers and acquisition.
• Mergers and acquisitions may help to accelerate the
pace of a company’s growth in a convenient and
inexpensive manner.
• Internal growth requires that the company should
develop its operating facilities such as manufacturing,
research, marketing etc. which might be costly and
may consume a lot of time.
Accelerated Growth
continued
• Thus, lack or inadequacy of resources and time
needed for internal development constrains a
company’s pace of growth. The company can
therefore acquire production facilities as well as
other resources from outside through mergers
and acquisition.
• This way the company will be able to growth at
a faster rate as compared to when it would have
chosen to expand internally.
2. Enhanced Profitability
• The combination of two or more companies may
result in more than the average profitability due
to cost reduction and efficient utilization of
resources. This may happen because of the
following reasons:
1. Economies of scale
2. Operating economies
3. Synergy
• Economies of Scale: Economies of scale arise when
increase in the volume of production leads to a
reduction in the cost of production per unit.
• Mergers may help to expand the volume of production
without corresponding increase in fixed cost, thus
fixed costs are distributed over a large volume of
production causing the unit cost of production to
reduce.
• Economies of scale may also arise other
indivisibilities such as production facilities,
management functions and management resources.
This happens because a given function, facility or
resource is utilized for a larger scale operation
• Operating economies: a combination of two or
more firms may result in cost reduction due to
operating economies.
• A combined firm may avoid or reduce
overlapping functions and facilities. It can
consolidate its management functions such as
manufacturing, marketing and reduce operating
costs.
• For example, a combined firm may eliminate
duplicate channels of distribution, or create a
centralized training center, or introduce an
integrated planning and control system.
• Synergy: Synergy implies a situation where the
combined firm is more valuable than the sum of the
individual combining firms.
• Synergy refers to benefits other than those related
to economies of scale and operating economies.
• Synergy may arise from enhanced managerial
capabilities, creativity, innovativeness and market
coverage capacity due to the complementariness of
resources and skills and a widened horizon of
opportunities
3. Diversification of risk
• Diversification implies growth through the
combination of firms in unrelated businesses.
Such mergers are called conglomerate mergers.
• This form of mergers can result into reduction of
total risk through substantial reduction of
cyclicality of operations.
• Total risk will be reduced if the operations of the
combining firms are negatively correlated.
4. Reduction in tax
liability
• In a number of countries, a company is allowed
to carry forward its accumulated loss to set-off
against its future earnings for calculating its tax
liability.
• A loss making company may not be in a position
to earn sufficient profits in future to take
advantage of the carry forward provision. If it
combines with a profitable company, the
combined company can utilize the carry-forward
loss and save taxes.
 5. Financial benefits
• A merger can result into financial benefits through the
following ways:
a) Eliminating financing constraint: a company may be
constrained to grow through internal development due
to shortage of funds. The company can grow externally
by acquiring another company by the exchange of
shares and thus release the financing constraints.
b) Deploying surplus cash: A cash rich company may not
have enough internal opportunities to invest in. It may
distribute the cash to the shareholders or use it to
acquire other companies. The shareholders may not
benefit much if the cash is distributed to them rather
their wealth might increase if the company was to use
that money to acquire another company.
c) Enhancing debt capacity: A merger of two
companies, with fluctuating, but negatively correlated,
cash flows, can bring stability of cash flows of the
combined company. The stability of cash flows reduces
the risk of insolvency and enhances the capacity of the
new entity to service a larger amount of debt.
d) Lowering financing cost: Since probability of
insolvency is reduced due to financial stability, the
merged firm should be able to borrow at a lower rate of
interest.
A merged firm is also able to realize economies of scale
in floatation and transaction costs related to an issue of
capital.
 6. Increased Market
Power
• A merger or Acquisition can increase the market
share of the merged firm. The increased market
share improves the profitability of the firm due to
economies of scale.
• A merged company is also able to limit competition
and this will enable the merged firm to earn super-
normal profit and strategically employ the surplus
funds to further consolidate its position and improve
its market power.
 Empirical Findings on
M&As
 50-80% of M&As fail to outperform their industry peers or
earn their cost of capital during the 3-5 years following
closing
 No evidence that alternative strategies to M&As are likely
to be more successful

 (Discuss the cases of M&A in Kenya ; CFCStanbic;

ICEALion etc)
 Value Creation Through
Mergers and Acquisitions
• Economic advantage when firms merge
represents the benefits resulting from;
– Operating efficiency
– Synergy
• The acquiring and the acquired firms may
share the EA between them.
• The acquiring firm can issue shares to the
target firm instead of paying cash.
 Value Creation Through Mergers
and Acquisitions
• Merger will create an economic advantage (EA)
when the combined present value of the merged
firms is greater than the sum of their individual
present values as separate entities.
• When analysing from a combined position;
– VPQ > (VP + VQ) thus economic advantage will be
– EA (∆V) = VPQ - (VP + VQ)
– Since M & A involves cost (cash paid – VQ), net economic
advantage (NPV) is given as;
Net economic advantage = Economic advantage – Cost of merger/acquisition
NEA  [VPQ  (VP  VQ )] – (cash paid  VQ )
 Value Creation Through Mergers
and Acquisitions
• When analysing from the acquiring company
perspective;
– VPQ > (VP + VQ) thus economic advantage will be
– EA (∆V) = VPQ - (VP + VQ)

– Where; ∆V = net incremental gain from merger

– The total value of firm Q to firm P, V*Q is:
– V*Q = VQ + ∆V
– Since M & A involves cost, net economic advantage
(NPV) is given as;
– NPV = V*Q – cost to Firm P of the Acquisition
 Example 1
• Firm P has a total market value of Sh. 180 million
(represented by 1,200,000 share whose market value per
share is Sh. 150). Firm Q has a total market value of Sh.30
million ( represented by 500,000 shares whose market
price per share is Sh. 60). Firm P is considering the
acquisition of firm Q. The value of P after merger (that is,
the combined value of the merged firms) is expected to be
Sh. 250 million due to the operating efficiencies. Firm P is
required to pay Sh. 45 million to acquire firm Q.
• Required: i. Determine the net economic advantage?
ii. What if instead of using cash the firm issues shares to the
target firm instead. How many shares should they issue?
iii. Determine the new market price of the share.
 Value Creation Through Mergers and
Acquisitions
• Example 2:
• Firm P is considering acquiring firm Q. The
expected value of the combined firm is
expected to be Kes. 50million. Firm P is
expected to pay Kes. 9million to acquire firm
Q. Determine the NEA to P if it acquires Q.
Firm P Firm Q
No. of shares 120,000 50,000
Price per share 300 120
 Value Creation Through Mergers and
Acquisitions
 Example 1:Soltn.
Net economic advantage = Economic advantage – Cost of merger/acquisition
NEA  [VPQ  (VP  VQ )] – (cash paid  VQ )

Market Value for P = 120,000 * 300 = 36million

Market Value for Q = 50,000 * 120 = 6million
EA = VPQ - (VP + VQ) = 50 – (36+6) = 8million
NEA = 8– (9-6) = Kes. 5million
 Value Creation Through Mergers and
Acquisitions
 Example 1:Soltn.

– V*Q = VQ + ∆V
– NPV = V*Q – cost to Firm P of the Acquisition

– EA (∆V) = VPQ - (VP + VQ) = 50 – (36+6) = 8million

– The total value of firm Q to firm P, V*Q is:
– V*Q = VQ + ∆V = 6 + 8 = 14 million (the value firm P will get by
acquiring Q)
– NPV = V*Q – cost to Firm P of the Acquisition (how much firm P
will pay)
– NPV = 14 – 9 = 5million
 The EA of 9 million is divided between the acquiring firm, P – Kes.5 million and
the target firm, Q – Kes. 4 million.
 Financing a Merger
• Cash Offer:
– A cash offer is a straightforward means of financing a merger. It
does not cause any dilution in the earnings per share and the
ownership of the existing shareholders of the acquiring company.
• Share Exchange:
– A share exchange offer will result into the sharing of ownership of
the acquiring company between its existing shareholders and new
shareholders (that is, shareholders of the acquired company). The
earnings and benefits would also be shared between these two
groups of shareholders. The precise extent of net benefits that
accrue to each group depends on the exchange ratio in terms of
the market prices of the shares of the acquiring and the acquired
companies.
– The bootstrapping phenomenon.
 Financing a Merger:
Cash
Example 2:
• The following is premerger information for two all –equity
firms; Great Firm (GF) and Small Firm (SF):

Great Small
Price per share 45 28
No. of shares 20,000 50,000

• Great Firm estimates that the value of the synergetic

benefits from acquiring Small firm is Kes. 120,000. Small
Firm has indicated that it will accept a cash purchase of
Kes. 30 per share. Should Great Firm proceed?
 Financing a Merger:
Cash
• Example 2: Soltn
• The total value of SF to GF is the premerger value of SF plus
the Kes. 120,000 gain from the merger.
• Premerger value of SF : Kes. 28 * 50,000 = Kes. 1.4million
• The total value for GF : 1,400,000 + 120,000 = 1,520,000
• At Kes. 30 per share, GF is paying: Kes. 30 * 50,000 = Kes.
1.5million
• NPV for the merger = Value – cost = 1.52million –1.5 million
= Kes. 20,000
• The merger has a positive NPV, hence SF is an attractive
merger partner.
• Assume GF is paying Kes. 35 per share, should GF
acquire SF?
 Financing a Merger:
Share Exchange
Example 3:
• The following is premerger information for Firm A and Firm
B:
Firm A Firm B
Total earnings (Kes. 000) 3,000 1,100
Shares outstanding (000) 600 100
Price per share 70 15

• Both this firms are 100% equity. Firm A is acquiring Firm B

by exchanging 100,000 of its shares in B.
– What is the cost of the merger if the merged firm is worth Kes.
63million.
– What will happen to A’s EPS?
 Financing a Merger:
Share exchange
• Example 3: Soltn
• Current EPS = Kes. 3,000 / Kes.600 = Kes. 5
• After the merger, the firm will have 700,000 outstanding
shares
• Because the total value of the merged firm is Kes.
63million, the price per share is; 63million / 700,000 = Kes.
90, up from Kes. 70. Because Firm B shareholders end up
with 100,000 shares in the merged firm, the cost of the
merger is Kes. 90 * 100,000 = Kes. 9million, not Kes. 70 *
100,000 = Kes. 7million.
• Also, the combined firm will have 3m + 1.1m = Kes. 4.1m in
earnings, so EPS will be Kes. 4.1m / 700,000 = Kes. 5.86,
up from Kes. 3m/600,000 = Kes. 5
 Analysis of Mergers and
Acquisitions
 There are several important steps involved in
the analysis of mergers or acquisitions:
Step 1: Planning – careful analysis of its
objectives...increase sales, stabilize sales, distribution
network, etc i.e.
 Establish a motive for the acquisition
Step 2: Search and screening – focuses on where and how
to look for suitable candidates for acquisition. i.e.
 Choose a target
 Analysis of Mergers
and Acquisitions
Step 3: Financial evaluation – determine the earnings and
cash flows, areas of risk, maximum price payable and the
best way to finance the merger. i.e.
 Value the target with the acquisition motive built in.
Step 4: Decide on the mode of payment - cash or stock, and
if cash, arrange for financing - debt or equity.
Step 5: Choose the accounting method for the
merger/acquisition - purchase or pooling.
Step 6: Integration – Integration of the acquired firm into the
acquiring firm.
 Primary Reasons for M&As
Frequent Failure to Meet
Expectations
1. Overpayment due to over-estimating
synergy
2. Slow pace of integration
3. Poor strategy
 The Merger Negotiation Process
• Mergers are generally facilitated by investment bankers --
financial intermediaries hired by acquirers to find suitable target
companies.
• Once a target has been selected, the investment banker
negotiates with its management or investment banker.
• If negotiations break down, the acquirer will often make a direct
appeal to the target firm’s shareholders using a tender offer.
 Types of Business Combination: 4:Takeover
• A tender offer is a formal offer to purchase a given number of
shares at a specified price. First, the acquiring company may
directly approach the target company for its takeover. If the
target company does not agree, then the acquiring company
may directly approach the shareholders by means of a tender
offer.
• The acquiring firm is usually interested in the synergy while the
target firm is interested in the premium.
• The offer is made to all shareholders at a premium above the
prevailing market price. E.g. Dimension ltd. In May 2013
offered to pay Kes. 14 per share of AccessKenya which
was trading at Kes. 9 share. The premium is 42%
• In general, a desirable target normally receives more than one
offer.
 Types of Business Combination:
4:Takeover
Hostile Takeover:
– Sometimes, the acquirer may go directly
to the shareholders without negotiations,
this is referred as hostile takeover.

In many cases, existing target company

management will implement takeover defensive
actions to ward off the hostile takeover.
 Defensive Tactics during
Takeover attempts
• Divestiture -
– spin off some of the its business to an independent subsidiary.
• Crown jewels
– Selling the attractive parts of a business
• Poison pill
– Acquiring company makes itself unattractive e.g. Issue debt or the
firm issues securities that give holders rights that become effective
when a takeover is attempted. These rights make the target less
desirable to acquirer. For example, these pills allow the holders to
receive the super-voting rights.
• Shark repellants
– are antitakeover amendments to a corporate charter that constrain
the firm’s ability to transfer managerial control of the firm as a result
of a merger.
 Defensive Tactics during Takeover
attempts
• Greenmail
– Incentive offered by management of target company to potential
bidder so as not to pursue the takeover. The firm may also
repurchases a large block of its own stock at a premium to end a
hostile takeover by those shareholders.
• White knight
– Management of target company offers to be acquired by a friendly
company more to its liking than the initial hostile acquirer to escape
a hostile takeover and prompts the two to compete to take over the
firm.. Maybe to avoid losing the management of the company.
• Golden parachutes
– Company (target) offers hefty compensation to its managers if they
get ousted due to takeover. This helps in reducing resistance.
 Types of Business Combination:
5:Leveraged Buy-outs

• A leveraged buy-out (LBO) is an acquisition of a company

in which the acquisition is substantially financed through
debt. When the managers buy their company from its
owners employing debt, the leveraged buy-out is called
management buy-out (MBO).
• The following firms are generally the targets for LBOs:
– High growth, high market share firms
– High profit potential firms
– High liquidity and high debt capacity firms
– Low operating risk firms
• The evaluation of LBO transactions involves the same
analysis as for mergers and acquisitions. The DCF
approach is used to value an LBO.
 Accounting for Mergers and
Acquisitions
• Pooling of Interests Method
• In the pooling of interests method of accounting, the
balance sheet items and the profit and loss items of the
merged firms are combined without recording the effects
of merger. This implies that asset, liabilities and other
items of the acquiring and the acquired firms are simply
added at the book values without making any
adjustments.
• Purchase Method
• Under the purchase method, the assets and liabilities of
the acquiring firm after the acquisition of the target firm
may be stated at their exiting carrying amounts or at the
amounts adjusted for the purchase price paid to the target
company.