Corporate restructuring

INTRODUCTION TO CORPORATE RESTRUCTURING

Corp Corpor orat ate e rest restru ruct ctur urin ing g is one one of the the most most comp comple lex x and fund fundam amen ental tal phenomena that management confronts. Each company has two opposite strat strateg egie ies s from from whic which h to choo choose se:: to dive divers rsif ify y or to refo refocu cus s on its its core core business. While diversifying represents the expansion of corporate activities, refo refocu cus s chara charact cter eriz izes es a conc concen entr trat atio ion n on its its core core busi busine ness. ss. From From this this perspective, corporate restructuring is reduction in diversification. Corporate restructuring is an episodic exercise, not related to investments in new plant and machinery which involve a significant change in one or more of the following 

Pattern of ownership and control



Composition of liability



Asset mix of the firm.

It is a comprehensive process by which a co. can consolidate its business operations and strengthen its position for achieving a chieving the desired objectives: (a)Synergetic (b)Competitive (c) Successful Successful It involves significant re-orientation, re-organization or realignment of assets and liabilities of the organization through conscious management action to improve future cash flow stream and to make more profitable and efficient.

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MEANING & NEED FOR CORPORATE RESTRUCTURING RESTRUCTURING Corporate restructuring is the process of redesigning one or more aspects of  a company. The process of reorganizing a company may be implemented due to a number of different different factors, factors, such as positioni positioning ng the company company to be more more compet competiti itive, ve, survive survive a curren currently tly adverse adverse econom economic ic climat climate, e, or poise poise the corporation to move move in an enti entire rely ly new new dire direct ctio ion. n. Here Here are are some some examples of why corporate restructuring may take place and what it can mean for the company. Restructuring a corporate entity is often a necessity when the company has grow grown n to the the poin pointt that that the the orig origin inal al stru struct ctur ure e can can no long longer er effi effici cien entl tly y manage the output and general general interests interests of the company. company. For example, example, a corpor corporate ate restru restructu cturin ring g may call call for spinning off some some departm department ents s into into subsidiaries as a means of creating a more effective management model as well as taking advantage of tax breaks that would allow the corporation to dive divert rt more more reve revenu nue e to the the prod produc ucti tion on proc proces ess. s. In this this sc scen enari ario, o, the the restructuring is seen as a positive sign of growth of the company and is often welcome by those who wish to see the corporation gain a larger market share.. share Corporate restructuring may also take place as a result of the acquisition of  the the comp company any by new new owne owners rs.. The The acqu acquis isit itio ion n may may be in the the form form of a leveraged buyout buyout,, a hostile takeover, takeover, or a merger of some type that keeps the company intact as a subsidiary of the controlling corporation. When the restructuring is due to a hostile takeover, corporate raiders often implement a dismantling of the company, selling off properties and other assets in order to make a profit from the buyout. What remains after this restructuring may be a smaller entity that can continue to function, albeit not at the level possible before the takeover took place In general, the idea of corporate restructuring is to allow the company to continue functioning in some manner. Even when corporate raiders break up 2

the company and leave behind a shell of the original structure, there is still usually a hope, what remains can function well enough for a new buyer to purchase the diminished corporation and return it to profitability.

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Purpose of Corporate Restructuring 

 To enhance the share holder value, The company should continuously evaluate its: 1. Portfolio of businesses,

2. Capi Capita tall mix mix,, 3. Owne Owners rshi hip p& 4. As Asse sett arran arrange geme ment nts s to find find oppo opportu rtuni niti ties es to incr increa ease se the the share holder’s value.  



 To focus on asset utilization and profitable investment opportunities. To reorganize or businesses/products.

divest

less

profitable

or

loss

making

 The company can also enhance value through capital Restructuring, it can innovate securities that help to reduce cost of capital.

Characteristics of Corporate Restructuring improve e the company company’s ’s Balanc Balance e sheet, sheet, (by selli selling ng unprof unprofita itable ble 1.   To improv division from its core business). 2.   To To acco accomp mpli lish sh staff staff redu reduct ctio ion n ( by sell sellin ing/ g/cl closi osing ng of unpr unprof ofit itab able le

portion) 3. Changes in corporate mgt 4. Sale of underutilized assets, such as patents/brands. 5. Outsourcing of operations such as payroll and technical support to a

more efficient 3rd party. 6. Moving of operations such as manufacturing to lower-cost locations. 7. Reorganization of functions such as sales, marketing, & distribution 8. Renegotiation of labor contracts to reduce overhead 9. Refinancing of corporate debt to reduce interest payments.

4

10.

A major public relations campaign to reposition the co., with

consumers.

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11.

Category of corporate restructuring

Corpor Corporate ate Restru Restructu cturin ring g entail entails s a range range of activi activitie ties s includ including ing financial restructuring and organization organization restructuring restructuring.

FINANCIAL RESTRUCTURING Financi Financial al restru restructu cturin ring g is the reorga reorganiz nizati ation on of the financ financial ial assets assets and liabilities of a corporation in order to create the most beneficial financial environment for the company. The process of financial restructuring is often associated associated with corporate restructuring, restructuring, in that restructuring the general function and composition of the company is likely to impact the financial health health of the corpora corporatio tion. n. When When comple completed ted,, this this reorde reorderin ring g of corpor corporate ate assets and liabilities can help the company to remain competitive, even in a depressed economy.  Just about every business goes through a phase of financial restructuring at one time or another. In some cases, the process of restructuring takes place as a means of allocating resources for a new marketing campaign or the launch of a new product line. When this happens, the restructure is often viewed as a sign that the company is financially stable and has set goals for future growth and expansion.

Need For Financial Restructuring   The process of financial restructuring may be undertaken as a means of  eliminating waste from the operations of the company. For For exam exampl ple, e, the the restr restruc uctu turi ring ng effo effort rt may may find find that that two two divi divisi sion ons s or departments of the company perform related functions and in some cases duplicate efforts. Rather than continue to use financial resources to fund the operat operation ion of both both depart departmen ments, ts, their their effort efforts s are combin combined. ed. This This helps helps to reduce costs without impairing the ability of the company to still achieve the same ends in a timely manner In some cases, financial restructuring is a strategy that must take place in order for the company to continue operations. This is especially true when sales decline and the corporation no longer generates a consistent net profit. A financial restructuring may include a review of the costs associated with each sector of the business and identify ways to cut costs and increase the net profit. The restructuring may also call for the reduction or suspension of  6

production facilities that are obsolete or currently produce goods that are not selling well and are scheduled to be phased out. Financial restructuring also take place in response to a drop in sales, due to a sluggish economy or temporary concerns about the economy in general. When When this this happ happen ens, s, the the corp corpor orat atio ion n may may need need to reor reorde derr fina financ nces es as a means of keeping the company operational through this rough time. Costs may be cut by combining divisions or depart artments, reass ssiigning responsibil responsibilities ities and eliminati eliminating ng personnel personnel,, or sc scal alin ing g back back prod produc ucti tion on at vario various us faci facili liti ties es owne owned d by the the comp compan any. y. With With this this type type of corp corpor orat ate e restructuring, the focus is on survival in a difficult market rather than on expanding the company to meet growing consumer demand. All businesses must pay attention to matters of finance in order to remain operational and to also hopefully grow over time. From this perspective, financial restructuring can be seen as a tool that can ensure the corporation is making the most efficient efficient use of available available resources resources and thus generating generating the highest amount of net profit possible within the current set economic environment.

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ORGANIZATIONAL RESTRUCTURING In organi organizat zation ional al restru restructu cturin ring, g, the focus focus is on manage managemen mentt and intern internal al corporate governance structures. Organizational restructuring has become a very common practice amongst the firms in order to match the growing competition

of

the

marke rket.

This

makes

the

firms

to

change

the

organizational structure of the company for the betterment of the business.

Need For Organization Organization Restructuring 

New skills and capabilities are needed to meet current or expected operational requirements.



Acco Ac coun unta tabi bili lity ty

for for

resu result lts s

are are

not not

clea clearl rly y

comm commun unic icat ated ed

and and

measurable resulting in subjective and biased performance appraisals. 

Parts of the organization are significantly over or under staffed.



Organi Organizat zation ional al commun communica icatio tions ns are incons inconsist istent ent,, fragmen fragmented ted,, and inefficient.



  Technology and/or innovation are creating changes in workflow and production processes.



Significant staffing increases or decreases are contemplated.



Personnel retention and turnover is a significant problem.



Workforce productivity is stagnant or deteriorating.



Morale is deteriorating.

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Some of the most common features of organizational restructures are: 

Regrouping of business

  This This involv involves es the firms firms regrou regroupin ping g their their existi existing ng busines business s into into fewer fewer business units. The management then handles theses lesser number of  compact and strategic business units in an easier and better way that ensures the business to earn profit. 

Downsizing

Often Often compani companies es may need to retren retrench ch the surplus surplus manpow manpower er of the business. For that purpose offering voluntary retirement schemes (VRS) is the most useful tool taken by the firms for downsizing the business's workforce

.



Decentralization

In order to enhance the organizational response to the developments in dynami dynamic c enviro environme nment, nt, the firms firms go for decent decentral raliza izatio tion. n. This This involv involves es reducing the layers of management in the business so that the people at lower hierarchy are benefited. 

Outsourcing

Outsou Outsourci rcing ng is anothe anotherr measur measure e of organi organizat zation ional al restru restructu cturin ring g that that reduces the manpower and transfers the fixed costs of the company to variable costs. 

Enterprise Resource Planning

Enterprise Enterprise resource planning is an integrated integrated management management informatio information n system that is enterprise enterprise-wide -wide and computer-b computer-base. ase. This management management system enables the business management to understand any situation in

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faster faster and better way. The advancement advancement of the information information technology technology enhances the planning of a business.

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

Business Process Engineering

It invo involv lves es rede redesi sign gnin ing g the the busi busine ness ss proc proces ess s so that that the the busi busine ness ss maximizes the operation and value added content of the business while minimizing everything else. 

 Total Quality Management

 The businesses now have started to realize that an outside certification for the quality of the product helps to get a good will in the market. Quality improvement is also necessary to improve the customer service and reduce the cost of the business.

 The perspective of organizational restructuring may be different for the employees. When a company goes for the organizational restructuring, it often leads to reducing the manpower and hence meaning that people are losing their jobs. This may decrease the morale of employee in a large manner. Hence many firms provide strategies on career transitioning and outplacement support to their existing employees for an easy transition to their next job.

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Corporate Restructuring Activities

Expansion Mergers & acquisition  Tender offers  Joint venture

SELL-OFFs Spin-off  Split-off  Equity carve-out

Corporate Restructuring A

Corporate control Premium buy-back Standstill Agreements Anti-take over Proxy contests

Change

in

ownership Exchange offer Share repurchase Going private

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CORPORATE RESTRUCTURING- Leveraged Buyout, Hostile Takeover & Merger Corporate restructuring may take place as a result of the acquisition of the company by new owners. The acquisition may be in the form of a leveraged buyout, a hostile takeover, or a merger of some type that keeps the company intact as a subsidiary of the controlling corporation.

HOSTILE TAKEOVER A host hostil ile e take takeov over er is a type type of corp corpor orat ate e take takeov over er whic which h is carri carried ed out out against the wishes of the board of the target company. This unique type of  acquis acquisiti ition on does does not occur occur nearly nearly as freque frequentl ntly y as friend friendly ly takeov takeovers ers,, in which the two companies work together because the takeover is perceived as beneficial. Hostile takeovers can be traumatic for the target company, and they can also be risky for the other side, as the acquiring company may not be able to obtain certain relevant information about the target company. Companies are bought and sold on a daily basis. There are two types of sale agreements. In the first, a merger merger,, two companies come together, blending thei theirr asse assets, ts, staff staff,, facil facilit itie ies, s, and and so fort forth. h. Afte Afterr a merg merger er,, the the orig origin inal al companies cease to exist, and a new company arises instead. In a takeover, a company company is purcha purchased sed by anothe anotherr compan company. y. The purcha purchasin sing g compan company y owns owns all all of the the targ target et comp compan any' y's s asse assets ts incl includ udin ing g comp compan any y pate patent nts, s, trademarks,, and so forth. The original company may be entirely swallowed trademarks up, or may operate semi-independently under the umbrella of the acquiring company.  Typically, a company which wishes to acquire another company approaches the target company's company's board with an offer. offer. The board members consider the offer, and then choose to accept or reject it. The offer will be accepted if the board believes that it will promote the long term welfare of the company, and it will be rejected if the board dislike the terms or it feels that a takeover would not be beneficial. beneficial. When a company company pursues pursues takeover takeover after rejection rejection by a board, it is a hostile takeover. If a company bypasses the board entirely, it is also termed a hostile takeover. Publicly traded companies are at risk of hostile takeover because opposing companies can purchase large amounts of their stock to gain a controlling share. In this instance, the company does not have to respect the feelings of  the board because it already essentially owns and controls the firm. A hostile take takeov over er may may also also invo involv lve e tacti actics cs like like tryi trying ng to swee sweete ten n the the deal deal for for individual board members to get them to agree. 13

An acquiring firm takes a risk by attempting a hostile takeover. Because the target firm is not cooperating, the acquiring firm may unwittingly take on debt debts s or seri seriou ous s prob proble lems ms,, sinc since e it does does not not have have acce access ss to all all of the the info inform rmat atio ion n abou aboutt the the comp compan any. y. Many Many firm firms s also also have have trou troubl ble e gett gettin ing g financing for hostile takeovers, since some banks are reluctant to lend in these situations.

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MERGER A merger occurs when two companies combine to form a single company. A merger is very similar to an acquisition or takeover, except that in the case of a merg merger er exis existi ting ng stoc stockho khold lder ers s of both both comp compan anie ies s invo involv lved ed reta retain in a shared interest in the new corporation corporation.. By contrast, in an acquisition one company purchases a bulk of a second company's stock, creating an uneven balance of ownership in the new combined company.  The entire merger process is usually kept secret from the general public, and often from the majority of the employees at the involved companies. Since the majority of merger attempts do not succeed, and most are kept secret, it is difficult difficult to estimate how many potential potential mergers occur in a given year. It is like likely ly that that the the numb number er is very very high high,, howe howeve ver, r, give given n the the amou amount nt of  successful mergers and the desirability of mergers for many companies. A merg merger er may may be soug sought ht for for a numb number er of reas reason ons, s, some some of whic which h are are bene benefi fici cial al to the the sh share areho hold lder ers, s, some some of whic which h are not. not. One One use of the the merger, for example, is to combine a very profitable company with a losing company in order to use the losses as a tax write-off  to offset the profits, while expanding the corporation as a whole. Increa Increasin sing g one's one's mar market ket sha share re is anot anothe herr majo ajor us use e of the the merge erger, r, particularly amongst large corporations corporations.. By merging with major competitors, a company can come to dominate the market they compete in, giving them a freer hand with regard to pricing and buyer incentives. This form of merger may cause cause proble problems ms when when two dominati dominating ng compan companies ies merge merge,, as it may trigger litigation regarding monopoly laws. Another Another type of popular merger brings brings together together two companies companies that make different, but complementary, products. This may also involve purchasing a company which controls an asset your company utilizes somewhere in its supply chain. chain. Major manufacturers buying out a warehousing chain in order to save on warehousing costs, as well as making a profit directly from the purchased business, is a good example of this. PayPal's merger with eBay is anoth another er good good exam exampl ple, e, as it allo allowe wed d eBay eBay to avoid avoid fees fees they they had had been been paying, while tying two complementary products together. A merger rger is us usu ually ally hand handlled by an invest investment ment banker banker,, who aids in transferring ownership of the company through the strategic issuance and sale sale of stoc stock. k. Some Some have have alle allege ged d that that this this rela relati tion onsh ship ip caus causes es some some problems, as it provides an incentive for investment banks to push existing clients towards a merger even in cases where it may not be beneficial for the stockholders.

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Mergers and acquisitions are means by which corporations combine with each other. Mergers occur when two or more corporations become one. To protect shareholders, state law provides procedures for the merger. A vote of the the boar board d of dire direct ctor ors s and and then then a vote vote of the the sh shar areh ehol olde ders rs of both both corporations is usually required. Following a merger, the two corporations cease to exist as separate entities. In the classic merger, the assets and liabil liabiliti ities es of one corpor corporati ation on are autom automati atical cally ly transfe transferre rred d to the other. other. Shareho Shareholde lders rs of the dis disapp appear earing ing company company become become shareh sharehold olders ers in the surviving company or receive compensation for their shares. Mergers may come as the result of a negotiation between two corporations interested in combining, or when one or more corporations "target" another for acq acquisition. Combinati ations that occur with the approval val and encouragement of the target company's management are called "friendly" merg merger ers; s; comb combin inat atio ions ns that that occu occurr despi despite te oppo opposi siti tion on from from the the targ target et company are called "hostile" mergers or takeovers. In either case, these consolidations can bring together corporations of roughly the same size and market power, or corporations of vastly v astly different sizes and market power.  The term "acquisition" is typically used when one company takes control of  another. This can occur through a merger or a number of other methods, such as purchasing the majority of a company's stock or all of its assets. In a purchase of assets, the transaction is one that must be negotiated with the management of the target company. Compared to a merger, an acquisition is treated differently for tax purposes, and the acquiring company does not necessarily assume the liabilities of the target company. A "tender offer" is a popular way to purchase a majority of shares in another company. The acquiring company makes a public offer to purchase shares from from the the targ target et comp compan any' y's s sh shar areh ehol olde ders rs,, thus thus by pass passin ing g the the targ target et compan company's y's manage managemen ment. t. In order order to induce induce the sharehold shareholders ers to sell, sell, or "tender,” their shares, the acquiring company typically offers a purchase price higher than market value, often substantially higher. Certain conditions are often placed on a tender offer, such as requiring the number of shares tender tendered ed be suffici sufficient ent for the acquirin acquiring g company company to gain gain contro controll of the target. If the tender offer is successful and a sufficient percentage of shares are acquired, control of the target company through the normal methods of  shareholder democracy can be taken and thereafter the target company's management management replaced. replaced. The acquiring acquiring company company can also use their control control of  the target company to bring about a merger of the two companies. Often, Often, a succes successful sful tender tender offer offer is follow followed ed by a "cash-o "cash-out ut merger merger." ." The target company (now controlled by the acquiring company) is merged into the the acqu acquir irin ing g comp company any,, and and the the rema remain inin ing g sh share areho hold lder ers s of the the targ target et company have their shares transformed into a right to receive a certain amount of cash. 16

Anothe Anotherr common common merger merger variati variation on is the "trian "triangul gular" ar" merge merger, r, in which which a subsidiary of the surviving company is created and then merged with the target. This protects the surviving company from the liabilities of the target by keeping them within the subsidiary rather than the parent. A "reverse triangular merger" has the acquiring company create a subsidiary, which is then then merg merged ed into into the the targe targett comp compan any. y. This This form form pres preser erve ves s the the targ target et company as an ongoing legal entity, though its control has passed into the hands of the acquirer. In general, mergers and other types of acquisitions are performed in the hopes of realizing an economic gain. For such a transaction to be justified, the two firms involved must be worth more together than they were apart. Some Some of the the pote potent ntia iall advan advanta tage ges s of merg merger ers s and and acqui acquisi siti tion ons s incl includ ude e achi achiev evin ing g econ econom omie ies s of sc scal ale, e, comb combin inin ing g comp comple leme ment ntary ary reso resour urce ces, s, garnering tax advantages, and eliminating inefficiencies. Other reasons for considering growth through acquisitions include obtaining proprietary rights to products or services, increasing market power by purchasing competitors, shoring up weaknesses in key business areas, penetrating new geographic regions, or providing managers with new opportunities for career growth and advancement. Since mergers and acquisitions are so complex, however, it can be very difficult to evaluate the transaction, define the associated costs and benefits, and handle the resulting tax and legal issues. When a small business owner chooses to merge with or sell out to another compan company, y, it is someti sometimes mes called called "harve "harvesti sting" ng" the small small busines business. s. In this this situation, the transaction is intended to release the value locked up in the small business for the benefit of its owners and investors. The impetus for a smal smalll busi busine ness ss owne ownerr to purs pursue ue a sale sale or merg merger er may may invo involv lve e esta estate te planning, a need to diversify his or her investments, an inability to finance growth independently, or a simple need for change. In addition, some small businesses find that the best way to grow and compete against larger firms is to merge with or acquire other small businesses. In principle, the decision to merge with or acquire another firm is a capital budgeting decision much like any other. But mergers differ from ordinary investment decisions in at least five ways. First, the value of a merger may depend on such things as strategic fits that are difficult to measure. Second, the accounting, tax, and legal aspects of a merger can be complex. Third, merg merger ers s ofte often n invo involv lve e issue issues s of corpo corporat rate e cont control rol and and are a mean means s of  replacing existing management. Fourth, mergers obviously affect the value of the firm, but they also affect the relative value of the stocks and bonds. Finally, mergers are often "unfriendly."

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Benefits of Mergers and Acquisitions Merger refers to the process of combination of two companies, whereby a new company is formed. An acquisition refers to the process whereby a company simply purchases another company. In this case there is no new company being formed. Benefits of mergers and acquisitions are quite a handful. Merger Mergers s and acquis acquisiti itions ons genera generall lly y succee succeed d in genera generatin ting g cost cost effici efficienc ency y through the implementation of economies of scale. It may also lead to tax gains and can even lead to a revenue enhancement through market share gain. Bird’s Bird’s Eye View View of the Benefi Benefits ts Accrui Accruing ng from from Merger Mergers s and Acquis Acquisiti itions ons   The The prin princi cipal pal bene benefi fits ts from from merge mergers rs and and acqu acquis isit itio ions ns can can be liste listed d as increa increased sed value value generat generation ion,, increas increase e in cost cost effici efficienc ency y and increa increase se in market share. Mergers and acquisitions often lead to an increased value generation for the company. It is expected that the shareholder value of a firm after mergers or acquisitions would be greater than the sum of the shareholder values of the parent companies. An increase in cost efficiency is affected through the procedure of mergers and and acqu acquis isit itio ions ns.. This This is beca becaus use e merg merger ers s and and acqu acquis isit itio ions ns lead lead to economies of scale. This in turn promotes cost efficiency. As the parent firms amalgamate to form a bigger new firm the scale of operations of the new firm increases. As output production rises there are chances that the cost per unit of production will come down.

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DEMERGER Deme Demerg rger ers s are are situ situati ation ons s in whic which h divi divisi sion ons s or su subs bsid idia iari ries es of pare parent nt companies are split off into their own independent corporations corporations.. The process for a demerg demerger er can vary sli slight ghtly, ly, dependin depending g on the reasons reasons behind behind the implementation of the split. Generally, the parent company maintains some degree of financial interest in the newly formed corporation corporation,, although that interest may not be enough to maintain control of the functionality of the new corporate entity. A demerger results in the transfer by a company of one or more of its unde undert rtaki aking ngs s to anot anothe herr comp company any.. The The comp compan any y whos whose e unde undert rtak akin ing g is trans transfe ferre rred d is call called ed the the deme demerg rged ed comp company any and and the the comp compan any y (or (or the the companies) to which the undertaking is transferred is referred to as the resulting company. A demerger may take the form of 

A spinoff or a split-up.

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Methods of Corporate Restructuring 

 Joint ventures



Sell off and spin off 



Divestitures



Equity carve out



Leveraged buy outs (LBO)



Management buy outs



Master limited partnerships



Employee stock ownership plans (ESOP)

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 Joint Venture  Joint ventures are new enterprises owned by two or more participants. They are typi typica call lly y form formed ed for for speci special al purpo purpose ses s for for a limi limite ted d dura durati tion on.. It is a combin combinati ation on of subset subsets s of assets assets contri contribut buted ed by two (or more) more) busine business ss entities for a specific business purpose and a limited duration. Each of the venture partners continues to exist as a separate firm, and the joint venture represents a new business enterprise. It is a contract to work together for a period of time each participant expects to gain from the activity but also must make a contribution. For Example: GM-T GM-Toy oyot ota a JV: JV: GM hope hoped d to gain gain new new expe experi rien ence ce in the the mana manage geme ment nt techni technique ques s of the Japanes Japanese e in buildi building ng high-q high-qual uality ity,, low-co low-cost st compac compactt & subc su bcom ompa pac ct

cars. ars. Whe Whereas reas,,

Toyo Toyotta

was see seeking king to

lear learn n

fro from

the

management traditions that had made GE the no. 1 auto producer in the world and In addition to learn how to operate an auto company in the envi enviro ronm nmen entt unde underr the the cond condit itio ions ns in the the US, US, deal dealin ing g with with cont contra ract ctor ors, s, suppliers, and workers. DCM group and Daewoo motors entered in to JV to form DCM DAEWOO Ltd. to manufacture automobiles in India.

Reasons for Forming a Joint Venture Build on company's strengths Spreading costs and risks Improving access to financial resources Economies of scale and advantages of size Access to new technologies and customers

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Access to innovative managerial practices

Rational For Joint Ventures  

To To augm augmen entt insu insuff ffic icie ient nt fina financ ncia iall or tech techni nica call abil abilit ity y to ente enterr a particular line or business.

   To

share share techno technolog logy y & generi generic c managem management ent skills skills in organi organizat zation ion,,

planning &

control.

 To

diversify risk

  To

obtain distribution channels or raw materials supply

  To

achieve economies of scale



To

extend

activities

with

smal smalller

invest vestm ment

than

if

done

independently    To

take advantage of favorable tax treatment or political incentives

(particularly in foreign ventures).

Tax aspects of joint venture. If a corporation contributes a patent technology to a Joint Venture, the tax conseq consequen uences ces may be less less than than on royalt royaltie ies s earned earned though though a licens licensing ing arrangements. Example One One part partne nerr cont contri ribu bute tes s the the tech techno nolo logy gy,, whil while e anot anothe herr cont contri ribu bute tes s depreciable facilities. The depreciation offsets the revenues accruing to the technology. The J.V. may be taxed at a lower rate than any of its partner & the partners pay a later capital gain tax on the returns realized by the J.V. if  and when it is sold. If the J.V. is organized as a corporation, only its assets are at risk. The partners are liable only to the extent of their investment, this is particularly important in hazardous industries where the risk of workers, production, or environmental liabilities is high.

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SPIN OFF Spin Spinof offs fs are are a way way to get get rid rid of unde underp rper erfo form rmin ing g or non-c non-cor ore e busi busine ness ss divisions that can drag down profits.

Process of spin off  1. The company company decides decides to spin spin off a business business divisio division. n. 2.  The parent company files the necessary paperwork with the Securities

and Exchange Board of India (SEBI). The spin pinoff off beco becom mes a compa ompany ny of its its own and and mus ustt also also file ile 3.   The paperwork with the SEBI. Shares es in the the new new comp compan any y are are dist distri ribu bute ted d to pare parent nt com company pany 4. Shar shareholders. 5.  The spinoff company goes public. public.

Noti Notice ce that that the the sp spin inof offf sh share ares s are are dist distri ribu bute ted d to the the pare parent nt comp compan any y shareholders. There are two reasons why this creates value: 1. Parent company company sharehold shareholders ers rarely rarely want anything anything to do with the new new spinoff. After all, it's an underperforming division that was cut off to impro improve ve the bottom bottom line. line. As a result result,, many many new sharehold shareholders ers sell sell immediately after the new company goes public. 2. Large institutions are often forbidden to hold shares in spinoffs due to

the smaller market capitalization, capitalization, increased risk, or poor financials of  the new company. Therefore, many large institutions automatically sell their shares immediately after the new company goes public. Simple supply and demand logic tells us that such large number of shares on the market will naturally decrease the price, even if it is not fundamentally  justified. It is this temporary mispricing that gives the enterprising investor an opportunity for profit.  There is no money transaction in spin-off. The transaction is treated as stock dividend & tax free exchange.

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SPLIT – OFF & SPLIT-UPSplit-off: Is a transaction in which some, but not all, parent company shareholders rece receiv ive e sh share ares s in a su subs bsid idia iary, ry, in retu return rn for for reli relinq nqui uish shin ing g thei theirr paren parentt company’s share. In other words some parent company shareholders receive the subsidiary’s shares in return for which they must give up their parent company shares

Features A portion of existing shareholders receives stock in a subsidiary in exchange for parent company stock.

Split-up:Is a transaction in which a company spins off all of its subsidiaries to its shareholders & ceases to exist. 

 The entire firm is broken up in a series of spin-offs.



 The parent no longer exists and



Only the new offspring survive.

In a split-up, a company is split up into two or more independent companies. As a sequel, the parent company disappears as a corporate entity and in its place two or more separate companies emerge. Sque Squeez ezee-ou out: t: the the shareholders.

elim elimin inat atio ion n

of mino minori rity ty

share sh areho hold lder ers s

by cont contro roll llin ing g

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SELL OFF – Selling a part or all of the firm by any one of means: sale, liquidation, spin-off  & so on. or General term for divestiture of part/all of a firm by any one of a no. of means: sale, liquidation, spin-off and so s o on. PARTIAL SELL-OFF 

A partial sell-off/slump sale, involves the sale of a business unit or plant of one firm to another.



It is the mirror image of a purchase of a business unit or plant.



From the seller’s perspective, it is a form of contraction; from the buyer’s point of view it is a form of expansion.

For example: When When Coro Coroma mand ndal al Fert Fertil iliz izer ers s Limi Limite ted d sold sold its its ceme cement nt divi divisi sion on to Indi India a Cement Limited, the size of Coromandal Fertilizers contracted whereas the size of India Cements Limited expanded.

Motives for sell off  

Raising capital



Curtailment of losses



Strategic realignment



Efficiency gain.

Strategic Rationale Divesting a subsidiary can achieve a variety of strategic objectives, such as: 

Unlo Unlocki cking ng hidd hidden en value value – Estab Establi lish sh a publ public ic mark market et valu valuat atio ion n for for undervalued assets and create a pure-play entity that is transparent and easier to value



Undiversification – Divest non-core businesses and sharpen strategic focus when direct sale to a strategic or financial buyer is either not compelling or not possible

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

Instit Instituti utional onal sponsor sponsorshi ship p – Promot Promote e equity equity resear research ch covera coverage ge and ownership by sophisticated institutional investors, either of which tend to validate SpinCo as a standalone business.



Public currency – Create a public currency for acquisitions and stockbased compensation programs.



Motivating Motivating management management – Improve Improve performance performance by better better aligning aligning management incentives with Spin Co’s performance (using Spin Co’s, rather rather than than Parent Parent Compan Company, y, stockstock-base based d awards awards), ), creati creating ng direct direct accountability to public shareholders, and increasing transparency into management performance.



Eliminating dissynergies – Reduce bureaucracy and give Spin Company management complete autonomy.

 Anti-trust  – 

Break up a business bus iness in response to anti-trust concerns.

Corporate defense – Divest "crown jewel" assets to make a hostile takeover of Parent Company less attractive

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DIVESTITURES Divesture is a transaction through which a firm sells a portion of its assets or a division to another company. It involves selling some of the assets or division for cash or securities to a third party which is an outsider. Dive Divest stit itur ure e is a form form of cont contrac racti tion on for for the the sell sellin ing g comp compan any. y. means means of  expansion for the purchasing company. It represents the sale of a segment of a company (assets, a product line, a subsidiary) to a third party for cash and or securities. Mergers, assets purchase and takeovers lead to expansion in some way or the other. They are based on the principle of synergy which says 2 + 2 = 5! , divestiture on the other hand is based on the principle of “anergy” which says 5 – 3 = 3!. Among Among the various various metho methods ds of divest divestitu iture, re, the most most import important ant ones ones are partial sell-off, demerger (spin-off & split off) and equity carve out. Some scho sc hola lars rs defi define ne dive divest stit itur ure e rath rather er narr narrow owly ly as part partia iall sell sell off off and and some some scho sc hola lars rs defi define ne dive divest stit itur ure e more more broa broadl dly y to incl includ ude e part partia iall sell sell offs offs,, demergers and so on.

MOTIVES FOR DIVESTITURES 

Change of focus or corporate strategy



Unit unprofitable can mistake

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Sale to pay off leveraged finance

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Antitrust

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Need cash



Defend against takeover



Good price.

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EQUITY CARVE-OUT – A transaction in which a parent firm offers some of a subsidiaries common stock to the general public, to bring in a cash infusion to the parent without loss of control. In other words equity carve outs are those in which some of a subsidiaries shares are offered for a sale to the general public, bringing an infusion of  cash to the parent firm without loss of control. Equity carve out is also a means of reducing their exposure to a riskier line of business and to boost shareholders value.

FEATURES OF EQUITY CARVE OUT 

It is the sale of a minority or majority voting control in a subsidiary by its parents to outsider investors. These are also referred to as “split-off  IPO’s”



A new legal entity is created.





  The equity holders in the new entity need not be the same as the equity holders in the original seller. A new control group is immediately created.

Difference between Spin-off and Equity carve outs: 1. In a spin off , distribution is made pro rata to shareholders of the parent company as a dividend, a form of non cash payment to shareholders In equity carve out; stock of subsidiary is sold to the public for cash which is received by parent company 2. In a spin off , parent firm no longer has control over subsidiary assets. In equity carve out, parent sells only a minority interest in subsidiary and retains control.

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LEVERAGED BUYOUT A buyout is a transaction in which a person, group of people, or organization buys a company or a controlling share in the stock of a company. Buyouts great and small occur all over the world on a daily basis. Buyouts can also be negotiated with people or companies on the outside. For example, a large candy company might buy out smaller candy companies with the goal of cornering the market more effectively and purchasing new brands which it can use to increase its customer base. Likewise, a company whic which h make makes s widg widget ets s migh mightt deci decide de to buy buy a comp compan any y whic which h make makes s thin thingam gamab abob obs s in orde orderr to expa expand nd its its oper operati ation ons, s, us usin ing g an esta establ blis ishi hing ng company as a base rather than trying to start from scratch. In a leveraged buyout, buyout, the company is purchased primarily with borrowed funds. In fact, as much of 90% of the purchase price can be borrowed. This can be a risky decision, as the assets of the company are usually used as collateral,, and if the company fails to perform, it can go bankrupt because collateral the people involved in in the buyout will not be able to service their debt. Leveraged Leverag ed buyout buyouts s wax and wane wane in popula popularit rity y depend depending ing on econom economic ic trends.   The buyers in the buyout gain control of the company's assets, and also have have the the righ rightt to us use e trademarks trademarks,, serv servic ice e mark marks, s, and othe otherr regi regist ster ered ed copyrights of the the com company pany.. They They can us use e the compa ompany ny's 's nam name and and reputation, and may opt to retain several key employees who can make the transition as smooth as possible. However, people in senior management may find that they are not able to keep their jobs because the purchasing comp compan any y does does not not want want redu redund ndan antt personnel personnel,, and and it wants to get its personnel into key positions to manage the company in accordance with their business practices. A leveraged buyout involves transfer of ownership consummated mainly with debt. While some leveraged buyouts involve a company in its entirety, most involve a business unit of a company. Often the business unit is bought out by its management and such a transaction is called management buyout (MBO). (MBO). After After the buyout buyout,, the company company (or the busine business ss unit) unit) invari invariabl ably y becomes a private company.

What Does Debt Do? A leveraged buyout entails considerable dependence on debt.

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What does it imply? Debt has a bracing effect on management, whereas equi equity ty tend tends s to have have a sopo sopori rifi fic c infl influe uenc nce. e. Debt Debt sp spur urs s mana manage geme ment nt to perform whereas equity lulls management to relax and take things easy. Risks and Rewards, The sponsors of a leveraged buyout are lured by the prospect of wholly (or largely) owning a company or a division thereof, with the help of substantial debt finance. They assume considerable risks in the hope of reaping handsome rewards. The success of the entire operation depends on their ability to improve the performance of the unit, contain its business risks, exercise cost controls, and liquidate disposable assets. If they fail to do so, the high fixed financial costs can jeopardize the venture. Purpose of debt financing for Leveraged Buyout 

 The use of debt increases the financial return to the private equity sponsor.



  The The tax shiel shield d of the acquis acquisiti ition on debt, debt, accord according ing to the Modigl Modiglian ianiiMiller theorem with taxes, increases the value of the firm.

Features of Leveraged Buyout 

Low existing debt loads;



A multi-year history of stable and recurring cash flows;



Hard assets (property, plant and equipment, inventory, receivables) that may be used as collateral for lower cost secured debt;

   The The

pote potent ntia iall for for new new mana manage geme ment nt to make make oper operat atio ional nal or othe otherr improvements to the firm to boost cash flows;



Market conditions and perceptions that depress the valuation or stock price.

Example – 

Acquisition of Corus by Tata.



Kohlberg Kravis Roberts, the New York private equity firm, has agreed to pay about $900 million to acquire 85 percent of the Indian software maker Flextronics Software Systems is the largest leveraged buyout in India.

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Management buyout – In this case, management of the company buys the company, and they may be join joined ed by empl employ oyee ees s in the the vent ventur ure. e. This This prac practi tice ce is some someti time mes s ques questi tion one ed bec because ause manag anagem emen entt can have ave unfa unfaiir adva advant ntag age es in negotiations, and could potentially manipulate the value of the company in order to bring down the purchase price for themselves. On the other hand, for employees and management, the possibility of being able to buy out thei theirr emplo mploye yers rs in the the futu future re may may serv serve e as an ince incent ntiv ive e to make make the the company strong. It occurs when a company's managers buy or acquire a large part of the company. The goal of an MBO may be to strengthen the managers' interest in the success of the company.

Purpose of MBO – from management point of view may be: 

  To To save save thei theirr jobs jobs,, eith either er if the the busi busine ness ss has has been been sc sche hedu dule led d for for closure or if an outside purchaser would bring in its own management team.



 To maximize the financial benefits they receive from the success they bring to the company by taking the profits for themselves.



 To ward off aggressive buyers.

  The goal of an MBO may be to strengthen the manager’s interest in the succ su cces ess s of the the comp compan any. y. Key Key cons consid ider erat atio ions ns in MBO MBO are are fair fairne ness ss to shareholders price, the future business plan, and legal and tax issues.

Benefits of MBO 

It provides an excellent opportunity for management of undervalued co’s to realize the intrinsic value of the company.



Lower agency cost: cost associated with conflict of interest between owners and managers.



Source Source of tax saving savings: s: since since intere interest st paymen payments ts are tax deduct deductibl ible, e, pushing up gearing rations to fund a management buyout can provide large tax covers.

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Master Limited Partnership – Master Limited Partnership’s are a type of limited partnership in which the shares are publicly traded. The limited partnership interests are divided into units which are traded as shares of common stock. Shares of ownership are referred to as units. MLPs generally operate in the natural resource (petroleum and natural gas extraction and transportation), financial services, and real estate industries.   The The advant advantag age e of a Mast Master er Limi Limite ted d Partn Partner ershi ship p is it comb combin ines es the the tax tax benefits of a limited partnership (the partnership does not pay taxes from the profit - the money is only taxed when unit holders holders receive receive distributions) distributions) with the liquidity of a publicly traded company.  There are two types of partners in this type of partnership: 1. The limited partner is the person or group that provides the capital to the MLP and receives periodic income distributions from the Master Limited Partnership's cash flow 2. The general partner is the party responsible for managing the Master Limited Partnership's affairs and receives compensation that is linked to the performance of the venture.

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Employees Stock Option Plan (ESOP) An Employee Stock Option is a type of defined contribution benefit plan that buys and holds stock. ESOP is a qualified, defined contribution, employee benefi benefitt plan plan design designed ed to invest invest primar primarily ily in the stock of the sponsorin sponsoring g employer. Empl Employ oyee ee Stoc Stock k Opti Option on’s ’s are “q “qual ualif ifie ied” d” in the the sens sense e that that the the ESOP ESOP’s ’s sponso sponsori ring ng comp compan any, y, the the sell sellin ing g sh shar areh ehol olde derr and and part partic icip ipant ants s rece receiv ive e various tax benefits. With an ESOP, employees never buy or hold the stock directly.

FEATURES  

Employee Stock Ownership Plan (ESOP) is an employee benefit plan.   The The sc sche heme me prov provid ides es empl employ oyee ees s the the owne owners rshi hip p of stoc stocks ks in the the company.



It is one of the profit sharing plans.



Employers have the benefit to use the ESOP’s as a tool to fetch loans from a financial institute.



It also provides for tax benefits to the employers.

The benefi benefits ts for the the compa company ny: increa increased sed cash flow, flow, tax savings, savings, and increased productivity from highly motivated workers. The benefit for the employees: is the ability to share in the company's success. HOW IT WORKS? 

 

Organizations strategically plan the ESOPs and make arrangements for the purpose.  They make annual contributions in a special trust set up for ESOPs. An employee is eligible for the ESOP’s only after he/she has completed 1000 hours within a year of service.

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

After completing 10 years of service in an organization or reaching the age of 55, an employee should be given the opportunity to diversify his/her share up to 25% of the total value va lue of ESOP’s.

The Leveraged Buy-out Deal of Tata & Tetley Case overview: The case 'The Leveraged Buyout Deal of Tata & Tetley' provides insights into the concept of Leveraged Buyout (LBO) and its use as a financial tool in acquis acquisiti itions, ons, with with specif specific ic refere reference nce to Tata Tata Tea's Tea's takeov takeover er of global global tea major Tetley. This deal which was the biggest ever cross-border acquisition, was also the first-ever successful leveraged buy-out by any Indian company.  The case examines the Tata Tea-Tetley deal in detail, explaining the process and the the stru struct ctur ure e of the the deal deal.. The The case case help helps s them them to unde underst rstand and the the mechanism of LBO. Through the Tata-Tetley deal the case attempts to give students an understanding of the practical application of the concept. In the summer of 2000, the Indian corporate fraternity was witness to a path brea breaki king ng achi achiev evem emen ent, t, neve neverr heard heard of or seen seen befo before re in the the hist histor ory y of  corporate India. In a landmark landmark deal, heralding a new chapter in the Indian corporate corporate history,  Tata Tea acquired the UK heavyweight brand Tetley1 Tetley1 for a staggering 271 millio million n pounds. pounds. This This deal deal which which happen happened ed to be the larges largestt cross-b cross-bord order er acquisition by any Indian company, marked the culmination of Tata Tea's strategy of pushing for aggressive growth and worldwide expansion.  The acquisition of Tetley pitch forked Tata Tea into a position where it could rub rub sh shou ould lder ers s with with glob global al behe behemo moth ths s like like Unil Unilev ever er and and Lawr Lawrie ie.. The The acquisition of Tetley made Tata Tea the second biggest tea company in the world. (The first being Unilever, owner of Brooke Bond and Lipton). Moreover Moreover it also went through through a metamorph metamorphosis osis from a plantation plantation company to an international consumer products company. Rata Ratan n Tata Tata,, Chai Chairm rman an,, Tata Tata grou group p said said,, "It "It is a grea greatt sign signal al for for glob global al indu indust stry ry by Indi Indian an Indu Indust stry ry.. It is a mome moment ntou ous s occa occasi sion on as an Indi Indian an company has been able to acquire a brand and an overseas company." Apart from the size of the deal, what made it particularly special was the fact that it was the first ever leveraged buy-out (LBO)2 (LBO)2 by any Indian company. This 35

method of financing had never been successfully attempted before by any Indian company. Tetley's price tag of 271 million pounds (US $450 m) was more than four times the net worth of Tata tea which stood at US $ 114 m.   Thi This s Davi David d & Goli Goliat ath h aspe aspect ct was was what what made made the the enti entire re tran transac sacti tion on so unusual. What made it possible was the financing mechanism of LBO. This mechanism allowed the acquirer (Tata Tea) to minimize its cash outlay in making the purchase.  Tata Tea was incorporated in 1962 as Tata Finlay Limited, and commenced busi busine ness ss in 19 196 63. The The comp compan any, y, in coll collab abor orat atio ion n with with Tata Tata Finl Finlay ay & Company, Glasgow, UK, initially set up an instant tea factory at Munnar (Kerala) and a blending/packaging unit in Bangalore. Over the years, the company expanded its operations and also acquired tea plantations. In 1976, the company acquired Sterling Tea companies from  James Finlay & Company for Rs 115 million, using Rs 19.8 million of equity and Rs. 95.2 million of unsecured loans at 5% per annum interest. In 1982,   Tat Tata a Indu Indust stri ries es Limi Limite ted d boug bought ht out out the the enti entire re stake stake of Jame James s Finl Finlay ay & Company in the joint venture, Tata Finlay Ltd. In 1983, the company was rena rename med d Tata ata Tea Tea Lim Limited ited.. In the mid 1980s, to offse ffsett the the erra errattic fluctuations in commodity prices, Tata Tea felt it necessary to enter the branded tea market. In May 1984, the company revolutionized the valueadded tea market in India by launching Kanan Devan tea3 tea3 in poly pack. In 1984, the company set up a research and development center at Munnar, Kerala. In 1986, it launched Tata Tea Dust in Maharashtra. In 1988, the Tata  Tea Leaf was launched in Madhya Pradesh. In 1989, Tata Tea bought a 52% stake stake in Karnata Karnatakaka-bas based ed Consol Consolida idated ted Coffee Coffee Limite Limited-t d-the he larges largestt coffee coffee plantation in Asia, in order to expand its coffee business. In 1991, Tata Tea formed a joint venture with Tetley International, UK, to market its branded tea tea abro abroad ad.. In 19 1992 92,, Tata Tata Tea Tea took took a 9.5% 9.5% stak stake e in As Asia ian n Coff Coffee ee-t -the he Hyderabad based 100% export oriented unit known for its instant coffee, through an open offer. This offer was the first of its kind in Indian corporate history. Later, in 1994, Tata Tea increased its stake in Asian Coffee to 64.5% through another open offer. This helped it to consolidate its position in the coffee industry. In 1995, Tata Tea unveiled a massive physical up gradation program at a cost of Rs 1.6 billion.

De-Mystifying De-Mystifying LBO

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 The Tata-Tetley deal was rather unusual, in that it had no precedence in Indi India. a. Trad Tradit itio ional nally ly,, Indi Indian an mark market et had pref prefer erre red d cash cash deal deals, s, be it the the Rs.1 Rs.10. 0.08 08 bill billio ion n take takeov over er of Inda Indall by Hind Hindal alco co or the the Rs. Rs. 4.99 4.99 bill billio ion n acquisition of Indiaworld by Satyam. What What set set the the deal deal apar apartt was was the the LB LBO O mech mechan anis ism m whic which h fina financ nced ed the the acqu acquis isit itio ion. n. (See (See Box Box item item to know know abou aboutt the the basi basics cs of LB LBOs Os). ). The The LB LBO O seemed to have inherent advantages over cash transactions. In an LBO, the acquiring company could float a Special Purpose vehicle (SPV) which was a 100% subsidiary of the acquirer with a minimum equity capital.  The SPV leveraged this equity to gear up significantly higher debt to buyout the target company. This debt was paid off by the SPV through the target company's own cash flows. The target company's assets were pledged with the lendin lending g instit instituti ution on and once once the debt debt was redee redeemed med,, the acquir acquiring ing company had the option to merge with the SPV

Structure of the Deal  The purchase of Tetley was funded by a combination of equity, subscribed by Tata tea, junior loan stock subscribed by institutional investors (including the vendor institutions Mezzanine Finance, arranged by Intermediate Capital Grou Group p Plc. Plc.)) and and seni senior or debt debt faci facili liti ties es arra arrang nged ed and and unde underw rwri ritt tten en by Rabobank International.  Tata Tea created a Special Purpose Vehicle (SPV)-christened Tata Tea (Great Britain) to acquire all the properties of Tetley. The SPV was capitalized at 70 mill millio ion n poun pounds ds,, of whic which h Tata Tata tea tea cont contri ribu bute ted d 60 mill millio ion n poun pounds ds;; this this included 45 million pounds raised through a GDR issue. The US subsidiary of  the company, Tata Tea Inc. had contributed the balance 10 million pounds.  The SPV leveraged the 70 million pounds equity 3.36 times to raise a debt of  235 23 5 millio million n pounds, pounds, to financ finance e the deal. The entire entire debt amount amount of 23 235 5 million pounds comprised 4 tranches (A, B, C and D) whose tenure varied from 7 years to 9.5 years, with a coupon rate of around 11% which was 424 basis points above LIBOR.

The Way to Go Some analysts analysts felt that Tata Tea's decision to acquire Tetley through a LBO was not all that beneficial for shareholders. They pointed out that though 37

there would be an immediate dilution of equity (after the GDR issue), Tata   Tea would not earn revenues on account of this investment in the near future (as an immediate merger is not planned). This would lead to a dilution in earnings and also a reduction in the return on equity. The shareholders woul would, d, thus thus have have to bear bear the the burd burden en of the the inve invest stme ment nt with withou outt any any immediate benefits in terms of enhanced revenues and profits. From the lenders point of view too there seemed to be some drawbacks.

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CORPORATE RESTRUCTURING AT ARVIND MILLS Case Overview  The case provides an overview of the Arvind Mills' expansion strategy, which resulted in the company's poor financial health in the late 1990s. In the mid 1990s, Arvind Mills' undertook a massive expansion of its denim capacity in spite of the fact that other cotton fabrics were slowly replacing replacing the demand for denim. The expansion plan was funded by loans from both Indian and overseas financial institutions. With the demand for denim slowing down, Arvind Mills found it difficult to repay the loans, and thus the interest burden on the loans shot up. In the late 1990s, Arvind Mills ran into deep financial problems because of its debt burden. As a result, it incurred huge losses in the the late late 19 1990 90s. s. The The case case also also disc discus usse ses s in deta detail il the the Arvi Arvind nd Mill Mills s debt debt-restructuring plan for the long-term debts being taken up in February 2001. Issues: » Debt driven expansion plan, financial restructuring of Arvind Mills

Introduction In the early 1990s, Arvind Mills1 Mills 1 initiated massive expansion of its denim capacity By the late 1990s, 1990s, Arvind Arvind Mills Mills was the third largest manufacturer manufacturer of denim in the world, with a capacity of 120 million metres. However, in the late 1990s, due to global as well as domestic overcapacity in denim and the shift in fashion to gabardine2 gabardine 2 and corduroy,3 corduroy,3 denim prices crashed and Arvind Mills was hit hard. The expansion had been financed mostly by loans from domestic and overseas institutional lenders. As the denim business continued to decline in the late 1990s and early 2000, Arvind Mills defaulted on interest payments on every loan, debt burden kept on increasing. In 2000, the company had a total debt of Rs 27 billion, of which 9.29 billion was owed to overseas lenders. In 2000, Arvind Mills, once the darling of the bourses was in deep trouble. Its share price was hovering between a 52 week high of Rs 20 and low of Rs 9 (in the mid 1990s, the share price was closer to Rs 150). Leading financial analysts no longer tracked the Arvind Mills scrip. 39

 The company's credit rating had also come down. CRISIL downgraded it to "defaul "default" t" in Octobe Octoberr 20 2000 00 from from "highe "highest st safety safety"" in 19 1997 97.. In early early 20 2001 01,, Arvind Arvind Mills Mills announ announced ced a restru restructu cturin ring g propos proposal al to improv improve e its financ financial ial health and reduce its debt burden. The proposal was born out of several meetings and negotiations between the company and a steering committee of lenders.

Expansion at What Cost Arvind Mills was promoted in June 1931, by Sanjay Lalbhai's grandfather, Kasturb Kasturbhai hai Lalbhai Lalbhai,, and his two two brothe brothers, rs, Narott Narottam am and Chiman Chimanbhai bhai,, in Ahmedabad. When Sanjay Lalbhai took over the reins in 1975, Arvind Mills was at the crossroads. A high wage structure, low productivity and surplus labor in the textile mills rendered its businesses unviable in most the products categories in which it competed. competed. The emergence emergence of power looms in the 1970s further aggravated the problems of Arvind Mills.   The The gove govern rnme ment nt's 's indi indire rect ct tax tax sy syst stem em at that that time time also also redu reduce ced d the the profitability of its product lines. In the mid-80s, to survive the onslaught of  the small-scale power loom sector, the composite mills,4 mills, 4 with their higher overheads had to change their strategies. It became imperative for them to switch to areas in which the power loom sector could not compete, viz, value added products. In the mid 19 1980 80s, s, Arvind Arvind Mills Mills switch switched ed to high-q high-qual uality ity fabrics fabrics requir requiring ing technical superiority that the power looms could not hope to match. Until 1987, like any other textile company, Arvind Mills had a presence only in conventional products like sarees, suitings and low value shirting, and dress materials. Realizing the bleak growth prospects for textiles in general, Arvind Mills identified denim as a niche area and set up India's first denim manufacturing unit in 1986 at Naroda Road, Ahmedabad.  To deal with competition from the power loom sector, which rolled out vast quantities of inexpensive fabrics, and to cope with the rising cost of raw materials, Arvind Mills diversified into indigo-dyed blue denim; high quality, cotton-rich, two-ply5 two-ply5 shirting, and Swiss voiles

Into the Red

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By the late 1990s, Arvind Mills was in deep financial trouble (Refer Table III) because of its increasing debt and interest burden. Its total long-term debt was estimated at Rs 27 billion, out of which the total overseas debt was Rs 9.29 billion and debt to Indian institutional lenders was Rs 17.71 billion. However, much of the debt to Indian financial institutions was secured was not known. Arvind Mills had defaulted on interest payments on every loan. ICICI was the largest Indian institutional lender, with a loan of over Rs 5 billion to Arvind Mills. (Refer Table IV for a list of lenders to whom Arvind Mills was indebted). In 2000, the company reported a net loss of Rs 3.16 billion against a profit of Rs .14 billion in 1999.

Into the Black  In February 2001, Arvind Mills announced a debt restructuring plan for its long term debt (Refer Box). While the company set itself a minimum debt buyback target of Rs 5.5 billion, the management was hopeful of a larger amount, possibly Rs 7.5 billion. In mid-2001, Arvind Mills got the approval of a majority of the lenders for its debt restructuring scheme. Forty-three out of fifty-four lenders approved the plan. As part of the restructuring, lenders offered over Rs 7.5 billion under the company's various debt buyback schemes. Some of the banks agreed to the buyback at a 55% discount on the principal amount, while some agreed to a five year rollover for which they would be entitled to interest plus the principal. Some banks also agreed to a ten year rollover for which they would be paid a higher rate of interest plus principal.   The debt revamp was expected to reduce Arvind Mills' interest burden by 50%.

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Many Many firms firms have have begun begun organi organizat zation ional al restru restructu cturin ring g exerci exercises ses in recent recent years to cope with heightened competition. The common elements of most organizatio organizational nal restructur restructuring ing and performance performance enhanceme enhancement nt programmers programmers are: are: regrou regroupin ping g of busine business, ss, decent decentral raliz izati ation, on, downsi downsizin zing, g, outsour outsourcin cing, g, business process engineering, enterprise resource planning, and total quality management. • Corp Corpo orate rate rest restru ruct ctur uriing is ofte often n an episo pisodi dic c exerc xercis ise. e. Corp Corpo orate rate restru restructu cturin ring g occurs occurs period periodica icall lly y due to an ongoin ongoing g tensio tension n betwee between n the organizational need for stability and continuity on the one hand and the economic compulsion to adapt to changes on the other.

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  The The case case disc discus usse ses s the the 'Orga 'Organi niza zati tion on 20 2005 05'' prog progra ram; m; a six-y six-yea earr long long organizational restructuring exercise conducted by the US based Procter & Gamble (P&G), global leader in the fast moving consumer goods industry.   The case examines in detail, the important elements of the restructuring program including changing the organizational structure, standardizing the work processes and revamping the corporate culture. The case elaborates on the mistakes committed by Durk Jager, the erstwhile CEO of P&G and examines the reasons as to why Organization 2005 program did not deliver the desired results. Finally, the case discusses how Alan George Lafley, the new CEO, accelerated the initiatives under the Organization 2005 program and revived P&G's financial performance. Issues: Gain insight into the common causes that contribute to steady decline over a period of time in the performance of a large multi-product multi-national company of high repute. Introduction   The US based Procter and Gamble (P&G), one of the largest fast moving consumer goods (FMCG) companies in the world, was in deep trouble in the first half of 2000. The company, in March 2000, announced that its earnings growth for the financial year 1999-2000 would be 7% instead of 14% as announced earlier. The news led P&G's stock to lose $27 in one day, wiping out $40 billion in its market capitalization.  To add to this, in April 2000, P&G announced an 18% decline in its net profit for January - March 2000 quarter. For the first time in the past eight years P&G was showing a decline in profits. In the late 1990s, P&G faced the problem of stagnant revenues and profitability (Refer Exhibit I). In order to accelerate growth, the erstwhile P&G's President and CEO, Durk Jager (Jager) officially launched the Organization 2005 program in July 1999. Organization 2005 20 05 was was a sixsix-ye year ar long long organ organiz izati ation onal al rest restru ruct ctur urin ing g exer exerci cise se whic which h incl includ uded ed the the stan standa dard rdiz izat atio ion n of work work proc proces esse ses s to expe expedi dite te grow growth th,, revamping the organizational culture in order to embrace change, reduction in hier hierarc archi hies es to enab enable le fast faster er deci decisi sion on-m -mak akin ing, g, and and retr retren ench chme ment nt of  employees to cut costs. With the implementation of the program, P&G aimed to increase its global revenu revenues es from from $3 $38 8 billio billion n to $7 $70 0 billio billion n by 20 2005 05.. Accord According ing to analyst analysts, s, though Organization 2005 program was well planned, the execution of the 43

plan plan was was a failu failure re.. An Anal alyst ysts s beli believ eved ed that that Jage Jagerr conc concen entr trat ated ed more more on developing new products rather than on P&G's well-established brands. Analysts felt, and Jager himself admitted, that he did too many things in too short a time. This resulted in the decline of the company's revenues and profitability. After a brief stint of 17 months, Jager had to quit his post. In  June 2000, Alan George Lafley (Lafley) took over as the new President & CEO of P&G. Under Lafley, P&G seemed to be on the right path. He was able to turn turn the company company around around throug through h his excel excellen lentt planni planning, ng, execut execution ion and focu focus. s. With With Lafle Lafley y at the the helm helm,, P&G' P&G's s fina financ ncia iall perf perfor orma manc nce e impr improv oved ed significantly (Refer Exhibit II). The company's share price shot up by 58% to $92 by July 2003, as against a fall of 32% in S&P's 500 stock index. A former P&G executive, Gary Stibel said, "If anybody had any doubts about AG, they don't anymore. This is about as dramatic a turnaround as you will see." However, analysts expressed doubts, whether the measures taken by Lafley would sustain P&G's growth in the long term. They felt that with a dominant market position in developed markets the scope for generating more growth there would be difficult for P&G. Background Note Procte Procterr & Gamble Gamble was establ establish ished ed in 18 1837 37 by Willia William m Procte Procter, r, a candle candle maker, maker, and his brothe brother-i r-in-l n-law, aw, James James Gamble Gamble,, a soap soap maker, maker, when when they they merg merged ed thei theirr smal smalll busi busine ness sses es.. They They set set up a sh shop op in Cinc Cincin inna nati ti and and nickna knamed it "porkopol polis" because of its dependence on swine slaughterhouses. The shop made candles and soaps from the leftover fats of  the the swin swine. e. By 18 1859 59,, P&G P&G had beco become me one one of the the larg larges estt comp compani anies es in Cincinnati, with sales of $1 million. The company introduced Ivory, a floating soap in 1879 and Crisco, the first all-vegetable shortening in 1911. In the peri period od betw betwee een n the the 19 1940 40s s and and 19 1960 60s, s, P&G P&G emba embark rked ed on a seri series es of  acquisitions. The company acquired Spic and Span (1945), Duncan Hines (1956), Chairman Paper Mills (1957), Clorox (1957; sold in 1968) and Folgers Coffee (1963). In 1973, P&G began manufacturing and selling its products in Japan through the acquisition of Nippon Sunhome Company. The new company was named "Proct "Procter er & Gamble Gamble Sunhom Sunhome e Co. Ltd." Ltd." In 19 1985 85,, P&G announ announced ced several several major ajor orga organi niza zati tion onal al chang hange es rel relatin ating g to categ ategor ory y manag anage ement ment,,3 purchasing, manufacturing, engineering and distribution.

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In 1988, the company started manufacturing products in China. P&G became one of the largest cosmetics companies in the US when it acquired Noxell (198 (1989) 9) and and Max Max Fact Factor or (199 (1991) 1).. Afte Afterr witn witnes essi sing ng a peri period od of sign signif ific ican antt organic and inorganic growth, P&G began to face several problems during the 1990s. In the early 1990s, a survey conducted by the consulting firm, Kurt Salmon Salmon Associates Associates,,4 had reve reveal aled ed that that almo almost st a quart quarter er of P&G' P&G's s products in a typical supermarket sold less than one unit a month and just 7.6% of the products accounted for 84.5% of sales. The remaining products went almost unnoticed by consumers. Complicated product lines and pricing were also causing problems to retailers who had to struggle with rebates and discounts... EXCERPTS  The 'Organization 2005' Program In January 1999, Jager, a P&G veteran became the new CEO taking charge at a time when P&G was in the midst of a corporate restructuring exercise that started in September 1998.   Jag Jager er face faced d the the chal challe leng ngin ing g task task of reva revamp mpin ing g P&G' P&G's s oper operat atio ions ns and and marketing practices. Soon after taking over as the CEO, Jager told analysts that he would overhaul product development, testing and launch processes.  The biggest obstacle for Jager was P&G's culture. Jager realized the need to change the mindset of the P&G employees who had been used to lifetime employment and a conservative management style. On July 1, 1999, P&G officially launched the Organization 2005 program. It was a program of sixyear durati duration, on, during during which, which, P&G planne planned d to retren retrench ch 15 15,00 ,000 0 emplo employee yees s globally. The cost of this program was estimated to be $1.9 billion and it was expe expec cted ted to gene genera rate te an annu annual al savi saving ngs s (aft after tax dedu deduc ction tions) s) of  approximately $900 million per annum by 2004... Change in Organization Structure  Till 1998, P&G had been organized along geographic lines with more than 100 10 0 prof profit it cent center ers. s. Unde Underr Orga Organi niza zati tion on 20 2005 05 prog progra ram, m, P&G soug sought ht to reorganize its organizational structure (Refer Exhibit III and IV) from four geographically-based business units to five product-based global business units - Baby, Feminine & Family Care, Beauty Care, Fabric & Home Care, Food & Beverages, and Health Care.

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 The restructuring exercise aimed at boosting P&G's growth (in terms of sales and profits), speed and innovation and expedition of management decisionmaking for the company's global-marketing initiatives. It also aim aimed to fix the str strategy-f y-formulation and profit-cr -creation responsibilities on products rather than on regions. The global business units (GBUs) had to devise global strategies for all P&G's brands and the heads of  GBU were held accountable for their unit's profit. The sourcing, R&D and manufacturing operations were also undertaken by the GBU. Standardization of Work Processes One of the the major ajor obj objecti ctives ves of Organ rganiizati zation on 2005 prog progra ram m was to signif sig nifica icantl ntly y impro improve ve all ineffi inefficie cient nt work work proces processes ses of P&G includ including ing its product development, supply chain management and marketing functions. In order to achieve this objective, P&G undertook several IT initiatives including collaborative technologies, B2C e-commerce, web-enabled supply chain and a data warehouse project for supplying timely data to company's various operations located globally. Revamping the Corporate Culture   The The Orga Organi niza zati tion on 20 2005 05 prog progra ram m made made effo effort rts s to chan change ge P&G P&G from from a cons conser ervat vativ ive, e, leth lethar argi gic c and bure bureau aucr crat atic ic to mode modern rn,, quic quick-m k-movi oving ng and inte intern rnet et-sa -savv vvy y organ organiz izati ation on.. The The new new stru struct ctur ure e was was dire direct cted ed towa toward rds s revam revampi ping ng the the work work cult cultur ure e of P&G P&G so as to focu focus s on its its new new Stre Stretc tch, h, Innovation Innovation and Speed (SIS) philosophy. philosophy. Emphasizi Emphasizing ng on innovation innovation,, Jager said said,, "Org "Organ aniz izat atio ion n 20 2005 05 is focu focuse sed d on one one thin thing: g: leve levera ragi ging ng P&G' P&G's s innovative capability.

The Mistakes Committed  The Organization 2005 program faced several problems soon after its launch. Analysts were quick to comment that Jager committed a few mistakes which proved costly for P&G. For instance, Jager had made efforts in January 2000 to acquire Warner-Lambert and American Home Products. Contrary to P&G's cautious approach towards acquisitions in the 1990s, this dual acquisition would have been the largest ever in P&G's history, worth $140 billion. However, the stock market greeted the news of the merger negotiations by selling P&G's shares, which prompted Jager to exit the deal.

Enter Lafley - Implementing Strategies to Revive P&G 46

In June 2000, Alan George Lafley (Lafley), a 23-year P&G veteran popularly known as 'AG,' took over as the new President and CEO of P&G. The major difference between Lafley and Jager was their 'style of functioning.' Soon after becoming CEO, Lafley rebuilt the management team and made efforts to improve P&G's operations and profitability. Lafley transferred more than half half of P&G's P&G's 30 senior senior most most office officers, rs, an unprec unprecede edente nted d move move in P&G's P&G's history. He assigned senior positions and higher roles to women.

P&G - Current Status In 2003, Lafley continued his efforts to make P&G more adaptable to the dynamic dynamic changes changes in business business environme environment. nt. He challenged challenged P&G's traditional traditional perspective that all its products should be produced in-house. In April 2003, Lafley started outsourcing the manufacturing of bar soaps (including P&G's longest existing brand, Ivory) to a Canadian manufacturer. In May 2003, IT oper operat atio ions ns were were outs outsou ourc rced ed from from HP HP.. Sinc Since e Lafle Lafley y beca became me CEO, CEO, P&G' P&G's s outsourcing contract went up from 10% to 20%. Lafley continued to review P&G's businesses and new investments with the aim of achieving sharper focu focus s on its core core busi busine ness sse es, cost ost com competi petiti tive vene ness ss and and improv proved ed productivity.

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Books

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Corporate Finance- By Aswath Damodaran

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Financial Management- By Khan and Jain

Web sites •

www.valueadder.com

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www.wisegeek.com www.wisegeek.com

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www.equitymaster.com

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www.investopedia.com

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