CORPORATE RESTRUCTURING

What is restructuring? It is a complex and multi-dimensional task. It can be re-assignment of human resources, downsizing, redrawing of systems & rules, selling off assets / businesses or changing the finance portfolio or a combination of all. The objective is to reorient or tune the organisation to make it more efficient and effective. Examples: AT&T had its share prices shoot up with an announcement of 40,000 cut in its workforce when faced with pressure on profits.

 Daewoo during early 90s experienced difficulties with its large diversified empire. By amputating unprofitable parts, restructuring and downsizing, it rewrote its success story. Subsequently it again got into trouble. Some Indian cases: Tata Steel had taken the services of 3 international consultants namely McKinsey & Co, Arthur D Little and Booz Allen & Hamilton to enable it to become it globally competitive. It sold of its cements division, had VRS & modernised its plants and thereafter became the lowest cost producer of steel in the world.
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Asian Paints has restructured its manufacturing operations into 3 SBU’s: Decorative India, Decorative International and another made up of chemical businesses along with industrial paints to ensure focus and greater accountability. Driving force being global operations.

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

THERE IS NO SET FORMULA OR STANDARD MODEL FOR RESTRUCTURING. HOWEVER IT SHOULD BE A CONSTANT PROCESS WITH PERIODIC DOSES TO FINE-TUNE THE ORGANISATION.

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Why restructure? Restructuring has caught up with Indian companies. In the US companies have undertaken a wide range of restructuring transactions including acquisition, divestiture, spin-off, split-off, leveraged buyout, etc. The major objective of restructuring is to enhance shareholder value. Besides other reasons as:
1.

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

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Changes in capital markets: [has triggered financial restructuring] Abolition of Controller of Capital Issues, empowering SEBI, freedom to FIIs to invest in new issues and existing stocks, access to capital globally at cheap rates, scope for private placement, scope for delisting, the emergence of angel investors as well as venture funds, etc, are forcing companies to rethink their capital structure.

3.

Changes in Govt. policies: Major changes in MRTP Act, FEMA, Industrial licensing, setting up of Competition Commission of India, etc; Size no longer is a constraint; growth strategy is based on competencies and not govt. licenses;
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MNCs can gain control of operations in India. A classic example is HUL. From associate companies to subsidiaries to 100% ownership

4.

To avoid unsolicited take-overs: As bidders believe that the stock prices of some companies do not reflect true values achievable via restructuring of businesses (after acquisition). Going concern value may be lower than break-up market value. Therefore, some firms increase debt considerably to become unattractive.

5. To gain long term competitive advantage: Honda Motors India broke up with Kinetic Engineering to set up HMSI Private Limited. HUL restructured itself via project millennium in 2000. Now after loosing market share to competitors in 2008-09 it is trying to reinvent itself. 6. To enter international markets: This is especially in the face of quota & other restrictions besides the effects of globalisation. Ranbaxi acquired firms’ abroad to penetrate foreign markets. Infosys reorganised itself as per demands of international stock exchanges and investors. Tata’s acquired Tetley, Chorus and Jaguar Land rover to enter global business in tea, steel and automobiles.
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7. To achieve operational & market related benefits: Restructuring of the appropriate kind can lead to improved competitive position (say via vertical integration), gains in market share (by business combinations) and increased productivity (via modernisation and retraining) 8. To reduce cost: Reducing the cost structure via a host of organisational, portfolio and financial restructuring is essential to make firms cost competitive/ profitable. 9. To increase management control: By merger of investment companies, increasing share holding pattern, etc.

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Types of Restructuring 1. Organisational Restructuring:

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

2.

Portfolio Restructuring:

It refers to changes in the sets of businesses comprising the corporation to create a more effective configuration of businesses. Effectiveness is enhanced by combining lines of businesses in areas where the firm has competitive advantage, and by shedding lines of business where it cannot obtain higher returns than its competitors.

3. •

Financial Restructuring: It mainly involves changes in the capital structure of the firm.

It has meant different things at different times. Increase in debt when it is attractive (trading on equity), greater reliance on equity when it proves to be cheap, going in for GDR issues, etc. It also involves change in the structure of debt & equity – convertible bonds – as well as improved treasury management, intercorporate deposits and commercial paper/ corporate bond.

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

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

 Portfolio Restructuring 1. Acquisitions: Various considerations (few are given below) have driven firms to acquire companies in India. Generally, instead of 100% acquisitions only controlling blocks of shares have been acquired. Acquisition for Market entry:

# Vodafone’s acquisition of 67% stake in Hutchison Essar from Li Ka Shing in February 2007. # NTT DoCoMo’s 26% acquisition of Tata Tele Services in Nov 08 # Daiichi Sankyo’s acquisition of >50% stake in Ranbaxy Ltd in 2008 Acquisition for Diversification: (By acquiring)

# Torrents group’s acquisition of the controlling interest in Ahmedabad Electric Co. Ltd. and Surat Electricity Co. Ltd # Acquisition of the erstwhile Union Carbide India Ltd. by Khaitans/ Mcleod Russell group in a court-mandated auction

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Acquisition for market share & industry consolidation:

# Hindalco’s acquisition of Novelis a Canadian company in Feb 2007 for $ 6 billion # Merger of Centurian Bank of Punjab with HDFC Bank in Feb 2008 at $ 2.4 billion Mergers and Amalgamations: Consolidation at the business / group level:

2.

This is done to gain critical mass, reduce costs, gain focus and eliminate intra-group competition. # RPL merger with RIL in March 2008 at $ 1.68 billion; the swap ratio was 16:1. # Series of mergers involving Unilever group of companies in India. Financial and tax considerations:

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

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3.

Divestitures: (For liquidity, focus, etc.)  Tata Steel’s divestment of Cement division to Lafarge of France

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Joint Ventures & Strategic Alliances  Hero Groups joint venture with Honda Motors to enter motorcycles market  ICICI converting its investment banking business into a JV company ICICI Securities with JP Morgan as the JV partner

5.

Demerger or spin-off: (increase business unit value)  Demerger of Aptech from Apple Industries Ltd.

 Financial restructuring Debt Restructuring: (when debt level is high)

Can be done through fresh issue of equity and / or divestment and asset sale to retire debt Converting debt to equity; FI loans are converted to equity to free the firm from interest and repayment burden when it is passing through a very difficult financial situation.
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Capital Reduction: Can be done by reducing equity by part conversion into preference capital/ debentures. (EPS increases and stock prices too)

Now share buy back has made the process less cumbersome.  Ownership Restructuring: A situation wherein, the shareholding structure undergoes changes even as the management remains the same. Targeted share issues: Companies issuing shares to the management or the promoter groups essentially to beef up the latter’s holdings (e.g. private placement, etc).

Indian affiliates of MNC’s were the first to do so when government relaxed ceiling on foreign holding of 40% The pricing of shares for increasing stake by MNC’s were in many cases low / unfair. Now it can be issued only at market prices. Shareholding by FII’s: The entry of FII’s as shareholders of Indian firms is affecting the quality of governance (positively)

This is reflected in company focus, information dissemination practices, etc.

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Restructuring Conglomerates in Emerging Markets

Tarun Khanna and Krishna Palepu have raised a relevant question whether it is desirable to dismantle the diversified business groups that dominate emerging markets?

 These conglomerates in developing countries provide the services that are necessary for proper functioning of an efficient market (e.g. capital market, market for labour, management, technology, etc.)

 In western countries independent institutions exist to provide these services like investment banks, venture capital firms, well developed capital markets, stock exchanges, B-schools, technical institutes, R&D labs, etc.

What the Business Groups provide? [Add value]

 They substitute for intermediaries by providing funds needed for diversification / growth for group businesses. Substitute for labour market institutions.

 Develop a common brand name, which group companies can leverage nationally or world-wide.
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 Therefore, if dismantling the business groups is not the best option, what needs to be done?  The BG’s should be encouraged in the short term to make proper reforms to substitute for market institutions.  Governments in these countries should focus on building these institutions in the long run.  Dismantling of BG’s will happen naturally once these institutions are in place.  Increasing competition will force these BG’s to restructure themselves. How should the BG’s improve their functioning? Reform business practices:

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They have to shift from ‘growth now, profitability later’ to ‘profitable growth now’ by: i) ii) iii) investing in internal information and incentive systems should learn how to exit a business; and need to change financial strategy from debt to equity
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2.

Investing in institutional value added: improving financial management by: distinguishing between financing new ventures and financing ongoing operations

i)

• behaving like a Venture capital firm Providing only risk capital Never transfer funds from one venture to another Rarely interfere in day-to-day operations ii) iii) superior role in MDP; and Promote standards in quality, customer service and ethics. • Assume leadership role in co-ordinating the design and dissemination of best business practices. • Lay the foundation for long term change by promoting transparency and sound corporate governance.

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