CHAPTER:2 INTRODUCTION TO CORPORATE RESTRUCTURE

Forms of restructuring business firms. (Ch. 1 Weston)

WHAT IS RESTRUCTURING?
Restructuring is an action taken by a company to significantly modify the
financial and operational aspects of the company, usually when the business is
facing financial pressures. Restructuring is a type of corporate action taken that
involves significantly modifying the debt, operations, or structure of a company
as a way of limiting financial harm and improving the business.
Corporate restructuring refers to the process of reconfiguring a company’s
hierarchy, internal structure, or operations procedures. Companies undergo
restructuring to achieve certain aims, such as to become more competitive or
to respond to changes in the market.
When a company is having difficulties with making the payments on its debt, it
will often consolidate and adjust the terms of the debt in a debt restructuring,
creating a way to pay off bondholders. A company can also restructure its
operations or structure by cutting costs, such as payroll, or reducing its size
through the sale of assets.
These corporate restructuring activities can be divided into two broad
categories - operational and functional. Operational restructuring refers to
outright or partial purchase or sale of companies or product lines or
downsizing by closing unprofitable, non-strategic facilities. Financial
restructuring refers to the actions taken by the firm to change its total debt and
equity structure.
Companies may also restructure when preparing for a sale, buyout, merger,
change in overall goals, or transfer of ownership.
There are numerous reasons why companies might restructure, including
deteriorating financial fundamentals, poor earnings performance, lackluster
revenue from sales, excessive debt, and the company is no longer competitive,
or too much competition exists in the industry.
A company may restructure as a means of preparing for a sale, buyout, merger,
change in overall goals, or transfer to a relative. For example, a company might
choose to restructure after it fails to successfully launch a new product or
service, which then leaves it in a position where it cannot generate enough
revenue to cover payroll and its debt payments.
When a company restructures internally, the operations, processes,
departments, or ownership may change, enabling the business to become
more integrated and profitable. Financial and legal advisors are often hired for
negotiating restructuring plans. Parts of the company may be sold to investors,
and a new chief executive officer (CEO) may be hired to help implement the
changes.
Restructuring can be a tumultuous, painful process as the internal and external
structure of a company is adjusted and jobs are cut. But once it is completed,
restructuring should result in smoother, more economically sound business
operations.
After employees adjust to the new environment, the company can be in a
better position for achieving its goals through greater efficiency in production;
however, not all corporate restructurings end well. Sometimes, a company may
need to admit defeat and begin selling or liquidating assets to pay off its
creditors before permanently closing.

REASONS / WHY RESTRUCTURING

 New product markets
 Expanding capacities
 Increasing efficiency
 Economies of scale
 Efficient use of resources
 Meeting competition
 Sickness etc.
 Eliminating redundant processes
 Consolidating debt
 Streamlining and optimizing routine operations

TYPES OF RESTRUCTURING
 Expansion
o Merger & Acquisition
  Product Expansion
 Market Expansion
 Pure Conglomerate
o Tender-offer
o Joint venture
 Sell-Offs
o Spin-offs
 Split offs
 Split ups
o Divestitures
 Equity curve outs
 Corporate Control
o Premium Buybacks
o Standstill Agreements
o Anti-takeover Amendments
o Proxy Contests
 Changes in Ownership Structure
o Exchange Offers
o Share Repurchases
o Going Private
o Leveraged Buy-outs
Legal restructuring
Turnaround restructuring
Cost restructuring
Repositioning restructuring
Spin-off restructuring
Divestment
Mergers and acquisitions

EXPANTION:
Expansion is a form of restructuring, which results in an increase in the size of
the firm. It can take place in the form of a merger, acquisition, tender offer or a
joint venture.
Merger
Merger is defined as a combination of two or more companies into a single
company where one survives and the others lose their corporate existence. The
survivor acquires all the assets as well as liabilities of the merged company or
companies. Generally, the surviving company is the buyer, which retains its
identity, and the extinguished company is the seller.
Merger is also defined as amalgamation. Merger is the fusion of two or more
existing companies. All assets, liabilities and the stock of one company stand
transferred to Transferee Company in consideration of payment in the form of:
 Equity shares in the transferee company,
 Debentures in the transferee company,
 Cash, or
 A mix of the above modes.
Example: Merger of Sahara Airline with Jet Air; and was given the name as Jet
light. Air Deccan with kingfisher Airline.
Acquisition
Acquisition in the general sense is acquiring the ownership in the property. In
the context of business combinations, an acquisition is the purchase by one
company of a controlling interest in the share capital of another existing
company. Acquisition is an act of acquiring company’s effective Control by one
company over assets as management of another company without any
combination of companies. Thus, in an acquisition two as more companies may
remain independent separate legal entity, but there may be change in control
of the company.
Methods of Acquisition
An acquisition may be affected by:
a) Agreement with the persons holding majority interest in the company
management like members of the board or major shareholders
commanding majority of voting power;
b) Purchase of shares in the open market;
 c) To make takeover offer to the general body of shareholders;
d) Purchase of new shares by private treaty;
e) Acquisition of share capital through the following forms of
considerations viz. Means of cash, issuance of loan capital, or insurance
of share capital.
Example: Hutch company was acquired by Vodafone.

Tender offer
Tender offer involves making a public offer for acquiring the shares of the
target company with a view to acquire management control in that company.
Example: India Cements giving an open market offer for the shares of Raasi
Cements.

Joint Venture
In a Joint Venture, two companies enter into an agreement to provide certain
resources towards the achievement of a particular common business goal. It
involves intersection of only a small fraction of the activities of the companies’
involved and usually for a limited duration. The venture partners according to
the pre-arranged formula share the returns obtained from the venture. Usually,
the multinational companies use this strategy to enter into the foreign markets.
Example: DCM Group and Daewoo Motors entered into a joint venture to
manufacture automobiles in India.

SELL-OFFS
Spin-offs
Spin-offs make sense if the subsidiary is a supplier to the parent and this
prevents the subsidiary from developing a market with the parent’s key
competitors. Selling a stake in a company, on the other hand, may be the most
suitable choice if the company requires better access to capital.
Alternatively, tracking stocks may be appropriate if a subsidiary can take
advantage of its parent’s lower cost of borrowing to finance its operations, or if
one or other of the entities can offset taxable profits against operating losses.
A spin-off is a transaction in which a company distributes on a pro rata basis all
of the shares it owns in a subsidiary to its own shareholders.
Hence, the stockholders proportional ownership of shares is the same in the
new legal subsidiary as well as the parent firm. The new entity has its own
management and is run independently from the parent company. A spinoff
does not result in an infusion of cash to the parent company.
Example: Kotak Mahindra Capital Finance Ltd. formed a subsidiary called Kotak
Mahindra Capital Corporation by spinning off its investment division.
Split-offs
In a split-off, a new company is created to take over the operations of an
existing division or unit. A portion of the existing shareholders receives stock in
a subsidiary (new company) in exchange for the parent company stock. The
logic of split-off is that the equity base of the parent company is reduced
reflecting the downsizing of the firm. Hence, the shareholding of the new
entity does not reflect the shareholding of the parent firm. A split-off does not
result in any cash inflow to the parent company. A split-off is the outright sale
of a company subsidiary doesn’t fit into the parent company’s core strategy.
The market may be Undervaluing the combined businesses due to a lack of
synergy between the parent and the subsidiary.
As a result, management and the Board decide that the subsidiary is better off
under different ownership.
Example: On 30th Sept 2009 ABNAMRO files to Split-off Royal Bank of Scotland
(RBS) owned assets after a 2007 takeover.
Split-ups
In a split-up, the entire firm is broken up in series of spin-offs, so that the
parent company no longer exists and only the new off-springs survive. A split-
up involves the creation of a new class of stock for each of the parent’s
operating subsidiaries, paying current shareholders a dividend of each new
class of stock, and then dissolving the parent company. Stockholders in the new
companies may be different as shareholders in the parent company may
exchange their stock for stock in one or more of the spin-offs.
Example: Restructuring of APSEB - The Andhra Pradesh State Electricity Board
(APSEB) was split-up in 1999 as part of the power sector reforms. The power
generation business and the transmission and distribution business were
transferred to two separate companies called APGENCO and APTRANSCO,
respectively. APSEB ceased to exist as a result of the split-up.
Divestiture
Divestiture is a transaction through which a firm sells a portion of its assets as 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.
These assets may be in the form of plant, division on product line, subsidiary
and so on. Divestiture process is a form of contraction for selling company and
means of expansion for the purchasing company. For a business, divestiture is
the removal of assets form books. Businesses divest by the selling of ownership
stake, the closure of subsidiaries, the bankruptcy of division and so on. The
buyers benefit due to low acquisition cost of a completely established product
line which is easy to combine in his existing business and increase profit and
market share. The seller can concentrate after divestiture more on profitable
segment and consolidate its business activities. The motive for divesture is to
generate cash for the expansion of other product line to get rid of poorly
performing operation, to streamline the comparator or to restructure the
company’s business consistent with its strategic goals. Divestiture enables the
selling firm to have more lean and focussed operation. This in turn, helps the
selling company to increase efficiency and profitability.
A divestiture is a sale of a portion of the firm to an outside party, generally
resulting in an infusion of cash to the parent. A firm may choose to sell an
undervalued operation that it determines to be non-strategic or unrelated to
the core business and to use the proceeds of the sale to fund investments in
potentially higher return opportunities. It is a form of expansion on the part of
the buying company.
Example: On 2nd July 2007 ELi Lilly announces the divestiture of its antibiotic
brand Distacle (R) (cefaclor), gives marketing rights to M/S pharma-link.
Equity Carve-out
Equity carve-out means reducing their exposure to a riskier line of business. In
the process of equity carve-out, some of the shares of subsidiary are offered
for sale to the general public for increasing cash flow without loss of control. A
carve-out occurs when a parent company sells a minority (usually 20% or less)
stake in a subsidiary for an IPO on rights offering.
In this form of restructuring, an established brick-and-mortar company looks
up with the venture investors and a new management team to launch a spin-
off. In most cases, parent company will spinoff the remain interests to existing
shareholders at a later date when the stock price is much higher.
An equity carve-out involves the sale of a portion of the firm through an equity
offering to outsiders. New shares of equity are sold to outsiders who give them
ownership of a portion of the previously existing firm. 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.
Example: Equity Carve-Out between Lanco Infrastructure and GVK Power and
Infrastructure for setting up new division for their power business.

CORPORATE CONTROL
Firms can also restructure without necessarily acquiring new firms on divesting
existing corporations. Corporate control refers to the third group of corporate
restructuring activities, which involves obtaining control over the management
of the firm. Control is the process by which managers influence other members
of an organisation to implement the organisational strategies. The various
techniques of obtaining corporate control are explained further.
Proxy Contests
A proxy contest is an attempt by a single shareholder or a group of
shareholders to take control or bring about other changes in a company
through the use of the proxy mechanism of corporate voting. In a proxy fight, a
bidder may attempt to use his or her voting rights and garner the support from
other shareholders to expel the incumbent board or management.

CHANGES IN OWNERSHIP STRUCTURE

Changes in the ownership structure represent the fourth group of restructuring
activities which results in restructuring the ownership of a firm. A firm’s
ownership structure affects, and is affected by other variables, and these
variables also influence the market value. These variables include the levels of
principal-agent conflict and information asymmetry and their effects on other
variables such as the firm’ operating strategy, dividend policy and capital
structure. The various technique of changing the ownership structure were
explained below.
Share Repurchases
This involves the company buying its own shares back from the markets. This
leads to reduction in the equity capital of the company. This, in turn,
strengthens the promoter’s controlling position by increasing his stake in the
equity of the company. It is used as a takeover defines to reduce the number of
shares that could be purchased by the potential acquirer.
Example: Recently, Sterlite Industries had proposed a buyback of its shares
through the open market to acquire a maximum of 25 per cent of the equity.
Exchange Offers
It provides one or more classes of securities, the right or option to exchange
part or all of their holdings for a different class of securities of the firm. The
terms of exchange offered necessarily involve new securities of greater market
value than the pre-exchange offer announcement market value. Exchange offer
involves exchanging debt for common stock, which increases leverage, or
conversely, exchanging common stock for debt, which decreases leverage. They
help a company change its capital structure while holding the investment policy
unchanged.
Example: On 11th Nov.2009 Tata Steal had launched an exchange offer of new
foreign currency convertible bonds fopr existing $ 857 million convertible
Alternative Reference Securities (CARS) due 20012
Leverage Buyout
It is a strategy involving the acquisition of another company using a significant
amount of borrowed money (bonds or loans) to meet the cost of acquisition. It
is nothing but the takeover of a company using the acquired firm’s assets and
cash flow to obtain financing. In LBO, the assets of the company being acquired
are used as collateral for the loans in addition to the assets of the acquiring
company. An LBO occurs when a financial sponsor gains control of a majority of
a target Company’s equity through the use of borrowed money or debt. The
purpose of LBO is to allow companies to make large acquisitions without
having to commit a lot of capital. LBO are risky for the buyers if the purchase is
highly leverage.
Leveraged buyout is a financing technique where debt is used in the acquisition
of a company. The term is often applied to a firm-borrowing fund to buy back
its stock to convert from a publicly-owned to a privately-owned company. A
management buyout is an LBO in which managers of the firm to be taken
private are also equity investors.
Going Private
It refers to the transformation of a public corporation into a privately held firm.
It involves purchase of the entire equity interest in a previously public
corporation by a small group of investors.
 CHAPTER:3 TYPES OF MERGERS AND THEIR CHARACTERISTICS

HORIZONTAL MERGER:
A horizontal merger occurs when companies operating in the same or similar
industry combine together. The purpose of a horizontal merger is to more
efficiently utilize economies of scale, increase market power, and exploit cost-
based and revenue-based synergies.
A horizontal merger is a merger between companies that directly compete with
each other. Horizontal mergers are done to increase market power (market
share), further utilize economies of scale, and exploit merger synergies.
A famous example of a horizontal merger was that between HP (Hewlett-
Packard) and Compaq in 2011. The successful merger between these two
companies created a global technology leader valued at over US$87 billion.

Reasons for a Horizontal Merger

When companies undergo a horizontal merger, the underlying principle is to
create value. A successful merger should create value in which combining the
companies would be worth more than if each company were under
independent ownership. In a horizontal merger, 1 + 1 (referring to two
independent companies) should be greater than 2 (the merged company).

Reasons for merging horizontally:

 Increase market share and reduce competition in the industry
 Further utilize economies of scale (thus reducing costs)
 Increase diversification
 Reshape the company’s competitive scope by reducing intense rivalry
 Realize economies of scope
 hare complementary skills and resources
VERTICAL MERGER:
A vertical merger is a merger between companies that operate along the same
supply chain. A vertical merger is the combination of companies along the
production and distribution process of a business. The rationale behind a
vertical merger includes higher quality control, better flow of information along
the supply chain, and merger synergies.
Ex: automobile manufacturing, oil industry, pharmaceutical industry etc.
Rationale:
 Technological economies
 Transportation costs
 Cost cutting
 Proper inventory management
 Removing uncertainty of input prices.
 Reducing transfer pricing.

A notable vertical merger happened between America Online and Time Warner
in 2000. The merger was considered a vertical merger due to each company’s
different operations in the supply chain – Time Warner supplied information
through CNN and Time Magazine while AOL distributed information through
the internet.
The purpose of a vertical merger between two companies is to heighten
synergies, gain more control of the supply chain process, and increase
business.
Anti-trust violations are often cited when vertical mergers are planned or occur
because of the probability of reduced market competition.
Vertical mergers may result in lower costs and increased productivity and
efficiency for the companies involved.

CONGLOMERATE MERGER:
A conglomerate merger is a merger between companies that are totally
unrelated. There are two types of a conglomerate merger: pure and mixed.
A pure conglomerate merger involves companies that are totally unrelated and
that operate in distinct markets.
A mixed conglomerate merger involves companies that are looking to expand
product lines or target markets.
The biggest risk in a conglomerate merger is the immediate shift in business
operations resulting from the merger, as the two companies operate in
completely different markets and offer unrelated products/services.
For example, the merger between Walt Disney Company and the American
Broadcasting Company (ABC) was a conglomerate merger. Walt Disney
Company is an entertainment company, while American Broadcasting company
is a US commercial broadcast television network (media and news company).
A conglomerate merger is a merger of two firms that have completely
unrelated business activities.
There are two types of conglomerate mergers: pure, where the two firms
continue to operate in their own markets, and mixed, where the firms seek
product and market extensions.
Two firms would enter into a conglomerate merger to increase their market
share, diversify their businesses, cross-sell their products, and to take
advantage of synergies.
The downside to a conglomerate merger can result in loss of efficiency, clashing
of cultures, and a shift away from the core businesses.
Opponents of conglomerate mergers believe that they can lead to a lack of
market efficiency when large companies consolidate the industry by acquiring
smaller firms.
A conglomerate merger consists of two companies that have nothing in
common. Their businesses do not overlap nor are they competitors of one
another; however, they do believe that there are benefits in joining their firms.
There are many reasons for conglomerate mergers, such as increased market
share, synergy, and cross-selling opportunities. These could take form in
advertising, financial planning, research and development (R&D), production,
or any other area. The overall belief, with any merger, is that the newly formed
company will be better than the two separate companies for all stakeholders.
Firms also merge to reduce the risk of loss through diversification. However, if a
conglomerate becomes too large from acquisitions, the firm's performance can
suffer. During the 1960s and 1970s, conglomerate mergers were popular and
most plentiful. Today, they are uncommon because of the limited financial
benefits.
Financial conglomerate:
A financial conglomerate merger involves the combination of two or more
companies operating in different industries but with similar economic
structures. This type of merger and acquisition (M&A) can help companies
strengthen their balance sheets and increase market capitalization. Doing this
allows them to raise funds from public markets and compete more effectively
in their respective industries.
Financial conglomerates provide a flow of funds to each segment of their
operations, exercise control and are the ultimate financial risk takers.
They undertake strategic planning but do not participate in operating decisions.
It improves risk-return ratio through diversification.
It avoids ‘gambling ruin’ (an adverse run of losses which might cause
bankruptcy.)
Establishing programmes of financial planning and control which leads to
improved quality of general and functional management, more efficient
operations and better resource allocation.
If management does not perform effectively but the productivity of assets in
the market is favorable, the management is changed. Assets are placed under
more efficient managements hence improved resource allocation.
Distinction is made between performance based on potential superiority of
product or market Vs. results related to better managerial performance.
Management conglomerate:
They not only assume financial responsibility and control but also play a role in
operating decisions and provide staff expertise and staff services to the
operating entities.
Since managerial functions of POSDCORB are transferable to any company,
such conglomerates increase potential for improving performance.
i.e. when any two firms with unequal management competence are combined,
the performance of the combined firm will improve.
This is due to the management expertise of the superior management firm.
Will give rise to synergy.
FRAMEWORK FOR ANALYSIS OF MERGER
Hypothesis:
Merger between companies in related industries lead to managerial synergy
and pure conglomerate mergers involve financial synergy.
Organization Learning and Organization Capital:
Organization learning: It is defined as improvement in the skills and abilities of
individual employees through learning by experience within the firm.
Concept of Production Knowledge:
One case of learning is in the area of entrepreneurial or managerial ability to
organize and maintain complex production processes economically.
3 forms of organization learning:
1. Raw Managerial experience: It refers to the capabilities developed in
generic management functions of planning, organizing, directing,
controlling and so on as well as in financial planning and control.
2. Industry Specific managerial experience: It refers to the development of
capabilities in specific management functions related to the
characteristics of production and marketing in particular industries.
3. Non managerial labour input: It refers to the level of skills of the
production workers that will improve over time through learning by
experience.
Organization capital: It is accumulated through experience within the
organization called the firm.
1. Employee Embodied Information: It is the firm specific information
embodied in every employee.
This type of information is obtained when the employee becomes familiar with
the firm’s production arrangements, management and control systems, other
employees’ skills, knowledge and job duties.
2. Team Effects:
a. The role of information here is to allow the firm to organize
efficient managerial and production teams within the firm.
 b. Match between workers and tasks: Information on employee
characteristics and matching the job to these characteristics.
c. Matching workers with workers.
These 3 types of information cannot be passed on from firm to
firm through transfer of labour.
OL becomes significant when it is combined with OC (firm specific information)
which cannot be transferred to other firms through labour market.

Investment opportunities:
Investment opportunities in a firm exist if the present value of an investment
project is positive.
Hence a value maximizing firm will attempt to internalize all investment
opportunities that it can find.
It is also termed as goodwill and may arise from many circumstances.

Managerial synergy-
horizontal and related mergers
Managerial synergy implies that the acquiring firm has managerial capacity in
excess of its needs.
For various reasons (team effects or industry demand conditions, for example),
this excess capacity cannot be utilized without merger.
One firm may have excess managerial capacity while the other firm has a
shortage, resulting in synergistic effects.
Operating synergy may result from economies of scale or complementarities.
A firm may be very strong in one area (e.g., R&D) to the point that this capacity
is underutilized relative to the firm’s output; this may also lead to
underinvestment in other complementary areas.
Merger with a firm which is strong in the complementary area will result in
operating synergies.
In management, virtually all firms need a minimum size of corporate staff,
which may be underutilized in smaller firms.
An acquisition of a target just approaching the size where it needs to add
corporate staff provides fuller utilization of the acquirer’s staff, while avoiding
the need to add staff to the target.
Vertical integration of firms at different stages of production results in more
efficient coordination and communication.

Financial synergy – conglomerate mergers

Financial synergy applies mainly to conglomerate mergers where managerial
and operating synergy are less likely.
Factors involved in financial synergy include the availability of low-cost internal
funds.
Typically, a firm in an industry with limited investment opportunities and hence
high availability of internal funds will merge with a firm with more investment
opportunities than it can fund
The resulting conglomerate firm acts as a mini capital market directing internal
funds from business segments with limited growth prospects to those with
high growth potential.
The coinsurance effect of merging firms with imperfectly correlated cash flow
streams results in increased debt capacity for the combined firm.
Support for financial synergy is found in the transfer of capital expenditure
financial management function to corporate headquarters following
conglomerate mergers; increased capital outlays and leverage increases were
also observed following conglomerate mergers.

THE ROLE OF INDUSTRY LIFE CYCLE:

The concept of ILC is used as a framework for indicating when different types of
mergers may have an economic basis at different stages of an industry’s
development.
1. Introduction
 2. Exploitation
3. Maturity
4. Decline
The industry life cycle refers to the evolution of an industry or business through
four stages based on the business characteristics commonly displayed in each
phase.

The four phases of an industry life cycle are the introduction, growth, maturity,
and decline stages. Industries are born when new products are developed, with
significant uncertainty regarding market size, product specifications, and main
competitors.
The industry life cycle refers to the evolution of an industry or business based
on its stages of growth and decline.
The four phases of the industry life cycle are the introduction, growth,
maturity, and decline phases.
The industry life cycle ends with the culmination of the decline phase, a period
when the industry or business is unable to sustain growth.
Mature industries include food and agriculture, mining, and financial services.
Investors can make better-informed investment decisions once they
understand industry life cycles.
Life cycles are present in all aspects of life. The industry life cycle can relate to
youth, inexperience, and determination (introduction), learning, improvement,
and social expansion (growth), achievement and fulfillment (maturity), and the
decreasing ability to compete, win, and thrive (decline).
Industry Life Cycle Phases
1. Introduction Phase
The introduction, or startup, phase involves the development and early
marketing of a new product or service. Innovators often create new businesses
to enable the production and proliferation of the new offering.
Information about the products and industry participants is often limited, so
demand tends to be unclear. During this stage, consumers of the goods and
services need to learn more about them, while the new providers are still
developing and honing the offering.
The industry or business tends to be highly fragmented in the introduction
stage. Participants tend to be unprofitable because expenses are incurred to
develop and market the offering while revenues are still low.
New firms sell to larger older firms-related or conglomerate mergers
Horizontal mergers between smaller firms to gain competitive position by
pooling management and capital resources
Smaller firms merge as they want to convert their income to capital gains and
reduce risk.

2. Growth Phase
In this second phase, consumers have come to understand the value of the
new offering, business, or industry. Demand grows rapidly.
A handful of important players usually becomes apparent, and they compete to
establish a share of the new market. Immediate profits usually are not a top
priority as companies spend on research and development or marketing.
Business processes are improved, and geographical expansion is common.
Once the new product has demonstrated viability, larger companies in adjacent
industries tend to enter the market through acquisitions or internal
development.
Similar to mergers during introductory stage.
Larger companies in maturity stage can get the benefit of high growth rate of
companies in the exploitation phase.

3. Maturity Phase
The maturity phase begins with a shakeout period, during which sales growth
slows, focus shifts toward expense reduction, and consolidation occurs (as
companies begin to merge or acquire each other).
Some firms attain economies of scale, hampering the sustainability of smaller
competitors. Growth can continue.
As maturity is achieved, barriers to entry become higher, and the competitive
landscape becomes more clear. Market share, cash flow, and profitability
become the primary goals of the remaining companies now that growth is
relatively less important.
Price competition becomes much more relevant as product differentiation
declines with consolidation.
Businesses may prolong the maturity phase by repositioning their offerings,
investing in new markets and technology, and spurring new growth.
Mergers to achieve economies of scale in research, production and marketing
in order to match the low cost and price performance of other firms, domestic
or foreign.
Mergers between smaller firms and larger firms

4. Decline Phase
The decline phase marks the end of an industry's or business' ability to support
growth. Obsolescence and evolving end markets (end users) negatively impact
demand, leading to declining revenues. This creates margin pressure, forcing
weaker competitors out of the industry.
Further consolidation is common as participants seek synergies and further
gains from scale. The decline phase often signals the end of viability for the
incumbent business model, pushing industry participants into adjacent
markets.
As with the maturity phase, the decline phase can be delayed with large-scale
product improvements or repurposing. However, these tend simply to prolong
the decline and ultimate market exit.
Horizontal mergers in order to survive
Vertical mergers to increase efficiency and profit margins.
Concentric mergers between firms in related industries to provide synergy and
carry over.
Conglomerate acquisitions of firms in growth industries to utilize accumulating
cash positions of mature firms in declining industry whose internal flow of
funds exceeds the investment requirements of their traditional lines of
business.

Examples
1. Introduction Phase
Some industries in the startup or emergent stage include the artificial
intelligence industry, the self-driving vehicle industry, the biotechnology
industry, and the virtual reality industry.

2. Growth Phase
Coca-Cola is an example of a savvy life cycle survivor. In western countries, it is
considered to be in the maturity stage because its market offers no room for
expansion. But its ability to change its business efficiently and effectively to
serve huge populations in Asia also put it in the growth phase.
The computer industry, as well, has had an extended growth phase because of
its longtime focus on updating hardware, features, and functionality.

3. Maturity Phase
In the U.S., mature industries include food and agriculture, mining, and
financial services. Companies such as Apple, Xerox, Intel, IBM, and Procter &
Gamble are considered mature-phase companies.

4. Decline Phase
Certain revenue analysis research indicates that the fastest declining industries
in the U.S. include:
 Iron and steel manufacturing
 Natural gas distribution
 Semiconductor machinery manufacturing
 Oil drilling and gas extraction
 Chicken egg production
 CHAPTER:4 THEORIES OF MERGERS AND TENDER OFFER

THEORIES OF MERGER:
1. Efficiency theories
 Differential management theory
 Inefficient management
 Operating synergy
 Pure diversification
 Strategic realignment to changing the environment
 Undervaluation
The efficiency theories hold that mergers and other forms of asset
redeployment have potential social benefits.
Involve improving the performance of incumbent management.
Most of the efficiency theories are used for conglomerate mergers.

DIFFERENTIAL MANAGEMENT THEORY:

If management of firm A is better than management of firm B, and firm A takes
over firm B, then the management of B will rise up to the level of A.
Social as well as private gain.
Problem is that if all firms take up this route, then there will be only one firm in
the economy.
BENEFITS:
 If firm A (acquiring firm) has excess managerial capacity and firm B
(acquired firm) has non managerial organizational capital.
 Firms with below average efficiency.
 Firms operating in similar kinds of business activities which are weak in
management.
This theory provides the logic that those companies which exist at suboptimal
levels operationally would benefit and it is in their interest that such companies
be taken over by another company whose management is more efficient than
the previous one. Another implication is that such an inefficient company
would always be in the throes of being taken over by a stronger company. Such
mergers will be particularly beneficial when they belong to the same industry,
creating reduction in costs due to efficient utilisation of resources. The basis of
the success of this theory lies in the managerial ability of efficient firms to
recognise firms with good prospects but functioning at low level of efficiency.
The only problem area could be if the acquirer pays too heavily for the target
company, thus, washing out the likely benefits yet to be accrued.
The managerial synergy hypothesis which is the extended version of the
Differential Efficiency Theory states that firms with efficient management
teams with great competency seek to invest their surplus resources in firms
lacking managerial abilities. This often happens in mergers between nonrelated
industries where the acquiring firm benefits from the other organisation’s
capital and gains ‘a toehold entry’. Efficiency theory predicts positive benefits
to both the parties involved the acquiring firm and the merged firm, they
suggest that operational synergies get created and gains in efficiency are
materialized due to cost effectiveness of scale & scope and transference of
knowledge.

INEFFICIENT MANAGEMENT:
Similar to differential efficiency.
However horizontal mergers are more relevant in differential management
whereas even conglomerate mergers are relevant in inefficient management.
Inefficient management is one reason for a firm to be undervalued thus,
becoming a motive behind M&As. This happens when management functions
below its potential capacity. It, therefore, becomes lucrative to another firm
with efficient management to include such an underperforming firm in its
ambit.

SYNERGY (OPERATING AND FINANCIAL):

Synergy refers to a concept where the combined force and power of two
entities is substantially higher than the sum of its individual parts. These are of
two types: financial and operating synergy. This theory states that internal
financing due to its very nature is cost effective in contrast to external financing
resulting in financial synergy. When two firms merge their potency in servicing
the collective debt is higher than the sum of their capacities individually. Other
considerations could be savings in taxes and reallocation of pooled capital.
Likewise, operating synergy results from combined use of resources, machinery
and manpower.
Operating synergy:
Economies of Scale
Firms Complementing each other
Vertical, horizontal and conglomerate mergers
Financial synergy:
Another school of thought says that only operating synergy is not enough.
Hence comes in the concept of financial synergy.
Synergy with respect to raising funds, internal and external capital, working
capital (vertical mergers), etc.

PURE DIVERSIFICATION:
Gives an opportunity to employees to improvise their skill and learn new skills.
Helps the businessman to reduce his risk.
When a firm is liquidated this information is lost. If a firm is diversified then this
firm specific information can be transferred to the new firm.
Reputational capital of firm can be used.
Diversification can increase the corporate debt capacity of the firm and
decrease the present value of future tax liability.
This theory states that mergers are preferable routes for expansion than
internal growth. This is owing to restrictions in the timing and non-availability
of diversified resources within a single entity. Reputational capital is a direct
value addition besides expansion geographically and/or in terms of products
and services.

STRATEGIC REALIGNMENT TO CHANGING ENVIRONMENT:

Developing the required skills and managerial capabilities internally.

UNDERVALUATION:
If a certain firm is undervalued, it is quite likely that another firm would want
to acquire it.
Reasons for undervaluation:
1. Underutilization of assets by mgt.
2. Acquirers have inside information.
3. Difference between market value of assets and replacement costs.

2. INFORMATION AND SIGNALING:

The basic premise of this theory is that different sets of investors behave, and
act differently given different sets of information. The announcement of a
merger signals to the market about the likely effect of the deal on the firm’s
value. It might even get reflected in a major rise in the value of the targeted
firm or in the ensuing cash flows.
This information asymmetry and associated predictions might affect the
acquiring firm’s offer price.
It has been observed frequently that the value of shares of the target firm
increases even if the tender offer goes unsuccessful.
The reasons:
 The tender offer disseminates information that that the target shares are
undervalued.
Also known as sitting on the goldmine.
 The offer compels the target firm to perform well on its own.
 Another view is that people expect that the company will be taken over
by someone else.
SIGNALING THEORY:
Certain actions of the firm give signals to the market due to which the firm
benefits.
For ex: Investors use the face amount of debt that the manager decides to
issue as a signal of the firm’s probable performance. If the optimum amount of
debt to be held by a company is D. Say there are 2 types of firms A and B. A will
be successful, B will be unsuccessful. If the firm issues debt more than D, then
is termed as type A, if less than D, then type B.
Firm B should signal its unsuccessfulness only if the benefit from telling the
truth is greater than that produced by telling lies.

3. AGENCY PROBLEM AND MANAGERIALISM:

An agency problem arises when managers own only a small portion of the
ownership shares of the firm.
This partial ownership may cause managers to work less vigorously than
otherwise and to consume more perquisites because majority owners bear
most of the cost.
REASONS FOR AGENCY PROBLEM:
Agency theory finds its origin in economics, derived in information economics
(Jensen and Meckling, 1976). This theory is based on the premise that conflict
arises irrespective of the principal and agent both being rational in their
approach. Agency theory critically analyses the role played by the managers
(agents) in working towards their own personal utility and not catering 100% to
the interests of the shareholders (principal). But these decisions carry personal
biases and cannot be categorized as erratic or irrational. Rather, they are
opportunities availed at the cost of the principal with full awareness and selfish
motive where superior information is used to take advantage Contracts
between managers (decision or control agents) and owners cannot be
costlessly written and enforced.
Agency costs include:
 Cost of structuring contracts.
 Costs of monitoring and controlling the behaviour of agents.
 Costs of taking guarantee that agents will make optimal decision.
 Residual loss to principals (majority shareholders)
Takeovers are a solution to agency problem
Managerialism:
This theory argues that the agency problem is not solved and the merger
activity is a manifestation of the agency problems of inefficient external
investments by managers.

HUBRICS HYPOTHESIS:
This theory is more of a psychological explanation to managements over
optimism resulting in erroneous decisions that may be overpriced. Thus,
overconfidence leads to overestimation increasing the probability of
overpaying. This theory also elaborates the ‘winner’s curse’, wherein post-
merger announcement, where the shareholdings of the acquirer firm
sometimes face loss in the prices of shares, while the target firms enjoy the rise
in price.
Managers commit errors of overoptimism in evaluating merger opportunities
due to excessive pride, animal spirits or Hubris.
So, the whole merger movement is based on taking the hubris hypothesis as
the null hypothesis and disproving it.

4. FREE CASH FLOW HYPOTHESIS:

Major conflicts between managers and shareholders arise over the payment of
free cash flows.
Free cash flows are basically profits after all the expenses are deducted.
Distribution of these profits.

5. MARKET POWER
Concentration of power with a few firms through merger activities and
collusions.
If 4 or fewer firms hold 40 % of the market, it leads to a skewed market
structure.
Herfindahl index: it registers a concern about inequality of firms as well as the
degree of concentration of industry sales.
4 firms with 15% stake and 40 firms with 1% stake,
H= 4(15)2 + 40(1)2 = 940

6. TAX BENEFITS
Carry over of Net operating losses and tax credits
Stepped up asset basis
Substitution of Capital Gains for Ordinary Income
Other Tax Incentives

7. REDISTRIBUTION
CHAPTER: 5 Sell- Offs and Divestitures (Ch. 9 Weston)