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CORPORATE RESTRUCTING AND BUSINESS VALUATION

Business restructuring is the discipline of applying financial or operational change in
an organisation.

This may be undertaken for a number of reasons including:

❖ improving efficiency and financial performance

❖ accessing cost reduction and profitability benefits from combining businesses
or business areas
❖ increasing levels of working capital.

Major forms of restructuring

Expansions

This includes mergers, consolidations, acquisitions and other activities that results into
enlargement of a firm or its scope of operations.

Mergers and acquisitions

Mergers

Is used to describe the fusing together of two or more companies to form a single
company; whether the fusion is voluntary or enforced.

Acquisition

Also known as a takeover; is the purchase of a controlling interest in one company by

another company. It may involve an offer to shareholders in the target company of
any or all of: - cash, shares and loan stock. No new company is formed.

Types of mergers and acquisition:

1. Horizontal integration. This results when two or more firms in the same line of
business combine, they are often competitors. The current trend in Bank and
Micro –Finance Institutions mergers is a good example of this type of
integration.
2. Vertical integration. This results from the acquisition of one company by
another, which is at a different level in the “chain of supply”. In other words,
same line of production e.g. supplier-customer. A customer and a company or
a supplier and a company are merged. Think of a cone supplier merging with
an ice-cream maker. There is more control over input quality and delivery.

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3. A conglomerate. Is when two companies in unrelated businesses combine. Two

companies that have no common business areas are merged.

FORMS OF PURCHASE CONSIDERATION

1. Cash consideration
2. Share exchange consideration
3. Earn-out considerations

SYNERGY

When two or more entities join hands to achieve growth results that individually could
not be achieved is called synergy

Types of Synergy

1. Cost Synergy
2. Revenue Synergy and
3. Financial Synergy

Reasons why mergers/acquisitions fail

1. Cultural Differences:
2. Poor Due Diligence:
3. Overpayment:
4. Integration Challenges:
5. Management Misalignment:
6. Loss of Key Talent:
7. Financial Performance Gap:
8. Synergy Unrealized:
9. Lack of Clear Strategy:
10. Loss of Customer Confidence:
11. Focus on Short-Term Goal
12. Market and Industry Changes
13. Lack of Flexibility:

Hostile takeovers

A hostile takeover occurs when one company (the acquiring company or "acquirer")
attempts to take control of another company (the target company) against the wishes
of the target company's management and board of directors.
Defenses Against Hostile Takeovers
1. Poison Pill (Shareholder Rights Plan)
2. Staggered Board
3. Supermajority Voting

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4. Golden Parachutes
5. White Knight
6. Crown Jewel Defense
7. Pac-Man Defense
8. Litigation
9. Greenmail
10. State Takeover Laws
11. Negotiation and Communication
BUSINESS VALUATION
❖ Business valuation is a process and a set of procedures used to estimate the
economic value of an owner's interest in a business.
❖ Businesses need to be valued for a number of reasons such as their purchase
and sale, obtaining a listing, inheritance tax and capital gains tax computations.

There are three broad approaches to share valuation:

1. Assets-based.
❖ Net book value (statement of financial position basis)
❖ Net realisable value basis
❖ Net replacement cost basis
2. Income-based.
❖ Price/earnings ratio method
❖ Earnings yield method
3. Cash flow-based
❖ Dividend valuation model
❖ Dividend growth model
❖ Discounted cash flow basis

ASSETS-BASED APPROACH

Net assets method of share valuation

The net assets valuation method can be used as one of many valuation methods, or
to provide a lower limit for the value of a company. By itself it is unlikely to produce
the most realistic value.

NET ASSETS = TOTAL ASSETS – TOTAL LIABILITIES

Using this method of valuation, the value of an equity share is equal to the net tangible
assets divided by the number of shares.

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Note:

Intangible assets (including goodwill) should be excluded, unless they have a market
value (for example patents and copyrights, which could be sold).

a) Goodwill, if shown in the financial statements, is unlikely to be shown at a true

figure for purposes of valuation, and the value of goodwill should be reflected
in another method of valuation (for example the earnings basis).
b) Development expenditure, if shown in the financial statements, would also have
a value which is related to future profits rather than to the worth of the
company's physical assets.

Example shared

INCOME-BASED VALUATION BASES

P/E ratio (price earnings)

The P/E ratio represents how much investors are willing to pay for each dollar of
earnings generated by the company.

Since P/E ratio = Market value

EPS
Then
then market value per share = EPS x P/E ratio

Remember: Earnings per share (EPS) = Profit / loss attributable to ordinary shareholders
Number of ordinary shares in issue

Example shared.

EARNINGS YIELD VALUATION METHOD

The Earnings Yield valuation method is an alternative approach to valuing a business

that focuses on the earnings generated by the company in relation to its market price.

Market price per share = Earnings per share

EY
In case of future earnings per share and no growth in earnings

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We can incorporate earnings growth into this method in the same way as the dividend
growth model

Market value per = Earnings per share (1 + g)

(EY - g)
In case of current earnings per share with growth in earnings

Example shared

CASH FLOW BASED VALUATION MODELS

Cash flow based valuation models include the dividend valuation model, the dividend
growth model and valuation on a discounted cash flow basis.

DIVIDEND VALUATION MODEL

The dividend growth model

Shareholders will normally expect dividends to increase year by year and not to remain
constant in perpetuity. The fundamental theory of share values states that the market
price of a share is the present value of the discounted future cash flows of revenues
from the share, so the market value given an expected constant annual growth in
dividends.

P0 = Do (1 + g) OR P0 = D1/ ke – g
Ke – g
Where; Do = Current year's dividend
D1 = Future year’s dividend
g = growth rate in dividends.
P0 = Ex-div market price per ordinary share
Ke = cost of equity

Example

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DISCOUNTED CASH FLOW BASIS OF VALUATION

A DCF model is based on the idea that a company's value is determined by how well
the company can generate cash flows for its investors in the future.

FREE CASH FLOW TO THE FIRM (FCFF)

Free cash flow to the firm (FCFF) represents the amount of cash flow from operations
available for distribution after accounting for depreciation expenses, taxes, working
capital, and investments.

FCFF =
Net profit after tax
Plus: net non-cash charges
Plus: Interest expense x (1-tax rate)
Less: Investment in fixed capital
Less: investment in working capital

OR

FCFF =
Profit before interest & tax
Plus: Depreciation & Amortization
Less: Corporation tax
Less: Investment in fixed capital
Less: investment in working capital

Note:

1. WACC is used to discount the Free cash flow to the firm to determine the
current value of the business (Prent value)
2. The value of the firm is the present value net of the current debt (Present value
- current value of debt)

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FREE CASH FLOW TO EQUITY

Free cash flow to equity (FCFE) is the amount of cash a business generates that is
available to be potentially distributed to shareholders.

Profit after tax (PAT) XX

Depreciation & Amortization XX
Net investment in assets
(x)
Increase in Working Capital
(x)
Free cash flow to equity
xx

Note:

1. Cost of equity is used to discount the Free cash flow to equity to determine the
current value of the business (Prent value).
2. The current debt is not netted off the present value of the cashflows.

Terminal value

Terminal value is the estimated value of a business beyond the explicit forecast period.
It is a critical part of the financial model, as it typically makes up a large percentage
of the total value of a business.

The perpetual growth method of calculating a terminal value formula is the preferred
method among academics as it has a mathematical theory behind it. This method
assumes the business will continue to generate Free Cash Flow (FCF) at a normalized
state forever (perpetuity).

Terminal value = FCFn (1 + g)

r–g
Where:
FCF = free cash flow
n = year 1 of terminal period or final year
g = perpetual growth rate of FCF
r = discount rate (WACC or Ke)

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