Different Types of Corporate Restructuring
Different Types of Corporate Restructuring
Corporate restructuring is a comprehensive term that can be broadly categorized into two types: a) Operational restructuring, which involves actions concerning the asset side of the balance sheet, such as acquisitions, divestments, joint ventures, strategic alliances, and workforce reduction; and b) financial restructuring, which involves actions concerning the capital side of the balance sheet, including reducing debt, raising debt, and repurchasing shares. Depending upon the specific objective, an appropriate strategy is deployed.
Key Learning Points
- Corporate restructuring is categorized into two main types: operational and financial.
- Operational restructuring involves actions such as mergers and acquisitions, divestments, the formation of joint ventures and alliances, and adjustments to the workforce.
- Financial restructuring includes activities such as reducing debt, securing additional debt, and buying shares back.
- Bankruptcy is the final stage of restructuring, which may result in either reorganization or liquidation.
- Corporate restructuring plays a vital role in adapting to change and improving overall efficiency.
Operational restructuring involves modifying a company’s asset structure, which might involve acquiring new businesses to drive growth, forming joint ventures, establishing strategic alliances to leverage synergies, discontinuing unprofitable product lines, divesting low-growth businesses, or reducing the workforce.
Mergers & Acquisitions (M&A)
An acquisition involves acquiring a controlling stake in a company, which then merges with the acquirer. The acquirer can offer cash, shares, or a combination of both to the target’s shareholders. The difference between a merger and an acquisition is that a merger is generally a transaction between two or more equals, resulting in the creation of an entirely new company.
Moreover, such business combinations can be categorized into three types:
Horizontal integration is the consolidation of companies operating in the same industry or market segment. This enhances market share, reduces competition, and achieves economies of scale.
Example: In May 1998, Daimler signed a contract to acquire Chrysler for ~US$39bn. This transaction made it possible to offer new products and services, and improved the competitive position in global terms for the group as a whole. (Source: mercedes-benz)
Forward integration occurs when a company acquires businesses that are downstream in the value chain. This offers the acquiring company control over distribution channels, ensures a steady market for products, and enhances control over the end-user experience.
Example: In March 2017, Toyota acquired material handling supplier Vanderlande for €1.2bn. This acquisition allowed Toyota to broaden its range of materials-handling equipment and systems globally beyond lift trucks, marking a significant step in expanding the materials-handling solutions business. (Source: toyota)
Backward integration occurs when a company acquires businesses that are upstream in the value chain. This helps the company gain control over key inputs, ensures a stable supply of raw materials, and can reduce dependency on external suppliers.
Example: In June 2021, Hyundai acquired a controlling stake of 80% in Boston Dynamics for the price of US$1.1bn. This transaction was expected to propel the development of future technologies encompassing autonomous driving, artificial intelligence, Urban Air Mobility, smart factories, and robots. (Source: bostondynamics)
Divestment: Divestiture, Spin-Off and Carve-Out
Divestment refers to a company’s strategic decision to sell, liquidate, or otherwise dispose of a portion of its assets, subsidiaries, or business units. Divestment is typically undertaken to streamline operations, focus on core business areas, improve financials, or generate capital for other strategic initiatives.
Types of Divestments
Divestiture involves the outright sale or disposal of a portion of a company’s assets, business units, or subsidiaries. The segment sold becomes independent, and the parent company no longer has any control over the segment or owns any stake.
Example: In June 2008, Ford sold Jaguar and Land Rover to Tata Motors for a net consideration of US$2.3bn in an all-cash transaction. As part of the deal, Ford agreed to contribute ~US$600mm to the Jaguar-Land Rover pension fund upon closing. The cash generated from this transaction likely enabled Ford to focus on turning around its loss-making operations in North America.
Spin-off occurs when a parent company separates a part of its business into a new, independent entity by distributing shares of the new company to existing shareholders.
Example: Imagine a major automobile manufacturer spinning off its car loan division, which has grown to a scale surpassing the core business of the parent company. This move allows the newly created entity to leverage its expertise and offer loan underwriting services not only to its parent company but also to other automobile manufacturers in the industry.
Carve-Out, similar to a spin-off, involves creating a new, independent entity from a segment of the parent company and then selling some of the shares to the public via an IPO. However, in a carve-out, the parent company retains a significant ownership stake in the new entity and may gradually reduce the stake over time.
Example: Picture a leading automobile manufacturer innovating a high-performance lithium-ion battery pack that stores 50% more energy with the same density. However, building a cutting-edge manufacturing facility for this technology requires a substantial investment of US$10bn. The manufacturer decides to carve out this unit, retaining a 60% stake and offers the remaining stake to institutional investors.
Note: The reason for initiating a spin-off or carve-out is the parent company’s opinion that a particular segment or product line requires focused management as a separate entity. This typically occurs when the proposed new entity has an unrelated business, substantial growth potential, or demands distinct management expertise and entirely new distribution capabilities.
Joint Venture and Strategic Alliance
Joint ventures and strategic alliances are both forms of partnership between companies that are created to achieve a specific business goal. A joint venture involves the creation of a new entity with shared ownership, while a strategic alliance involves collaboration and the sharing of resources between independent entities without forming a new separate entity. Both forms of partnerships aim to achieve specific strategic goals through cooperation and leveraging each other’s strengths and resources.
Example: DENSO and Toyota established a joint venture in July 2019 to conduct research and develop next-generation in-vehicle semiconductors, driven by the rising integration of in-vehicle semiconductors into vehicles. (Source: Company website)
Example: In January 2016, General Motors and Lyft formed a strategic partnership to develop a cohesive network of autonomous vehicles for on-demand services. General Motors committed a US$500mm investment in Lyft to support the expansion of its flourishing ridesharing platform. As part of the agreement, GM also secured a position on Lyft’s board of directors. (Source: gm
This involves a deliberate and strategic decrease in a company’s headcount through layoffs or early retirements. It is typically undertaken to streamline operations, improve efficiency, cut costs, adapt to changing market conditions, or respond to a decline in business activity.
Example: Ford Motors, which was facing profitability issues in Europe, announced in June 2019 that it would trim its workforce by cutting 12,000 of the existing 65,000 employees in the region. Most of the employees impacted were offered voluntary separation programs. (Source: The New York Times)
Financial restructuring involves modifying a company’s capital structure, focusing on its financial aspects. There are several components involved in financial restructuring, including reducing debt reduction, raising debt to impact the weighted average cost of capital (WACC), or repurchasing stock.
This involves minimizing a company’s overall debt burden. This can be achieved by paying off existing debt, negotiating better terms, or refinancing debt to obtain more favorable interest rates and terms.
Example: In March 2021, Renault declared a plan to sell its stake in Daimler, valued at ~US$1.4bn. The funds obtained from the sale were intended to accelerate Renault’s financial deleveraging efforts. (Source: renaultgroup)
Raising Debt to Reduce WACC
Raising debt to reduce WACC is a strategic move in which a company may choose to increase its debt level, assuming that the cost of debt is lower than the cost of equity. By reducing WACC, the company can potentially lower its capital costs, making new projects or investments more financially attractive.
Example: Suppose XYZ Automotive has US$10mm in equity and US$5mm in debt, resulting in a WACC of 8%. To reduce the WACC and make new projects more appealing, XYZ decided to raise an additional US$5mm in debt, maintaining equity at US$10mm. Assuming a cost of 4% for this new debt, the WACC would decrease as a result.
Share buybacks involve a company repurchasing its own outstanding shares from the market. The shares purchased are either retired or held as treasury stock. Share buybacks can have multiple objectives, including signaling to the market that the company believes its shares are undervalued, and enhancing EPS by reducing the total number of outstanding shares. It can also be a way for the company to deploy excess cash effectively.
Example: In May 2022, BMW approved a buyback of up to 10% of its share capital over five years. The main goal was to retire these shares, consequently decreasing the share capital. Moreover, this could facilitate the transfer of shares to BMW employees as part of their employee share program. (Source: bmwgroup)
Bankruptcy is the final phase of corporate restructuring, triggered when a company is in financial distress and struggling to meet debt obligations (interest or principal payments), or when the market value of its liabilities surpasses that of its assets. The former scenario is termed technical insolvency, while the latter is known as legal insolvency.
Bankruptcy involves legal proceedings meant to shield the company from liquidation due to either technical or legal insolvency. A company is not declared bankrupt until it files for bankruptcy or if its creditors initiate reorganization or liquidation petitions.
Firms and creditors have two options for dealing with insolvency: out-of-court settlement and in-court settlement. In-court settlement can be one of two types: Chapter 11, focused on rehabilitating and restructuring the business to ensure ongoing operations and financial stability, and Chapter 7, entailing asset liquidation to repay creditors and often leading to the cessation of the company’s operations.
Example: On Jun 1, 2009, General Motors Corporation (Old GM) and three of its domestic direct and indirect subsidiaries filed voluntary petitions for relief under Chapter 11 of the U.S. Bankruptcy Code. For restructuring purposes and to continue the operations, Old GM was divided into two entities – General Motors Company (the New GM) and Motors Liquidation Company (MLC). On July 10, 2009, New GM acquired substantially all the assets and assumed certain liabilities of Old GM under Section 363 Sale, while MLC continued to exist as a distinct legal entity for the sole purpose of liquidating remaining assets and liabilities. The Section 363 Sale was completed in accordance with the Bankruptcy Court’s sale order dated July 5, 2009. The New GM exited bankruptcy protection in a mere 40 days. This was the largest industrial bankruptcy in the history of the USA. (Source: gm)
Corporate restructuring is vital for adapting to change, enhancing efficiency, and optimizing financial health. It may involve M&A activity, divestment, or workforce adjustments. Financial strategies such as reducing debt, raising capital, and repurchasing shares play a critical role. These strategies are crucial for sustained success and resilience, regardless of the industry.