STRATEGIC FINANCIAL
MANAGEMENT – PART 2
KU Leuven
Summary of Strategic Financial Management (Part 2)
This is a summary of the second part of the course ‘Strategic Financial Management’ taught
by Prof. N. Dewaelheyns. The summary is based on the PowerPoint slides of Prof. N.
Dewaelheyns and notes taken in class.
Academic year: 2020-2021
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PART 2 ............................................................................................................................................................2
1 RESTRUCTURING AND DIVESTITURES .....................................................................................................2
1.1 BENEFITS OF M&A ACTIVITIES .....................................................................................................................2
1.2 ALTERNATIVE FORMS OF COOPERATION..........................................................................................................2
1.2.1 Joint venture................................................................................................................................2
1.2.2 Alliance ........................................................................................................................................3
1.2.3 Licensing......................................................................................................................................3
1.2.4 Minority investments ..................................................................................................................3
1.3 DIVESTITURES ...........................................................................................................................................4
1.3.1 Divestitures and value creation: theory ......................................................................................5
1.3.2 Why divest? .................................................................................................................................6
1.3.3 Empirical studies .........................................................................................................................7
2 FINANCIAL RESTRUCTURING ................................................................................................................10
2.1 FINANCIAL AND STRATEGIC VALUE CREATION .................................................................................................10
2.2 LEVERAGED RECAPITALIZATIONS .................................................................................................................10
2.2.1 Result 1 – More tax-deductible interest expenses.....................................................................10
2.2.2 Result 2 – change in ownership percentage of managers/insiders ...........................................11
2.2.3 Empirical studies .......................................................................................................................12
2.3 DUAL-CLASS STOCK RECAPITALIZATION (DCR) ...............................................................................................13
2.4 EXCHANGE OFFER ....................................................................................................................................14
2.5 FINANCIAL DISTRESS .................................................................................................................................14
2.5.1 Bankruptcy ................................................................................................................................15
2.5.2 Costs of financial distress ..........................................................................................................15
2.5.3 Liquidations ...............................................................................................................................17
3 GOING PRIVATE AND LEVERAGE BUYOUTS (LBOS) ...............................................................................18
3.1 GOING PRIVATE .......................................................................................................................................18
3.2 LEVERAGE BUYOUT ..................................................................................................................................18
3.2.1 LBO versus leveraged recap ......................................................................................................18
3.2.2 Deal structure............................................................................................................................18
3.2.3 Valuation of LBO companies .....................................................................................................21
3.2.4 LBO stages.................................................................................................................................22
3.2.5 LBO targets ...............................................................................................................................23
3.3 EXIT STRATEGIES ......................................................................................................................................23
3.4 EMPIRICAL STUDIES ..................................................................................................................................23
3.4.1 Overview (‘80s sample) .............................................................................................................23
3.4.2 Value creation in LBOs ..............................................................................................................24
3.4.3 Optimism or misrepresentation? ..............................................................................................25
3.4.4 LBO activity ...............................................................................................................................25
3.4.5 LBO activity and covid-19 ..........................................................................................................26
4 SHARE REPURCHASES...........................................................................................................................28
4.1 REPURCHASE AND PAY-OUT POLICY .............................................................................................................28
4.2 REPURCHASE MOTIVES..............................................................................................................................28
4.3 DIFFERENT TYPES .....................................................................................................................................29
4.3.1 Fixed-price tender (FPT) offers ..................................................................................................29
4.3.2 Dutch auction repurchase (DAR) ...............................................................................................30
4.3.3 Transferable put rights (TPR) ....................................................................................................31
4.3.4 Open market repurchases (OMR)..............................................................................................31
4.4 EVENT STUDIES .......................................................................................................................................32
4.5 UNDERVALUATION MODEL ........................................................................................................................32
4.6 REPURCHASES VS. DIVIDENDS .....................................................................................................................33
4.7 COVID-19 AND PAYOUT POLICY ..................................................................................................................34
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,5 TAKEOVER DEFENSES ...........................................................................................................................35
5.1 HOSTILE TAKEOVERS .................................................................................................................................35
5.2 DEFENSE MECHANISMS .............................................................................................................................35
5.2.1 Indirect strategies .....................................................................................................................35
5.2.2 Preventative strategies .............................................................................................................36
5.2.3 Ad-hoc strategies ......................................................................................................................38
5.3 TAKEOVER DEFENSES IN EUROPE VERSUS US .................................................................................................40
5.4 EMPIRICAL EVIDENCE ................................................................................................................................40
5.4.1 Do takeover defenses work? .....................................................................................................40
5.4.2 Shareholder value .....................................................................................................................40
5.4.3 Effectiveness and stock price impact.........................................................................................41
5.4.4 Shift towards softer strategies (in the US) ................................................................................41
5.4.5 Shareholder activism .................................................................................................................41
6 INVESTMENT STRATEGIES AND MERGER ARBITRAGE ...........................................................................42
6.1 INVESTMENT STRATEGIES ..........................................................................................................................42
6.2 MERGER ARBITRAGE ................................................................................................................................42
6.2.1 Cash offer ..................................................................................................................................43
6.2.2 Exchange offer ..........................................................................................................................44
6.2.3 Combined offer..........................................................................................................................46
6.3 EMPIRICAL EVIDENCE ON MERGER ARBITRAGE PERFORMANCE ...........................................................................47
6.4 MERGER ARBITRAGE FUNDS .......................................................................................................................47
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,Part 2
1 Restructuring and divestitures
1.1 Benefits of M&A activities
Synergy – the sum is greater than the parts:
• Economies of scale – by far the most important driver of value creation in M&As:
o Cost reduction in production, administrative expenses and R&D
o Increased market power
• Economies of scope:
o Wider range of products
o Complementarities
• Technological advantages – buying knowhow is much faster than creating it yourself:
o Purchase existing technologies and patents
o Purchase R&D capacity and know-how
• Industry consolidation:
o Reduce capacity surplus
o Focus on activities with potential for growth and profit
• Attract new skills:
o Management
o Highly qualified personnel
• Client relationship:
o ‘Follow the client’ – if the client becomes active in another country, you could
try to follow the client.
o One-stop shopping solutions
• Globalisation:
o Growth in foreign markets
o Delocalised production (low wages, low regulation)
• Diversification:
o Reduce risk in uncertain times – not putting all your eggs in one basket
However, expansion through traditional M&A’s are not the only nor often the optimal
solution in terms of focus and profitability.
1.2 Alternative forms of cooperation
There are alternative forms of cooperation which have a lower impact than the formal M&A’s
and allow to achieve very specific goals. Get some of the advantages of M&A without all the
drawbacks.
1.2.1 Joint venture
Joint venture= a new entity is created with input from 2 or more partners/shareholders and
then you pool your resources to create something larger.
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, • Scope advantages/build experience – you can scale without having to merge
E.g. LG and Philips: the technology to make very big flatscreen tv’s existed, but it was
too expensive; the production size needed to be scaled up (expensive), but if you work
together the production size gets bigger without having to make a lot of costs.
• Cooperation with a local partner
• Often technology driven
It is less formal than an M&A, but you still need to create a new company (invasive).
1.2.2 Alliance
Alliance= informal cooperation and pooling of resources; there are a large number of partners
of equal magnitude without having to create a new company.
• An alliance does not create a new company, it is a cooperation with other players in
the same industry to obtain a certain goal.
• It is very flexible and easy to tailor make to get the advantages you need.
• E.g. airlines: Star Alliance; tech: Blu-ray alliance
1.2.3 Licensing
Licensing= cash in on existing technology/know-how without the need for additional
investments.
• It is an inexpensive way to spread a branch across the world – scope or scale without
having to do anything yourself.
• E.g. Walt Disney: they develop characters (intellectual property) and if you want to do
anything at all with one of those characters, they will not do that themselves; other
people can pay Walt Disney a licensing fee to make products/movies/… with the Disney
characters.
1.2.4 Minority investments
Minority investment= buy a limited amount of shares to formalize cooperation.
• Often used as an option to buy interesting technology.
• It can also be used to limit future competition – if you step in early, you can do it cheap;
you will get complete information on what those companies are doing without having
to invest big time and when the company becomes bigger the large corporation buys
out the ‘smaller’ company for a reasonable price and limits its competition.
• You almost never get into trouble with anti-trust, because you are investing in
relatively small companies.
• E.g. Microsoft, Intel
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,1.3 Divestitures
External changes force companies to adjust:
• Type of change causes a need for certain types of synergy gains.
• Type of synergy needed drives the choice of growth strategy.
Mergers, asset acquisitions, minority investments, alliances, joint ventures and licensing are
all ways of creating value by expanding a company/operation/… However, it can also be
advisable to become smaller: through divestiture (becoming smaller but hopefully more
efficient and manageable – creating value by removing existing activities).
In some cases, the most appropriate way to create value is not to add new activities, but to
remove existing activities: divestiture.
Types:
• Asset sale= straight sale of subsidiaries/divisions because they are not needed
anymore for the long-term growth strategy; it raises cash for other purposes.
Motives for asset sales are:
o Cash generation – generates cash fast
o Anti-trust – often, you are allowed to do M&As only if you sell some activities
to stay under the maximum threshold for market share (regulatory restrictions)
o Conglomerate focus – selling activities you do not need anymore
• Spin-off= create a new company for a part of the original company’s activities;
distribute the shares of the new company among the existing shareholders of the
original company (no cash generation) – increase attention for that specific part.
• Carve-out= sort of like a spin-off, but the new company’s shares are offered to the
general public (IPO).
There is a difference between a…
o Full carve-out: all the new company’s shares are sold to the general public.
o And a partial carve-out: not letting loose of the entire new company, sell half
of the shares and keep the other half for a while to show that you believe in
the new company.
Summary:
Asset sale Spin-off Carve-out
Description Divestiture of a Transfer of Offering of parts of a
company’s subsidiary ownership of part of company subsidiary
to another company a company to to the public (IPO)
or a private equity- shareholders
firm
Proceeds to seller Full transaction price None IPO (typically <50%)
Synergies Yes None None
Transaction speed Fast (6-9 months) >12 months Slow (>12-18
months)
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,Divestitures are often executed in stages (e.g. Partial carve-out followed by an asset sale or
spin-off of the remainder of the new equity) – divestment plan in different phases.
Divestitures are often part of a corporate restructuring plan but can also be forced by poor
market conditions or regulation (e.g. anti-trust).
The most extreme type of divestitures is split-up (‘starbursting’):
• Voluntary and complete split-up of the parent company to increase shareholder value.
• If you keep on selling and splitting up divisions, your whole company will be split up in
the end – this is very uncommon because managers do not like this.
• E.g. Tyco International, GB-Inno-BM (GIB)
Less frequently used (sub-)types of divestitures are:
• Exchange offer: spin-off in which the shareholders of the parent company can choose
whether or not to accept shares of the new company.
• Tracking stocks (‘internal spin-off’): create a new class of shares; value of the shares is
linked to the performance of a specific division within the company.
o Investors can choose whether they want to invest in the company as a whole
or in a specific activity.
o Rationale:
§ Offers a solution for the conglomerate discount of diversified
companies.
§ Possibility to increase the market value of ‘hot activities’, without
having to formally reorganize the company.
o Drawback: there are problems regarding transparency and bad performance of
tracking stocks à virtually all tracking stocks have disappeared.
1.3.1 Divestitures and value creation: theory
Irrelevance theories (assumptions) – build a framework to think about a certain problem by
creating a list of assumptions to create an ideal world to get to a point where nothing matters
anymore in order to understand the imperfect real world.
• Modigliani & Miller (1985, 1961): value of a corporation is not related to its capital
structure or dividend policy.
• Coase (1960): liability & ownership structure; economic agents will always choose the
same optimal solutions regardless the distribution of ownership (‘invariance thesis’).
• Vickrey (1961): auction design; an action’s revenues are not related to the design of
the auction mechanism (‘revenue equivalence theorem’).
à The irrelevance theories imply that in a ‘perfect world (e.g. no transaction costs, no costs
of information), it is impossible to create value through restructuring (value sum = sum of the
parts).
So, potential value drivers in the real world are the reduction in:
• Monitoring costs: divestitures will make it more efficient to monitor costs
• Information costs: the attention for a spin-off or carve-out increases
• Transaction costs: taxes or regulation can give rise to M&A or divestiture waves in
order to minimize those costs
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, 1.3.2 Why divest?
Many companies are active in different industries. However, if the motivation for
diversification is risk reduction, there is a conglomerate discount:
• If investors believe that the main reason for diversification is risk minimization,
investors will pay less for your shares.
• Investors want to pay more for a company with more focus than for a general
conglomerate. The difference between the valuation of a general conglomerate and a
more focused company is the conglomerate discount.
• On average, conglomerate discount is 10-15%, but if you are extremely diversified it
could be a lot more (e.g. up to 30%) – Berger and Ofek (1995)
M&A/Divestiture motives – Mukherjee, Kiymaz and Baker:
• Did a survey of CFOs of companies involved in the largest M&A deals in the US during
1990-2001.
• The most important motives for M&A are synergies and diversification (economists
are less happy about diversification, but it is understandable from a manager point of
view).
• The most important motives for divestitures are increasing focus and divesting a low-
performing division (other motives are increasing managerial efficiency or a specific
organizational form).
A more recent analysis from Boston Consultancy Group found that divestiture motives differ
across industries:
à On average, 45% of all buying and selling deals are divestitures (= scale reducing
rather than scale enlarging).
à In health and high technology industries, there are noticeably less divestitures.
Those industries are still growing, so the companies do more scale enlarging deals.
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