Theory of Business Restructuring

Theory of Business Restructuring

Business Restructuring: Profitable growth constitutes one of the prime objectives of most of the business firms. It

can be achieved internally by developing new products or enlarging capacity of existing products. Alternatively it

can be facilitated ‘externally’ by acquisitions of existing business firms. The acquisitions may be in the form of

mergers, acquisitions, amalgamations, takeovers, absorption, consolidation and so on. All these terms are

interchangeably used to denote the process of corporate or business re-structuring. There is no common definition

of these terms. In general terms, the terms are explained below:

Merger: The term merger includes consolidation, amalgamation and absorption. It refers to a situation when two or

more existing firms combine together and form a new entity. Either a new company may be incorporated for this

purpose or one existing company (generally a bigger one) survives and another existing company (which is smaller)

is merged into it.

If a new company is incorporated it is known as a case of consolidation/ amalgamation.

However if an existing company is merged into another existing company, it is known as absorption.

Acquisition: It includes takeovers also. In general, acquisition refers to the acquiring of ownership right in the

property and asset of other company. The other company of which the control is so acquired, remains a separate

company and is not liquidated. E.g. AV Birla group had acquired Cement division of L & T ltd now known as

Grasim Cements. Mahindra Tech took over Satyam ltd. Acquisition can be by purchase of shares wherein the

purchaser acquires the control and management of the target company or Acquisition can be by purchase of assets

and liabilities against which cash is paid to the target company. In this case the buyer cherry picks the assets he is

interested in and leave the rest, example: RIL acquiring shale gas assets in US.

Functional classification of Mergers and Acquisitions (M & A)

Different types of merger and acquisitions can be classified on the basis of the functional relationship between two

companies and the economic impact of the merger on their operations. The merger may take place in any of the

following situations.

1. Horizontal Merger: It is a case of merger of two or more companies that compete in the same industry. It is a

merger with a direct competitor and hence expands the firms operations in the same industry. Horizontal

mergers are designed to produce, primarily, substantial economies of scale and result in decrease in the

number of competitors in the industry.

2. Vertical Merger: It is a merger which takes place upon the combination of two companies which are operating

in the same industry but at different stages of production or distribution system. It a company takes over its

supplier/producers of raw material, and then it may result in backward integration of its activities. On the

other hand, forward integration may result if a company decides to take over the retailer or Customer

Company. Vertical merger may result in many operating and financial economies. The transferee firm will get a

stronger position in the market as its production/ distribution chain will be more integrated than that of the

competitors.

3. Conglomerate Merger: It is a merger of two or more firms operating in different and unrelated industries. It is

an expansion of a company into areas unrelated to existing lines of business. In this case, the company may

not get the operating economies such as those which may arise in case of horizontal or vertical merger. This is

a case of diversification.

De-merger: Demerger is a process where the part of the business is divided or the product line of the company is

separated. In case of multi product business, often the management thinks of division of different products into

different companies for several reasons like creating value to the shareholder, making business more transparent to

the stakeholders, family arrangement etc e.g. Ruias of ESSAR group is proposing to demerge their existing business

into separate entities of shipping, logistics and oilfields. Bajaj auto demerged their business into separate entities

for manufacturing business and financial service in view of their family arrangement.

Reverse Merger: It is a merger of a prosperous and profit-making company into a loss making company which is

generally a sick company and having eroded a substantial portion of its networth. The motive mainly is to takes

advantage of the tax concessions which otherwise will be lost if loss making business operates separately.

Motives and reasons behind Mergers:

1. Operating economies: When a firm having strength in one functional area acquires another firm with

strength in a different functional area, synergy may be gained by exploiting the strength in these areas.

2. Diversification: Diversification into new areas and new products can also be a motive for a firm to merge

another with it.

3. Financial Synergy: Financial synergy refers to increase in the value of the firm that accrues to the

combined firm from financial factors such as better use of cash slack or tax benefit, etc.

a) Cash Slack: It is a situation in which the firm has excess cash than what is needed to finance firm’s

existing viable projects. It makes a sense for a company with excess cash and no investment

opportunities (known as cash slack) to takeover a cash poor firm with good investment opportunities or

vice-versa.

b) Tax Benefits: Several tax benefits may accrue from take-overs. First if one of the firm has tax

deductions that it cannot use because it is incurring losses, whereas the other firm has profits on

which it pays taxes, combining the two firms can result in tax benefits.

4. Corporate Control: There may be company’s with good business models but poor management. In such a

case many hostile take-over bids are justified on the basis of existence of a value for corporate control.