Corporate Restructuring: Types and Importance

Table of contents

1. Introduction
2. Benefits
3. Need for Corporate Restructuring
4. The importance of Synergy
5. Global challenges prompting for Corporate
6. Inorganic Growth in lieu of Organic Growth
7. Types of corporate restructuring
8. Differences between Merger and Acquisition
9. Strategic Alliance
10. Joint Ventures
11. Instances of beneficial corporate restructuring

1. Introduction

• • When a company wants to grow or survive in a competitive environment, it needs to restructure itself and focus on its competitive advantage.
  • A larger company can achieve economies of scale. A bigger size also enjoys a higher corporate status. Such status allows it to take advantage of raising funds at lower cost. Such reduction in the cost of capital results into higher profits.
  • Corporate Restructuring focuses on cost reduction and improving efficiency and profitability.
  • Corporate Restructuring means rearranging the business of a company for increasing its efficiency and profitability. Today, restructuring is not an option but a conscious choice made by companies.
  • Every corporate restructuring exercise aims at eliminating disadvantages and to combine advantages. It plans to achieve synergy benefits through a well-planned restructuring strategy.

Dive Deeper:
[FAQs] on Accounting Aspects of Corporate Restructuring

2. Benefits

Mergers, amalgamations and acquisitions are forms of inorganic growth strategy. Such corporate restructuring strategies have one common goal viz. to create synergy. Such synergy effect makes the value of the combined companies greater than the sum of the two parts. Basically, synergy may be in the form of increased revenues and/or cost savings. Corporate Restructuring aims at improving the competitive position of an individual business and maximizing its contribution to corporate objectives.

Through mergers and acquisitions, companies hope to benefit from the following:

(1) Increase in Market Share – Merger facilitates increase in market share of the merged company. Such rise in market share is achieved by providing an additional goods and services as needed by clients. Horizontal merger is the key to increasing market share. (E.g. Idea and Vodafone)

(2) Reduced Competition – Horizontal merger results in reduction in competition. Competition is one of the most common and strong reasons for mergers and acquisitions. (HP and Compaq)

(3) Large size – Companies use mergers and acquisitions to grow in size and become a dominant force, as compared to its competitors. Generally, organic growth strategy takes years to achieve large size. However, mergers and acquisitions (i.e. inorganic growth) can achieve this within few months. (E.g. Sun Pharmaceutical and Ranbaxy Pharmaceutical)

(4) Economies of scale – Mergers result in enhanced economies of scale, due to which there is reduction in cost per unit. An increase in total output of a product reduces the fixed cost per unit.

(5) Tax benefits – Companies also use mergers and amalgamations for tax purposes. Especially, where there is merger between profit making and loss-making company. Major income tax benefit arises from set-off and carry forward provision u/s 72A of the Income-tax Act, 1961.

(6) New Technology – Companies need to focus on technological developments and their business applications. Acquisition of smaller companies helps enterprises to control unique technologies and develop a competitive edge. (E.g. Dell and EMC)

(7) Strong brand – Creation of a brand is a long process; hence companies prefer to acquire an established brand and capitalize on it to earn huge profits. (E.g. Tata Motors and Jaguar)

(8) Domination – Companies engage in mergers and acquisitions to become a dominant player or market leader in their respective sector. However, such dominance shall be subject to regulations of the Competition Act, 2002. (E.g. Oracle and I-Flex Technologies)

(9) Diversification – Amalgamation with companies involved into unrelated business areas leads to diversification. It facilitates the smoothening of business cycles effect on the company due to multiplicity of businesses, thereby reducing risk. (E.g. Reliance Industries & Network TV18)

(10) Revival of Sick Company – Today, the Insolvency and Bankruptcy Code, 2016 has created additional avenue of acquisition through the Corporate Insolvency Resolution Process.

Notable mergers/demergers/acquisitions that took place are Myntra acquiring Jabong, RIL acquiring Network TV18, Sun Pharma absorbing Ranbaxy; Wirpo demerger, Reliance Industries demerger.

3. Need for Corporate Restructuring

• • Corporate Restructuring means re-arranging business of a company for increasing its efficiency and profitability. Restructuring is a method of changing the organizational structure in order to achieve the strategic goals of the organization. It involves dramatic changes in an organization.
  • The strategy adopted shall depend on the purpose or organizational goals and hence a different strategy shall apply to different companies. Corporate Restructuring aims at different things at different times for different companies and the single common objective in every restructuring exercise is to eliminate the disadvantages and combine the advantages.
  • The above statement is true in every sense. The various needs for undertaking a Corporate Restructuring exercise are as follows –

(a) focus on core competence, operational synergy, cost reduction and efficient allocation of managerial capabilities;

(b) balance utilization of available infrastructure and resources;

(c) economies of scale by expansion to exploit domestic and international markets;

(d) revival and rehabilitation of a sick unit by adjusting losses of the sick unit with profits of a healthy company;

(e) acquiring constant supply of raw materials and access to scientific research and technological developments;

(f) capital restructuring by appropriate mix of loan and equity funds to reduce the cost of servicing and improve return on capital employed;

(g) improve corporate performance to achieve competitive advantage by adopting the radical changes brought out by information technology.

4. The importance of Synergy

All mergers and acquisitions have one common goal, i.e., to create synergy that makes the value of the combined companies greater than the sum of the two parts. The success of a merger or acquisition depends on whether this synergy is achieved or not. Synergy may be in the form of higher revenue streams and cost savings.

Synergy implies that combined result of two enterprises is better that simple addition of each of them, i.e. 1+1 > 2. It means that merger leads to operational efficiencies. The combination of operations creates integration, which in turn increases earnings potential and reduces cost. Synergies can be expected to flow from highly focused operational efforts, rationalization and simplification of processes, rise in productivity, better procurements, and eliminate duplication. It leads to combining their resources, such as production facilities, marketing channels, managerial skills etc. Synergy is based on an ability of an enterprise to utilize its resources for better results in combination with another enterprise.

5. Global challenges prompting for Corporate

5.1 Restructuring

• • Industrial Policy of 1991, introduces liberalization, privatization and globalization in the Indian economy. This led to relaxation of licensing, inflow of foreign investments, foreign technology, boost to private section, Govt. disinvestments etc.
  • Due to these changes, traditional businesses became dynamic, Govt. protection to private sector reduced, entry of multinationals in Indian markets etc. Hence, there was considerable rise in number of suppliers and cut-throat competition.
  • In view of such cut-throat competition, there is a need to align business activities with a focus on maximizing shareholders’ wealth. This gives rise to various strategic decisions.
  • Competition is an important driver for change, and hence corporate restructuring becomes vital. Competition drives technological development, cost cutting and value addition. Innovations and inventions happen out of necessity to meet challenges of competition.
  • Globalization leads to increased competition. Such competition can be related to product and service cost and price, target market, technological adaptation, quick response, quick production by companies, etc. Such competition drives people to change and adapt and face global challenges.
  • Thus, to be globally competitive and survive in the business with surplus, an enterprise needs to restructure with inventions and innovations.

6. Inorganic Growth in lieu of Organic Growth

• • Liberalization, Privatization and Globalization of Indian economy led to relaxation of licensing, inflow of foreign investments, boost to private section, Govt. disinvestments etc. Due to these changes, traditional businesses became dynamic, rise in cut-throat competition etc.
  • Aligning business activities in line with the prime objective of maximizing shareholders’ wealth has driven large corporate entities into taking various strategic decisions.Basically, organic growth strategy relates to business or financial restructuring within the organization that results in higher customer base, increased sales, better revenue etc. Organic growth does not result in any change of corporate entity.
  • Inorganic growth strategy includes change in the corporate identity through involvement/alliance/association with other entities.
  • In an organic growth strategy, there is change in the business model, along with management styles, financial structure etc.
  • Mergers, demergers, disinvestments, takeovers, joint ventures, franchising, strategic alliances, slump sale are some options that are adopted as a measure to achieve inorganic growth strategy.
  • Rationale for inorganic growth strategy —

i. Orderly redirection of activities,

ii. redeployment of surplus cash in other enterprises,

iii. utilizing inter-dependence among businesses,

iv. risk reduction through diversification

v. development of core competencies

vi. economies of scale through vertical, horizontal integration etc.

7. Types of corporate restructuring

• To achieve strategic and financial synergies, following types of restructuring can be performed :

1. Merging of two or more companies.

2. Purchasing assets of another company

3. Acquisition of equity shares of another firm resulting in change of ownership

4. Financial re-engineering

5. Buying-back of shares

6. Issuing different types of debts to meet the need for fixed and working capital

7. Infusing foreign debts and equity

• Further, to achieve internal reorganizing, following strategies-
  • • Reducing the manpower
    • Closing uneconomical/non-value-adding units
    • Cost reduction programs:
    • Disposing off obsolete assets
    • Reorganizing the business processes
• Different modes of Corporate Restructuring are as under:

(1) Merger

(2) Demerger

(3) Reverse Merger

(4) Disinvestment

(5) Takeovers

(6) Joint Venture

(7) Strategic alliance

(8) Franchising

(9) Slump Sale

8. Differences between Merger and Acquisition

9. Strategic Alliance

Strategic Alliance is an agreement between two or more parties to collaborate/cooperate with each other in order to achieve certain commercial objectives.

• • In a strategic alliance, all participating companies retain their independent existence. In other words, no separate entity is created.
  • Strategic alliance is a partnership between enterprises for common benefits such as cost reduction, technology sharing, product development, market access etc.
  • The basic idea is to pool resources and facilitate innovative ideas and techniques with the common objective of sharing benefits. E.g. Flipkart and OLX.
  • Strategic alliances allow organizations to pursue opportunities at a faster pace. It provides access to additional knowledge and resources that are held by the other party.

10. Joint Ventures

Joint Venture is a separate entity formed by two or more companies to undertake commercial activities together. In a joint venture, a new enterprise is formed with participation in ownership, control and management of two or more parties.

• • The parties agree to contribute equity to form a new entity and shares the revenues, expenses and capital of the company. E.g. Vistara Airlines is a JV between Tata and Singapore Airlines.
  • A joint venture may be of two types —
    i. Project based JV entered into by the companies in order to achieve specific tasks.
    ii. Functional based JV is entered into by companies in order to achieve mutual benefit.
  • A joint venture provides access to assets, knowledge and funds from both of its partners it can combine the best features of those companies without altering the parent companies.

11. Instances of beneficial corporate restructuring

1. L&T Ltd. demerged its cement division into a separate company Ultratech Cement Co. Ltd. Later, the resulting company was transferred to Grasim Industries (Aditya Birla Group). Post deal, L&T benefited from realized value of its cement division and focus on their core businesses such as engineering and construction. Grasim Ind. was benefited through economies of scale, increased capacity, overall competitiveness, multifunctional synergies and combined resource pool.

2. Tata Steel Ltd. acquired overseas Corus Group Plc. that drastically improved the production synergies for Tata Steel Ltd. Through the acquisition, Tata Steel Ltd. could combine its low-cost production with the high quality of Corus. It resulted utilization of wide retail and distribution network, technology transfer and enhanced R&D capabilities.

3. Dr. Reddy’s Laboratory Ltd. is known for their inorganic growth strategies. Since its formation in 1984, it has acquired many companies such as Benzex Lab (1984), Meridian Healthcare (2002), Falcon (2005), Betapharm (2006), DowPharma Small Molecules Business (2008), BASF (2008), Alliance with GlaxoSmithKline (2009).

4. Piramal Healthcare transferred its undertaking (Formulation business) to Abbot Healthcare on a slump sale basis. The deal was finalized for a lumpsum consideration. The deal also contained a non-compete clause, which prohibited Primal group from entering in similar formulation business. As per Section 50B of the Income Tax Act, capital gains arising from the deal were taxed, without any indexation benefit (applicable for long term assets)

5. Bharti Airtel Ltd. acquired Zain Telecom (Africa business) through a leveraged buyout strategy. The acquisition of Zain Africa International BV was majorly financed through borrowed funds. Bharati Airtel formed a Special Purpose Vehicle (SPV) and the deal was structured through the SPV. Hence, the Balance Sheet of Bharati Airtel was untouched. However, as a guarantor for special purpose vehicles, Bharti Airtel assumes full responsibility.