Corporate Restructuring

Corporate Restructuring

Corporate restructuring is another area where extraordinary changes, ones that don’t always occur under the best of circumstances, can create investment opportunities. While the term “corporate restructuring” can mean a lot of things, when we talk about restructuring, we won’t be talking about minor tweaking around the edges, we’ll be talking about big changes. Not just any division, either. We’re talking a big division, at least in relation to the size of the entire company.

Of course, corporate restructurings are going on all the time. It’s painful and sometimes necessary part of the capitalist system. The type of restructuring situations that we’ll focus on and the ones that provide the most clear-cut investment opportunities are the situations where companies sell or close major divisions to stanch losses, pay off debt, or focus on more promising lines of business.

The reason why major corporate restructurings may be a fruitful place to seek out investment opportunities is that oftentimes the division being sold or liquidated has actually served to hide the value inherent in the company’s other business. A simple example might be a conglomerate that earns $2 a share and whose stock trades at thirteen times earnings, or $26. In reality that $2 in earnings may really be made up of the earnings of two business lines and the losses of another. If the two profitable divisions are actually earning $3 per share while the other division contributes a $1 loss, therein lies an opportunity. If the money-losing division could simply be sold or liquidated with no net liability, the conglomerate would immediately increase its earning to $3 per share. At a price of $26, this would lower the stock's earnings multiple from 13 to less than nine. In many cases, the sale or liquidation of a loss-ridden business can result in positive proceeds. Of course, this would make the investment opportunity more compelling.

Similar to the benefits that result from spinoffs, the sale of a major division may create a more focused enterprise which can offer real advantages to both the company and its shareholders. This benefits both management - who can focus on more limited and promising operations - and the value of the company in the marketplace - which may be willing to pay a premium for more specialized and profitable business operations. Though it may seem counter-intuitive (because, in many such cases, there has been a business failure), companies that pursue a major restructuring are most often among the most shareholder oriented. Unless a company is in extreme distress, just making the decision to sell a major division is an extremely difficult thing to do. Most managements that go through with such a plan have their eye on shareholder interests.

There are basically two ways to take advantage of a corporate restructuring. One way is to invest in a situation after a major restructuring has already been announced. There is often ample opportunity to profit after an announcement is made because of the unique nature of the transaction. It may take some time for the marketplace to fully understand the ramifications of such a significant move. Generally, the smaller the market capitalization of a company (and consequently the fewer the anlysts and institutions following the situation), the more time and opportunity you may have to take advantage of a restructuring announcement. 

The other way to profit is from investing in a company that is ripe for restructuring.This is much more difficult to do. I don't usually seek out these situations, although sometimes an opportunity can just fall in your lap. The important thing to learn is to recognize a potential restructuring candidate when you see one. If it's obvious to you, many managements (especially those with large stock positions) are often thinking along the same lines.

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Joel Greenblatt