A leveraged buyout ( LBO ) is a financial transaction in which a company is purchased with a combination of equity and debt, so that the company's cash flow is the collateral used to secure and repay the loan. The use of debt, which has a lower capital cost than equity, serves to reduce the overall cost of acquisition financing. Lower debt costs as interest payments reduce corporate income tax liabilities, while dividend payments are not. This decrease in financing costs enables greater gains for equity, and, as a result, debt serves as a lever to increase return on equity.
The term LBO is commonly used when a financial sponsor acquires a company. However, many of the company's transactions are partially funded by bank debt, thus effectively also representing LBO. LBO can have various forms such as purchasing management (MBO), buy-in management (MBI), secondary purchases and tertiary purchases, among others, and can occur in growth situations, restructuring situations, and bankruptcy. LBO mostly occurs in private companies, but can also be employed by public companies (in so-called PtP transactions - Public to Private).
Because financial sponsors increase profits by using very high leverage (ie high debt to equity ratio), they have an incentive to use as much debt as possible to finance the acquisition. This, in many cases, leads to situations where companies are "over-leveraged", meaning that they do not generate sufficient cash flow to service their debt, which in turn leads to bankruptcy or debt-to-equity swap in which the owner of the equity loses control of the business to the lender.
Video Leveraged buyout
Characteristics
LBOs have become attractive because they usually represent a win-win situation for financial sponsors and banks: financial sponsors can increase their equity returns by using leverage; banks can make a much higher margin when it supports LBO financing compared to regular corporate loans, since interest rates are much higher. Banks may increase their likelihood of being repaid by obtaining assurance or security.
The amount of debt that banks are willing to provide to support LBO varies greatly and depends, inter alia, on:
- Quality of assets to be acquired (cash flow stability, history, growth prospects, hard assets, etc.)
- The amount of equity provided by the financial sponsor
- The history and experience of the financial sponsors
- The overall economic environment
For companies with very stable and secure cash flow (eg, real estate portfolio with rental income secured by long-term lease agreements), debt volume of up to 100% of the purchase price has been provided. In a "normal" corporate situation with normal business risks, the 40-60% debt of the purchase price is an ordinary figure. Debt ratios that may vary significantly between target regions and industries.
Depending on the size and purchase price of the acquisition, the debt is given in various stages.
- Senior debt: This debt is secured by the assets of the target company and has the lowest interest margin
- junior debt (usually mezzanine): this debt usually has no securities and thus bears a higher interest margin
In larger transactions, sometimes all or some of these two types of debt are replaced by high yield bonds. Depending on the size of the acquisition, debt and equity can be provided by more than one party. In larger transactions, debt is often syndicated, meaning that the bank managing the credit sells all or part of the debt in pieces to other banks in an effort to diversify and thereby reduce the risk. Another form of debt used in LBOs is the seller's record (or vendor loan) in which the seller effectively uses part of the proceeds to lend to the buyer. Such seller records are often used in management purchases or in situations with very tight bank financing environments. Note that in close proximity to all LBO cases, the only guarantee available for debt is the company's assets and cash flows. Financial sponsors can treat their investments as general equity or preferred equity among other types of securities. The selected equity can pay dividends and have a payment preference for general equity.
As a rule of thumb, senior debt usually has a 3-5% interest margin (above Libor or Euribor) and must be repaid within 5 to 7 years; junior debt has a margin of 7-16%, and must be paid back in one payment (as a bullet) after 7 to 10 years. The junior debt often also has a warrant and its interests are often part or partial of the PIK nature.
In addition to the amount of debt that can be used to fund purchases with leverage, it is also important to understand the type of company sought by private equity firms when considering purchases with leverage.
While different companies pursue different strategies, there are several characteristics that apply in many types of leverage purchases:
- Stable cash flow - Companies acquired in leveraged buyouts must have sufficiently stable cash flows to pay interest expenses and pay principal from time to time. So mature companies with long-term customer contracts and/or relatively predictable cost structures are usually obtained at LBO.
- Relatively low fixed costs - Fixed costs create big risks for private equity firms because companies still have to pay them even if their income is down.
- relatively little debt is present - "mathematics" in LBO works because private equity firms add more debt to the firm's capital structure, and then the company repays it over time, resulting in lower effective effective purchases; it is more difficult to make a deal successful when the company already has a high debt balance.
- Valuation - Private equity firms prefer companies that are rated too low to be appraised properly; they prefer not to acquire trading companies with a very high multiple of ratings (relative to this sector) because the risk of valuation may decrease.
- Strong management team - Ideally, C-level executives will work together for a long time and will also have some interest in LBO by rolling out their shares during the transaction.
Maps Leveraged buyout
History
Origins
The first leveraged purchase may have been purchased by McLean Industries, Inc. from the Steam Pan-Atlantic Company in January 1955 and Waterman Steamship Corporation in May 1955. Under the terms of the transaction, McLean borrowed $ 42 million and raised an additional $ 7 million through preferred stock issues. When the deal was closed, $ 20 million in cash and Waterman assets were used to retire $ 20 million of borrowed debt.
Similar to the approach used in McLean transactions, the use of publicly traded holding companies as investment vehicles to obtain investment portfolios in company assets is a relatively new trend in the 1960s, popularized by the likes of Warren Buffett (Berkshire Hathaway) and Victor. Posner (DWG Corporation), and later adopted by Nelson Peltz (Triarc), Saul Steinberg (Reliance Insurance) and Gerry Schwartz (Onex Corporation). This investment vehicle will use a number of similar tactics and target the same type of company as the more traditional leveraged purchases and in many ways can be considered a pioneer of the then private equity firm. In fact, it is Posner that is often credited with the term coining "leveraged buyout" or "LBO."
The burgeoning debt purchases of the 1980s were conceptualized in the 1960s by a number of corporate financiers, notably Jerome Kohlberg, Jr. and then his protégé, Henry Kravis. Working for Bear Stearns at the time, Kohlberg and Kravis, along with Kravis's cousin, George Roberts, began a series of what they described as "bootstrap" investments. Many target companies do not have a viable or appealing solution for their founders, because they are too small to be public and the founders are reluctant to sell to competitors. So, sales to buyers may prove to be interesting. The acquisition of Orkin Gutted Company in 1964 was one of the first significant leverage purchase transactions. In the following years, three Bear Stearns bankers will complete a series of purchases including Stern Metals (1965), Incom (divisions of Rockwood International, 1971), Cobblers Industries (1971), and Boren Clay (1973) and Thompson Wire, Eagle Motors and Barrows through their investment in Stern Metals. In 1976, tensions had awakened between Bear Stearns and Kohlberg, Kravis and Roberts leading to their departure and the establishment of Kohlberg Kravis Roberts that year.
1980s
In January 1982, former US Treasury Secretary William E. Simon and a group of investors acquired Gibson Greetings, a greeting card manufacturer, for $ 80 million, of which only $ 1 million was rumored to have been donated by investors. In mid-1983, just sixteen months after the initial deal, Gibson completed a $ 290 million IPO and Simon earned about $ 66 million. The success of Gibson's Speech investments attracted wider media attention to a newborn boom in overpaid purchases. Between 1979 and 1989, it was estimated there were more than 2,000 debt purchases worth over $ 250 billion
In the summer of 1984, LBO was subjected to ferocious criticism by Paul Volcker, then chairman of the Federal Reserve, by John S.R. Shad, chairman of the US Securities and Exchange Commission, and other senior financiers. The essence of all cancellations is that an inverted pyramid of heavy debt is being made and that they will soon fall, destroying assets and jobs.
During the 1980s, constituents within the acquired company and the media were perceived as "corporate raids" for many private equity investments, particularly those featuring brutal corporate takeovers, perceived reduction of assets, massive layoffs or significant corporate restructuring. Among the most notable investors to be labeled corporate robbers in the 1980s include Carl Icahn, Victor Posner, Nelson Peltz, Robert M. Bass, T. Boone Pickens, Harold Clark Simmons, Kirk Kerkorian, Sir James Goldsmith, Saul Steinberg and Asher Edelman. Carl Icahn developed a reputation as a cruel corporate robber after the brutal takeover of TWA in 1985. Many corporate robbers who once served as clients of Michael Milken, whose investment banking firm Drexel Burnham Lambert helped raise the blind capital with corporate robbers who could make legitimate efforts to take over the company and provide high-yield debt financing from the purchase.
One of the major purchases of the late 1980s proved to be the most ambitious and marked the high-water mark and the early sign of the end of the explosion that began almost a decade earlier. In 1989, the KKR closed on a $ 31.1 billion takeover from RJR Nabisco. It was, at that time and for over the next 17 years, the largest leverage purchase in history. This event is recorded in the book (and then the movie), Barbarian at the Gate: The Fall of RJR Nabisco . The KKR will eventually win a RJR Nabisco of $ 109 per share that marks a dramatic increase from the original announcement that Shearson Lehman Hutton will take a private RJR Nabisco for $ 75 per share. A series of fierce negotiations and horse trading took place that pitted the KKR against Shearson Lehman Hutton and then Forstmann Little & amp; Co Many major banking players today, including Morgan Stanley, Goldman Sachs, Salomon Brothers, and Merrill Lynch are actively involved in advising and financing the parties. After Shearson Lehman's initial offer, the TRC immediately introduced a tender offer to get RJR Nabisco for $ 90 per share - a price that allowed it to proceed without RJR Nabisco's management approval. The RJR management team, working with Shearson Lehman and the Salomon Brothers, made a bid of $ 112, a figure they believed would allow them to surpass any response by the Kravis team. The KKR's final offer of $ 109, while the lower dollar figure, was finally received by RJR Nabisco's board of directors. At $ 31.1 billion in transaction value, RJR Nabisco is by far the largest leveraged purchase in history. In 2006 and 2007, a number of leveraged purchase transactions were completed, which for the first time exceeded RJR Nabisco's rebate purchase in the case of a nominal purchase price. However, adjusted for inflation, no leverage purchases for the period 2006-2007 will surpass RJR Nabisco.
In the late 1980s, the excess of the buyout market began to emerge, with the bankruptcy of several major purchases including Robert Campeau's 1988 purchase from the Federation Department Store, the purchase of Revco 1986, Walter Industries, FEB Trucking and Eaton stores. Leonard. In addition, the RJR Nabisco agreement showed signs of tension, leading to a recapitalization in 1990 involving a $ 1.7 billion new equity contribution from the TRC.
Drexel Burnham Lambert was the investment bank most responsible for the explosion in private equity during the 1980s because of his leadership in the issuance of high yield debt. Drexel reached an agreement with the government in which he pleaded for nolo contendere (no contest) for six serious crimes - three stock parking indictments and three counts of stock manipulation. He also agreed to pay a $ 650 million fine - at that time, the biggest fine ever imposed under securities laws. Milken left the company after his own indictment in March 1989. On February 13, 1990, after being advised by US Treasury Secretary Nicholas F. Brady, the US Securities and Exchange Commission (SEC), the New York Stock Exchange and the Federal Reserve, Drexel Burnham Lambert formally filed for Chapter 11 bankruptcy protection.
Mega-buyout age
The combination of lower interest rates, loosening loan standards, and regulatory changes for publicly traded companies (especially Sarbanes-Oxley Act) will set the stage for the biggest boom ever seen by the private equity industry. Characterized by the purchase of Dex Media in 2002, multibillion-dollar purchases of billions of dollars can once again obtain significant high-yield debt financing from various banks and larger transactions can be completed. In 2004 and 2005, large purchases once again became common, including the acquisition of Toys "R" Us, The Hertz Corporation, Metro-Goldwyn-Mayer and SunGard in 2005.
Since 2005 ends and 2006 begins, the newest "largest purchases" record has been set and exceeded several times with nine of the top ten purchases by the end of 2007 announced in an 18-month window from early 2006 to mid-2007. In 2006, private equity firms bought 654 US firms for $ 375 billion, representing 18 times the transaction rate closed in 2003. In addition, US-based private equity firm raised $ 215.4 billion in investor commitments to 322 funds, exceeding the previous record set in 2000 by 22% and 33% higher than total fundraising in 2005 The following year, despite the turmoil in the credit market in the summer, saw another fundraising year with $ 302 billion investor commitment to 415 funds Among the mega purchases completed during the boom 2006 to 2007 are: Property Office of Equity, HCA, Alliance Boots, and TXU.
In July 2007, the turmoil that has affected the mortgage market spilled into leveraged finance and high-yielding debt markets. The market has been very strong during the first six months of 2007, with a very friendly development of publishers including PIK and PIK Toggle (interest is " P accessible n K ind ") and light debt agreement is widely available to finance purchases with large leverage. July and August experienced significant slowdown in the issuance rates in high yield leveraged and leveraged markets with only a few emitters accessing the market. Unpredictable market conditions led to significant widening of yields, accompanied by typical summer slowdowns led many firms and investment banks to put their plans to issue debt on hold until the fall. However, the expected rebound in the market after Labor Day 2007 did not materialize and the lack of market confidence prevented the transaction from pricing. By the end of September, the entire credit situation became clear when major lenders including Citigroup and UBS AG announced a major writedown due to credit losses. Financial markets that lever almost stalled. When 2007 is over and 2008 begins, it is clear that lending standards have been tightened and the era of "buyout-mega" has ended. Nevertheless, private equity continues to be a large and active asset class and private equity firm, with hundreds of billions of dollars of capital made from investors looking to spread capital in new and different transactions.
Purchase management
A special case of acquisition with leverage is purchasing management (MBO). In MBO, the incumbent management team (which usually does not have or close to no shares in the company) acquires a substantial share of the company's shares. Similar to MBO is MBI (Purchase Management) where an external management team acquires stocks. MBO can occur for a number of reasons; for example.,
- Business owners want to retire and want to sell the company to the management team they trust (and with whom they have worked for years)
- The business owner has lost confidence in the business and is willing to sell it to management (who believes in the future of the business) to get value for the business
- Managers see value in businesses that the current owner does not see and do not want to pursue
In most situations, the management team does not have enough money to fund the necessary equity for acquisitions (combined with bank debt to form a purchase price) so the management team works with the financial sponsors to finance part of the acquisition. For the management team, negotiating an agreement with a financial sponsor (that is, who gets how much of a company's stock) is a key value creation lever. Financial sponsors often sympathize with MBO because in these cases they believe that management believes in the company's future and has an interest in value creation (not just employed by the company). There is no clear guidance as to how much of a part the management team should have after the acquisition to qualify as an MBO, compared to regular leveraged purchases where management invests with financial sponsors. However, in the use of regular terms, MBO is a situation where the management team initiates and actively encourages acquisitions.
The MBO situation leading the management team is often a dilemma because they are facing a conflict of interest, attracted to a low private purchase price while at the same time being employed by owners who clearly have an interest in high purchase prices. Owners usually react to this situation by offering transaction fees to the management team if a certain price threshold is reached. Financial sponsors usually react to this again by offering compensation to the management team for lost transaction costs if the purchase price is low. Another mechanism for dealing with this problem is profit (purchase price depending on the achievement of certain future profitability).
There may be many successful MBOs because some have failed. Important for the management team at the beginning of the process is negotiation of purchase price and agreement structure (including jealousy ratio) and selection of financial sponsorship.
Secondary and tertiary purchase
Secondary purchases are a form of leveraged purchase where buyers and sellers are private equity firms or financial sponsors (ie, leverage purchases from companies earned through leveraged purchases). Secondary purchases will often provide a net break for the sale of private equity firms and their limited partner investors. Historically, given that secondary purchases are perceived as depressed sales by sellers and buyers, limited partner investors consider them unattractive and largely avoid them.
The increase in secondary purchasing activity in the 2000s was driven largely by an increase in available capital for leveraged purchases. Often, selling private equity firms pursues secondary purchases for a number of reasons:
- Sales to strategic buyers and IPOs may not be possible for small or small businesses.
- Secondary purchases can generate liquidity faster than other routes (ie, IPOs).
- Some types of businesses - for example, those with relatively slow growth but generating high cash flow - may be more attractive to private equity firms than to public stock investors or other companies.
Often, a secondary purchase has been successful if the investment has reached the age where it is required or desirable to sell rather than withholding further investment or where the investment has generated significant value to the sales company.
Secondary purchases are different from secondary or secondary market purchases that typically involve acquiring a portfolio of private equity assets including limited partnership shares and direct investment in corporate securities.
If the company acquired in a secondary purchase will be sold to another financial sponsor, the resulting transaction is called a tertiary purchase.
Failure
Some LBOs before 2000 have resulted in corporate bankruptcies, such as Robert Campeau's 1988 purchase from the Federated Department Store and the 1986 purchase of the Revco drugstore. Many LBO periods of the 2005-2007 boom were also financed with exorbitant debt burdens. Federation purchasing failure is caused by excessive debt financing, which accounts for about 97% of total consideration, leading to large interest payments that exceed the company's operating cash flow.
Often, instead of declaring bankruptcy, the company negotiates debt restructuring with its lender. Financial restructuring may require that equity owners inject more money in companies and lenders release some of their claims. In other situations, the lender injects new money and considers the company's equity, with current equity owners losing their shares and investments. Company operations are not affected by financial restructuring. However, financial restructuring requires significant management attention and may cause customers to lose confidence in the company.
The inability to pay debt in LBO can be caused by the initial overpricing of the target company and/or its assets. Over-optimistic estimates of target company earnings may also cause financial difficulties after the acquisition. Some courts have found that under certain circumstances, LBO debt is a fraudulent transfer under US insolvency laws if it is decided as the cause of the failure of the acquired company.
Litigation results that attack leveraged purchases as fraudulent transfers will generally alter the financial condition of targets at the time of the transaction - ie whether the risk of major failure is known at LBO, or whether subsequent unexpected events lead to failure. This analysis historically relies on expert witness "duel" and is notoriously subjective, expensive, and unpredictable. However, courts are increasingly turning to more objective market-based measures.
In addition, the Bankruptcy Code includes so-called "safe harbor" provisions, preventing bankruptcy guardians from settling settlement payments to purchased shareholders. In 2009, the US Court of Appeals for the Sixth Circuit stated that settlement payments were inevitable, regardless of whether they occurred in LBO public or private companies. To the extent that public shareholders are protected, insiders and secured lenders are the main targets of fraudulent transfers.
Banks have reacted to failed LBOs by necessitating a lower debt-to-equity ratio, thereby increasing the "skin in the game" for financial sponsors and reducing the debt burden.
Popular references
LBO forms the basis of several cultural works. As mentioned earlier, Barbarians at the Gate: The Fall of RJR Nabisco and movie adaptations, based on actual events. The fictitious LBO is the basis of the 1963 Japanese film High and Low . This process was covered during the 2012 US presidential election, as Mitt Romney previously worked in business for Bain Capital.
See also
- Bootstrap funding
- Purchase division
- Hash rate
- The history of private equity and venture capital
- List of private equity firms
- Vulture capitalist
Note
External links
- Jarrell, Gregg A. (2002). "Leveraged Takeovers and Purchases". In David R. Henderson (ed.). Economic Concise Encyclopedia (1st ed.). Library of Economy and Freedom. CS1 maint: Additional text: editor list (link) OCLCÃ, 317650570, 50016270, 163149563
- LCD Loan Market Primer: LBOs - What is a leveraged loan?
- Definition of Investopedia - Leveraged Purchase
Source of the article : Wikipedia
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