Leveraged Buyout

1. Presented By:
Sameep Bansal

2. Topics covered
 Definitions
 Real Life Examples
 Characteristics
 Stages of LBO
 Financing LBO
 Sources of Gain
 Conclusion with help of Case solution

3. Leveraged Buyout (LBO)
 Buyout
The purchase of a company or a controlling interest of a
company's shares.
 Leverage buyout:
 The acquisition of a company using debt and equity
finance.
 As the word leverage implies, more debt than equity is
used to finance the purchase, e.g. 90% debt to 10%
equity.
 Normally, the assets of the company being acquired are
put up as collateral to secure the debt. (RJR Nabisco LBO
by KKR)
 Going Private
Refers to transformation of a public corporation into a
privately held firm.

4. Example of LBO in Daily life
Mortgaging a Home.
Buying a Car/Taxi, financed by bank.

5. How LBOs work?
 Financial buyer like LBO fund (KKR, Blackstone etc)
takes over public or private firm.
 Synergies?
 Financed partly by fund’s own money which is used
as equity, partly with large amounts of debt:
 Bank debt
 Junk bonds
 Fund holds firm for 2-10 years, then must sell it
(exit):
 IPO
 Trade sale
 Secondary (sell to other LBO fund)

6. LBO v/s MBO
 Management buy-out (MBO)
 A transaction where a company’s management team
purchases the assets and operations of the business
they manage.
 A management buyout is appealing to professional
managers because of the greater potential rewards
from being owners of the business rather than
employees.

7. Stages of LBO
I. First Stage: Raising Funds
II. Second Stage: Creating an Shell Company or an
SPV and Transferring the Funds raised
III. Third Stage: Purchasing the Shares or Assets
IV. Fourth Stage: Putting the Taken-Over Company
on Track
V. Fifth Stage: Taking the Company Public again-
Second IPO

8. Features of Target Company
 History of profitability.
 Predictable cash flows to service financing.
 Low current debt and high excess cash.
 Strong management team - risk tolerant.
 Known products, strong market position
 Little danger of technological change (high tech).
 Low-cost producers with modern capital.
 Take low risk business, layer on risky financing.

9. LBO Financing
 Hierarchy of funding / financing alternatives –
1. Loans
2. Senior Debt (Secured by firm’s assets – Accounts
receivable, fixed assets)
3. Mezzanine financing – unsecured
4. Junior debt / subordinated debt
5. Equity

10. Sources of Gains
 LBO ‘s are done at high premium price.
 The premium paid is 40% or more than average stock
value of last two months.
 What are the sources of these gains?
 Tax Savings.
 Management Incentives.
 Asymmetric Information and under pricing.

11. Tax Savings
 Most of the premium paid is financed by Tax savings.
 New company can operate Tax free for as long as 4-5
years.
 In this time period the debt/equity ratio is pulled
down from 10 to 1.
 Often the LBO is sold after this time horizon or
reverse LBO is done.

12. Management Incentives
 Control and hence stakes are with few people.
 Incentives of Management increases.
 Dividends are not necessary.
 Debt payment is effective substitute for dividend
payment.
 To save company from the Bankruptcy.
 Restructuring of the acquired firm saves substantial
amount of costs.
 Changes in marketing strategies.
 Employee reduction
 Economies of Scale.

13. RJR Nabisco Case
A good example of an LBO is KKR’s buyout of RJR Nabisco
• On October 28,1988 Ross Johnson, the company’s CEO, had
formed a group of investors that was prepared to buy all RJR’s
stock for $75 per share in cash and take the company private
• RJR’s share price immediately moved to about $75,handling
shareholders a 36 percent gain over the previous day’s price
of $56
• At same time RJR’s bonds fell, since it was clear that
existing bondholders would soon have a lot more company
• Johnson’s offer lifted RJR onto the auction block.

14. RJR Nabisco Case
•
Four days later KKR bid $90 per share,$79 in cash plus PIK
preferred valued at $11
• The resulting bidding contest had many surprises, but in the end it
was Johnson group against KKR
• KKR offered $109 per share, after adding $1 per share in the last
hour
• The KKR bid was $81 in cash, convertible subordinated
debentures valued at about $10,and PIK preferred shares valued at
$18.Johnson group bid $112 in cash and securities
• RJR board chose KKR although Johnson’s group had offered $3
per share more, its security valuations were viewed as “softer” and
perhaps overstated