Going Private – Leverage Buyout

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  • 1. Presented By: Sameep Bansal
  • 2. Topics covered
    • Case Study – TATA Tetley
    • Definitions
    • Real Life Examples
    • Characteristics
    • Methods of LBO
    • Financing LBO
    • Sources of Gain
    • Conclusion with help of Case solution.
  • 3. Case Study - TATA Tetley
    • Tata Tea one of the largest company in the world was sheltered from competition by a protectionist Indian government for most of its history.
    • In 1999, Tata Tea company faced several new challenges:
      • Upcoming deregulation.
      • Changing consumer tastes.
      • Ban on tea imports scheduled to be lifted in 2001
    • Majority of the company’s tea is sold in India, with 12% total international sales only.
    • Possibility of future stiff competition from Nestle, Sara Lee Corporation, and Associated British Foods.
  • 4. Possible Strategies/Solutions
    • To enhance its position in the current brand
    • Acquire a well-known brand
  • 5. Some disturbing questions???
    • Tata Tea company has to beat the growing global competition – but how?
    • Any possibilities for further growth in the Indian stagnant market?
    • If popular brand in India can penetrate into the global markets?
    • Perhaps it would need to develop a brand of international demand or taste.
    • Or acquire an other company
    • These questions become more urgent as Tetley Tea, well-known in the US and UK, unexpectedly comes up for sale. Provide refernce
  • 6. Pros and Cons of acquiring Tetley
    • Pros
    • Acquiring Tetley would mean capturing the higher end of the value chain
    • Tetley is well-established in international markets
    • Tata’s gross margin is 36%, while Tetley’s is a more efficient 55%
    • The combination of the two companies would allow for synergies that competitors couldn’t match
    • Opportunity to buy a brand the likes of Tetley is rare
  • 7. Pros and Cons of acquiring Tetley - Cont
    • Cons
    • Tata had already tried acquiring Tetley five years prior and failed
    • Tata may have difficulty raising the required £200-300 million purchase price
      • The £200-300 million asking price is much higher than the £190 million the company was valued at in 1995
    • The sheer size of the transaction could prove unwieldy
    • Wouldn’t investing in building its own global brand be more efficient than buying a foreign brand?
  • 8. Finally
    • TATA choose to acquire Tetley.
    • The major challenge was financing
      • The value of Tata Tea was $114 million.
      • Tetley was valued at $450 million.
    • The solution was provided by Leverage Buy outing the Deal.
  • 9. LBO = Definition
    • 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. (Beatrice Foods by Esmark, Levis Strauss, etc.)
    • Going Private: Refers to transformation of a public corporation into a privately held firm.
  • 10. Example of LBO in Daily life
    • Mortgaging a Home.
    • Buying a Car/Taxi, financed by bank.
  • 11. Other Similar Term
    • Management buy-out (MBO) - A private equity firm will often provide financing to enable current operating management to acquire at least 50% of the business they manage. In return, the private equity firm usually receives a stake in the business.
  • 12. Characteristics
    • LBOs are a way to take a public company private, or put a company in the hands of the current management, MBO.
    • LBOs are financed with large amounts of borrowing (leverage), hence its name. Debt:Equity ratio can go more than 90:10
    • LBOs use the assets or cash flows of the company to secure debt financing, bonds or bank loans, to purchase the outstanding equity of the company.
    • After the buyout, control of the company is concentrated in the hands of the LBO firm and management, and there is no public stock outstanding.
  • 13. How LBO is done? Ref: The McGraw-Hill Guide to Acquiring and Divesting Businesses
    • Asset Purchase
    • Stock Purchase
    • The choice is dictated by balancing Legal, Financial, Tax and Accounting advantages and disadvantages.
  • 14. Asset Purchase
    • Suitable for Small and Medium sized transactions.
    • Allows selection or rejection of assets and liabilities.
    • Leads directly to price allocation and stepped up asset value, that are part of Tax and Accounting aspects of transactions.
  • 15. Stock Purchase
    • In Stock purchase , the target shareholders simply sell their stock and all their interest in target corporation to the buying group and then the two firms may be merged.
    • This method cannot be used if one or more minority share holders refused to sell.
  • 16. Successful Strategy
    • Finding cheap assets – buying low and selling high (value arbitrage or multiple expansion)
    • Targetting firms with low Q-Ratio
        • (Market Value/Asset Value)
    • Unlocking value through restructuring:
      • Financial restructuring of balance sheet – improved combination of debt and equity
      • Operational restructuring – improving operations to increase cash flows
  • 17. Scanning 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.
  • 18. LBO Financing
    • LBO sponsors have equity funds raised from institutions like pensions & insurance companies
    • Balance from commercial banks (bridge loans, term loans, revolvers).
    • Banks concentrate on collateral of the company, cash flows, level of equity financing from the sponsor, coverage ratios, ability to repay (5-7 yr)
    • Some have “Mezzanine Funds” as well that can be used for junior subordinated debt and preferred
    • Occasionally, sponsors bring in other equity investors or another sponsor to minimize their exposure
  • 19. SPV – Special purpose vehicle
    • In our case SPV - Tata Tea Great Britain Ltd ., was created.
    • The cash flow from the Tetley and hence this SPV, was used to repay the debt.
    • SPV merged with TATA after repayment of the debt.
  • 20. 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.
  • 21. 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.
  • 22. 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.
  • 23. Underpricing
    • Investors have more information on the value of firm than public shareholders.
    • Investors buy firms that have low Q-Ratio.
    • Net value of the firm may still be higher than LBO price paid.
    • Such firms are generally resold at much higher price after the new management brings the firm to its true value by restructuring activities.
      • Example, Kohlberg Kravis Roberts and Thomas H Lee Company started in 1970’s, seas opportunity in inefficient and undervalued corporate.
  • 24. Tata – Tetley LBO; Solution
    • First Leveraged Buy-out ( Rs. 2,135 cr)
      • Instant access to Tetley’s worldwide operations, combined turnover at Rs 3,000 crores.
    • Financial Innovation at its best
      • SPV created to ring fence risk with equity contributed by Tata Tea and Tata Tea Inc
      • Debt of 235 mn pounds raised in the form of long term debt and revolver; charge against Tetley’s brand and assets.
      • Tata Tea’s exposure only to the extent of equity component of 70 mn pounds
    March 2000 Tata Tea Limited Acquisition of 100% equity stake in Tetley Tea (UK) INR 21,350,000,000