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.
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
Editor's Notes
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