Leverage buyout - Finance

1. LBO

2. • Leverage Buyout is the process of acquiring a firm in which
the investment for acquiring is made partially by equity and
partially by other debt instruments (borrowing).
• The acquisition of the company or a segment of the
company is funded by debt. The assets of the acquired
company are used as collateral for the borrowed capital,
sometimes with assets of the acquiring company.
• A financial buyer say private equity fund invests small
amount of equity, as compared to the total purchase price
and uses leverage also called gearing (using debt or other
non equity based source of funding) to fund the remainder.

3. • Financial sponsor raises debt by issuing bonds
or securing a loan which is secured by the
assets of the acquisition target or for that
matter the cash flow of the target so as to
make the timely payment of interest and
principal amount.

4. Purposes of Debt Financing for LBOs
• Following are the purposes of debt financing for
LBOs:
– Increased use of debt increases the leverage which
results in increased financial return to the private
equity sponsor. The debt in an LBO has a relatively
fixed cost of capital, thus any return in excess of this
cost of capital flows to the equity investor.
– The benefit of tax shield is also applicable in case of
high debt. This results in higher valuation as well.
Income flowing to equity is taxed on the other hand,
the interest payments to debt are not. Thus the
capitalized value of cash flowing to debt is greater
than the same cash stream flowing to equity.

5. Management Buyout (MBO)
• MBO or the Management Buyouts are a special case of
a leveraged acquisition. As the name very well suggests
it occurs when a company’s managers buy or acquire a
large part of the company.
• The goal of an MBO may be to strengthen the
managers’ interest in the success of the company. One
of the most widely discussed and thought after issue of
MBOs is that they create a conflict of interest.
• There is always an incentive created for managers to
mismanage or inefficiently manage the firm so as to
lower its stock price for executing a handsome
profitable MBO.

7. • LBOs involve institutional
investors and financial sponsors who make
large acquisitions, without committing all the
capital required for the acquisition.

8. Characteristics of LBO
• Efficient and experienced management team
• Assurance of sufficient and stable cash flow
• Lower degree of operating risk
• Limited amount of debt
• Other factors

9. Sources of LBO financing
• Senior debt
– Are given in the form of banks loans held by a
syndicate
– Interest rate is usually low
– Are structured in 3 trenches A, B and C
– The debt is usually secured on specific assets of the
company
– It is prepayable and has a floating rate of interest
– This is a better option for both the parties
– It may form 50% of the total financing

10. • Subordinate Debt
– This debt ranks behind senior debt in order of
priority on any liquidation
– Terms are less stringent
– Security given is less as compared to senior debt
and so the lending cost are higher
– One of the important form of subordinate debt is
the high yield bond

11. • Mezzanine finance

12. • Preference shares and ordinary shares

13. Building an LBO model
• Forecast cash flows
• Estimate debt capacity
• Estimate equity required
• Estimate the exit price
• Calculate the IRR

14. Stages of LBO operation
• 1st stage Arrangement of Finance
• 2nd Stage Going private
• 3rd Stage Restructuring
• 4th Stage Reverse LBO

15. Advantages of LBO
• The acquiring co is benefited from acquisition of
international brand without incurring huge amount of
outlay from the internal resources of the firm
• Since a new SPV is created in a LBO system, the existing
co business will not get affected. When debts are fully
repaid, the parent co can merged with the newly
created SPV
• The newly created SPV can enjoy tax benefits in
operating the business. Due to the existence of debt
capital, tax benefits can be achieved in respect of
payment of interests.

16. • The LBO system helps simulating the cross
border acquisition
• High gearing tends to be a discipline on
management, since a company’s cash flow is
quite tight due to the high interest burden

17. Limitations
• High degree of financial risk
• A LBO candidate should have strong asset
base that can be used as collateral for
financing the acquisition

18. Tata-Tetly

19. TATA-CORUS

20. TATA Jaguar- Land Deal
• The deal has started in June, 2007 when FORD had announced to sell two
prime brands such as Jaguar & Land Rover.
• At that time there were many players interested to acquire such as Apollo
Management, TPG Capital, Cerberus Capital Management, Mahindra &
Mahindra and Tata Motors. From them only two main bidders have bid for
acquiring the Jaguar & Land Rover, one was Mahindra & Mahindra and
second was Tata Motors.
• In June 2008, India-based Tata Motors Ltd. announced that it had
completed the acquisition of the two iconic British brands - Jaguar and
Land Rover (JLR) from the US-based Ford Motors for US$ 2.3 billion.
• Tata Motors stood to gain on several fronts from the deal. One, the
acquisition would help the company acquire a global footprint and enter
the high-end premier segment of the global automobile market. After the
acquisition, Tata Motors would own the world’s cheapest car. The US$
2,500 Nano and luxury marquees like the Jaguar and Land Rover.

23. Public to Private

24. • The Securities and Exchange Board of India
(“SEBI”) finally notified the SEBI (Delisting of
Equity Shares) (Amendment) Regulations,
2015 (“Amendment Regulations”) on March
24, 2015 introducing certain path breaking
changes to the existing delisting framework in
India.

25. • A public company may choose to go private for a
number of reasons. An acquisition can create
significant financial gain for shareholders and CEOs,
while the reduced regulatory and reporting
requirements private companies face can free up time
and money to focus on long-term goals.
• Because there are advantages and disadvantages to
going private as well as short- and long-term issues to
consider, companies must carefully weigh their options
before making a decision.

26. Advantages of Being Public
• Being a public company has its advantages and
disadvantages. On the one hand, investors who hold stock
in such companies typically have a liquid asset; buying and
selling shares of public companies is relatively easy to do.
• However, there are also tremendous regulatory,
administrative, financial reporting and corporate
governance bylaws to comply with.
• These activities can shift management's focus away from
operating and growing a company and toward compliance
with and adherence to government regulations.

27. Advantages of Privatization
• Investors in private companies may or may not hold a
liquid investment. Covenants can specify exit dates,
making it challenging to sell the investment, or private
investors may easily find a buyer for their portion of
the equity stake in the company.
• Being private frees up management's time and effort
to concentrate on running and growing a business
• Thus, the senior leadership team can focus more on
improving the business's competitive positioning in the
marketplace. Internal and external assurance, legal
professionals and consulting professionals can work on
reporting requirements by private investors.

28. What It Means to Go Private
• A "take-private" transaction means that a large private-
equity group, or a consortium of private-equity firms, purchases or
acquires the stock of a publicly traded corporation.
• Because many public companies have revenues of several hundred
million to several billion dollars per year, the acquiring private-
equity group typically needs to secure financing from an investment
bank or related lender that can provide enough loans to help
finance (and complete) the deal.
• The newly acquired target's operating cash flow can then be used
to pay off the debt that was used to make the acquisition possible.

29. • Less than 24 hours after he decided to take Dell private through a
$24.4-billion buyout deal, Michael Dell is already facing a tough
time, with quite a few shareholders taking a dim view of the price.
Companies in India would empathise with Dell as their delisting
experience hasn’t been easy, either. Take Cadbury India, for
example. Its delisting move has been stuck since it was announced
in 2003, as minority shareholders demanded a 50 per cent higher
price than the Rs 1,340-a-share Cadbury proposed.
“We think the company did not offer us a good exit price and it was
not valued like its peers, such as Nestle,” says small investor
Sobhana Mehta.
Shareholders of Essar-owned India Securities had protested against
delisting move last year, saying the shares were infrequently traded
and, hence, the company was not valued properly while going
private.

30. • In last five years, 200 firms have delisted their shares from Indian stock exchanges
— mainly due to a merger or acquisition activity.
The race to delist shares began after the Securities and Exchange Board of India
(Sebi) came out with a fiat of a minimum 25 per cent public shareholding in listed
entities. Companies with more than 75 per cent promoter shareholding had the
option: Either go private or dilute shareholding to 75 per cent.
But companies soon realised minority shareholders, led by institutions, were not
enthusiastic about exiting, even when a company’s shares were valued by
independent valuers. Last year, only 11 companies went private (see table). Many
like Carol Infoservices, owned by Wockhardt’s Khorakiwalas, are still sending out
letters to shareholders, offering to buy back their shares.
While small investors have in the past taken erring companies to court, domestic
institutions have remained passive investors and have seldom voiced their opinion.
A top official of LIC, the biggest investor in Indian firms, says LIC takes case-to-case
decision on selling shares during delisting or an open offer. LIC and other
institutions like GIC and UTI have rarely made their stand clear on these issues.
•

31. • Shriram Subramanian, MD, InGovern, a corporate governance
research firm, says: “The exit price determined by reverse book-
building process in India takes care of price discovery. This process
generally takes care of minority shareholders’ interests in pricing.”
To avoid a shareholders versus management fight, Subramaniam
advises that the global best practice is that shareholder approval for
delisting is based on a majority of minority shareholders voting for
it.
But the main problem is pricing. Firms that have done right pricing
have had it smooth. For example, Alfa Laval offered Rs 4,000 a
share, as against the discovered price of Rs 3,000 a share. The
delisting offer received an overwhelming response from
shareholders.