Going private and lb os


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Going private and lb os

  1. 1. Going Private and LBOs
  2. 2. Costs of Staying Public <ul><li>Cost of reporting </li></ul><ul><li>Disclosures </li></ul><ul><li>Self- dealings </li></ul><ul><li>Inactive market, low price </li></ul><ul><li>Control </li></ul>
  3. 3. <ul><li>Going private: transformation of a public company into privately held firm </li></ul><ul><li>Mainly through repurchasing of some/all of firm’s equity by private investors </li></ul><ul><li>Issues: </li></ul><ul><ul><li>justice to minority shareholders </li></ul></ul><ul><ul><li>Sourcing of funds for the transaction </li></ul></ul><ul><li>Methods: </li></ul><ul><ul><li>Through merger directly with target company </li></ul></ul><ul><ul><li>Tender/ public offer to purchase shares from shareholders </li></ul></ul><ul><ul><li>Reverse stock split: reduces number of stockholders </li></ul></ul>
  4. 4. Leveraged Buyout (LBO) <ul><li>Financing technique where primarily debt is used to purchase a company’s stock </li></ul><ul><li>Is normally followed by taking public company, private </li></ul><ul><li>Elements of a typical LBO operation: </li></ul><ul><ul><li>A portion of funding in the form of equity is provided by the managers/ owners </li></ul></ul><ul><ul><li>Loans are arranged for the balance amount </li></ul></ul><ul><ul><li>Acquire the company and make it private </li></ul></ul><ul><ul><li>Overhaul firm’s operations to increase profitability </li></ul></ul><ul><ul><li>Again take the firm (now with higher valuation), public through SIPO/ reverse LBO </li></ul></ul>
  5. 5. Financing for LBOs <ul><li>Secured LBO financing/ asset based lending: </li></ul><ul><ul><li>Is against pledge of assets used as collateral </li></ul></ul><ul><ul><li>Assets are mostly of target firm </li></ul></ul><ul><ul><li>Specially applicable to capital intensive/ asset rich firms </li></ul></ul><ul><ul><li>Debt could be senior or subordinate </li></ul></ul><ul><li>Unsecured LBO Financing/ cash flow based lending: </li></ul><ul><ul><li>May use mezzanine financing: debt with warrants </li></ul></ul><ul><ul><li>Are cash flow LBOs since cash flows of the target company, and not its assets, provide comfort to the lenders </li></ul></ul><ul><ul><li>Especially useful for service industries with strong cash flows </li></ul></ul>
  6. 6. Structuring LBOs <ul><li>Bust-up LBOs: </li></ul><ul><ul><li>Depend upon sale proceeds of assets to generate returns to equity investors/ to retire the debt </li></ul></ul><ul><ul><li>Normally used when value of sub units is higher than valuations given by the market </li></ul></ul><ul><ul><li>These are sold off after the acquisition, to exploit the discrepancy </li></ul></ul><ul><li>Cash flow LBOs: </li></ul><ul><ul><li>Servicing of debt from cash flows from operations </li></ul></ul><ul><li>Hybrid LBOs: </li></ul><ul><ul><li>Servicing partly from sale of select portion of assets </li></ul></ul><ul><ul><li>Balance from operating cash flows </li></ul></ul>
  7. 7. Characteristics of an ideal LBO Candidate <ul><li>Since high level of debt is involved, a small error can lead to default and bankruptcy </li></ul><ul><li>Experienced management team </li></ul><ul><li>Strong and secure cash flows: to service debt </li></ul><ul><li>Strong asset base: as collateral </li></ul><ul><li>Low operating/ business risk: since financial risk is high, so need to contain overall risk </li></ul><ul><li>Limited existing debt on firm’s balance-sheet </li></ul><ul><li>Sufficient equity interest of owners/ management </li></ul><ul><li>Separable, non-core businesses </li></ul><ul><li>Other intangible factors </li></ul>
  8. 8. <ul><li>Timing: </li></ul><ul><ul><li>Companies that lack strategic fit with parent: acquirer may see more value in it than the parent </li></ul></ul><ul><ul><li>Retiring owner situations: with no heirs willing to takeover </li></ul></ul><ul><ul><li>Companies that must be sold because of regulators </li></ul></ul><ul><ul><li>Subsidiaries that lack attention of the parent company: due to size, lack of foreseeable potential </li></ul></ul>
  9. 9. Sources of Gain <ul><li>Taxes: </li></ul><ul><ul><li>Tax shield on higher interest costs </li></ul></ul><ul><ul><li>Higher depreciation benefit on asset set ups </li></ul></ul><ul><li>Management incentives: </li></ul><ul><ul><li>Can be better structured after LBO/MBO </li></ul></ul><ul><ul><li>Unification of ownership and management reduces agency costs </li></ul></ul><ul><li>Efficiency considerations: due to faster decision process and secrecy in private firm </li></ul><ul><li>Wealth transfer effects: through payment of premiums </li></ul><ul><li>Signals that target company is considered to be underpriced by acquirer </li></ul>
  10. 10. <ul><li>Types of LBO risk: </li></ul><ul><ul><li>Higher financial risk </li></ul></ul><ul><ul><li>Interest rate risk: higher sensitivity to interest rate fluctuations </li></ul></ul><ul><li>LBOs as White Knights: as an alternative to a hostile bid </li></ul>
  11. 11. Other Types <ul><li>Management Buyout: </li></ul><ul><ul><li>When existing management buys out the company </li></ul></ul><ul><ul><li>Agency problems are avoided </li></ul></ul><ul><li>Management Buy-in: </li></ul><ul><ul><li>When outside management buys the controlling stake </li></ul></ul><ul><li>Leveraged Cash Out: </li></ul><ul><ul><li>Also called leveraged recapitalization </li></ul></ul><ul><ul><li>Outside shareholders receive large one time cash dividend, mostly by raising debt (not permissible in India) </li></ul></ul><ul><ul><li>Inside shareholders receive new stock, instead </li></ul></ul><ul><ul><li>Increases ownership stake of management/ promoters </li></ul></ul>
  12. 12. <ul><li>Leveraged Joint Venture: </li></ul><ul><ul><li>Company (mostly public), alongwith a passive financial partner in JV, acquires a firm through LBO </li></ul></ul><ul><ul><li>Public firm may not show debt on its B/S </li></ul></ul><ul><li>Leveraged Sell Out: seller retains interest in equity of the divested business, arranges debt to facilitate the sell out </li></ul>
  13. 13. Indian Scenario <ul><li>Underdeveloped corporate debt market </li></ul><ul><li>Limited availability of control transactions and professional management: managers lack resources to engineer a buyout </li></ul><ul><li>Regulatory Restrictions: </li></ul><ul><ul><li>RBI restriction on banks to lend money to buy shares </li></ul></ul><ul><ul><li>FIPB press note 9 bars a foreign investment company from borrowing money from an Indian bank for buying equity </li></ul></ul><ul><ul><li>Public companies to comply with provisions of SEBI/ listing agreement, on delisting </li></ul></ul><ul><ul><li>Restrictions relating to exit (for SIPO): promoters contribution and lock in period, domestic listing a precondition to foreign listing </li></ul></ul><ul><ul><li>Companies Act restrictions on share buyback provisions </li></ul></ul>