Leveraged Buyouts
-Transactions financed mainly with debt —> whereby public company goes private
-Leverage: Equity will be replsced with debt
-Leverage multiplies possible returns —> increases risks
-Sponsors want returns over 20%
Equity replaced by debt
-Debt has lower cost of capital
-Cost of debt is tax deductive
MBO
-Management Buyout
-Buyers are managers
LMBO
-Leveraged Management Buyout
-Financed with debt
LBO
-Leveraged Buyout
-Without management
MBI
-Management Buyin
-Pro rata acquisition by external managers
Spin off
Separation & restructuring of company parts to work independently —> Outsourcing & sale of assets
Expansion Buyout
Acquisition of a company
EBO
Employee Buyout
Texas Energy Deal (TXU)
-Largest LBO that time
-$45 billiondeal with 7 PE-firms in 20017
-Was a natural gas utility
Characteristics of Leveraged Buyouts
-Acquisitions financed primarily with debt
-Debt is secured with acquired Assets
-Most LBOs —> acquire division rather than whole firm
Typical LBO Process
-Company decides to divest itself of a Division
-Management of Division decides to buy Division
-Company & BUyers conduct financial analysis of Division
-Agreement on sale price greater than liquidation value
-Buyers arrange financing
-Purchase finalized
Company & Buyer conduct financial analysis
-Book Value
-Replacement Value
-Liquidation Value
-Cash-Flow Projections
Buyers arrange financing
-Buyer’s equity financing
-Outside equity investment
-Debt financing
LBO Characteristics
-LBOs are cash purchases
-Cash is borrowed using target’s assets
-Result: Division becomes private company
Agency Costs
-Agency costs —> Result: lower profits
-Increase shareholder protection
-Agency problem —> when management owns small percent of company
Benefits of going Private
-Eliminate separation of ownership & control
-Managers eliminate costs —> service the debt
Capital Structure Categories of LBOs
-Senior Debt (secured up to 5 years)
-Intermediate-Term Debt (unsecured more 10-15 years)
Senior Debt
-Debt has collateral protection
Intermediate-Term Debt
Usually subordinate to senior debt
Capital Structure of Equity
-Preferred Stock
-Common Stock
Recourse or Non-Recourse
-Borrower fails to pay debt —> money is owed after assets are sold
-Recourse financing —> Lender can go after borrowers assets
-Non-recourse financing —> lender has no claim
Reverse LBOs
Taking a company private —> taking it public later
Effect of Reverse LBOs
-Profitability was improved
-Cost reductions & less expenditures
-Leverage from LBO was decreased after LBO
Conclusion Reverse LBO
-Reverse LBO forms are in better shape after LBO
-Market pays more when they go public again
LBOs & Capital Structure
-Management & Buyout firms monitor equity closely
-More focus on CF
-Firms minimize taxable income —> increase after-tax CF
Treatment of Minority Stockholders
-Depends on voting right —> veto for LBO
-Law —> minority shareholders must be given fair deal —> means fair price
-Cashed put —> minority get paid for their stock
Management Buyouts
Management group makes offer to buy the company
Conflicts of Interest in Management Buyouts
-Managers conflicts
-Revlon Duties
Prohibit directors from favoring bid
Requires auction process
Manager Conflicts
-Fiduciaries duties for stockholders —> maximize sell price for shareholders
-Buyer Management —> minimize purchase price
Insider Trading & LBOs
-Avoid in MBO —> Management must disclose everything from trading
-Disclosure by management is defense against possible allegations
-Purchasing Shares at low Price —> no violation
Wealth Transfer Effects in LBOs
-Target shareholders approve deal —> not bondholders
-Shareholders receive premium
-Post-LBO firm has greater debt
—> more debt —> lower bond value —> loss for bondholders
LBO Research
-Increased debt can be benefit to corporation
-Debt leads to more efficiency
-Increased debt —> freedom for wasting money
Desirable Characteristics of LBO Candidates
-Stable CF
-Stable Management
-Cost Reduction Possibilities
-Separable Non-Core Businesses
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