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Encyclopedia > Leveraged buyout

A leveraged buyout (or LBO, or highly-leveraged transaction (HLT), or "bootstrap" transaction) occurs when a financial sponsor gains control of a majority of a target company's equity through the use of borrowed money or debt. A financial sponsor is another name commonly used to refer to private equity investment firms, particularly those private equity firms that engage in leveraged buyout or LBO transactions. ... Ownership equity, commonly known simply as equity, also risk or liable capital, is a financial term for the difference between a companys assets and liabilities -- that is, the value that accrues to the owners (sole proprietor, partners, or shareholders). ... This article does not cite any references or sources. ...


A leveraged buyout is a strategy involving the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. Often, the assets of the company being acquired, in addition to the assets of the acquiring company, are used as collateral for the loans. The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital. In an LBO, there is most often a ratio of 70% debt to 30% equity, although debt can reach as high as 90% to 95% of the target company's total capitalization. The equity component of the purchase price is typically provided by a pool of private equity capital. Look up acquisition in Wiktionary, the free dictionary. ... Private equity is a broad term that refers to any type of equity investment in an asset in which the equity is not freely tradable on a public stock market. ...


Typically, the loan capital is borrowed through a combination of prepayable bank facilities and/or public or privately placed bonds, which may be classified as high-yield debt, also called junk bonds. Often, the debt will appear on the acquired company's balance sheet and the acquired company's free cash flow will be used to repay the debt. It has been suggested that Private Issue of Public Equity be merged into this article or section. ... In finance, a high yield bond (non-investment grade bond, speculative grade bond or junk bond) is a bond that is rated below investment grade at the time of purchase. ... For alternative meanings, see bond (a disambiguation page). ... In corporate finance, free cash flow (FCF) is a measure of a firms financial performance. ...

Contents

History

In the industry's infancy in the late 1960s the acquisitions were called "bootstrap" transactions, and were characterized by Victor Posner's hostile takeover of Sharon Steel Corporation in 1969. The industry was conceived by people like Jerome Kohlberg, Jr. while working on Wall Street in the 1960s and 1970s, and pioneered by the firm he helped found with Henry Kravis and George Roberts, Kohlberg Kravis Roberts & Co. (KKR). Victor Posner (18 September 1918 to 11 February 2002) was a US businessman, millionaire and philanthropist. ... A takeover in business refers to one company (the acquirer, or bidder) purchasing another (the target). ... History of the Sharon Steel Corporation - Frank Buhl launches Mercer county into steel production. ... Jerome Kohlberg, Jr. ... Elaborate marble facade of NYSE as seen from the intersection of Broad and Wall Streets For other uses, see Wall Street (disambiguation). ... Henry R. Kravis (born January 6, 1944 in Tulsa, Oklahoma, United States) is an American business financier and investor, notable for co-founding and heading the leading private equity firm, Kohlberg Kravis Roberts & Co. ... George R. Roberts (1945-) is a financier and was one of the founders of Kohlberg Kravis Roberts & Co. ... Kohlberg Kravis Roberts & Co (commonly referred to as KKR) is a New York City-based private equity firm that focuses primarily on late stage leveraged buyouts. ...


Working for Bear Stearns at the time, Kohlberg and Kravis are credited by Harvard Business School as completing what is believed to be the first leveraged buyout in business history, through the acquisition of Orkin Exterminating Company in 1964. However, the first LBO may have been the purchase by McLean Industries, Inc. of Waterman Steamship Corporation in May 1955. Under the terms of that transaction, McLean borrowed $42 million and raised an additional $7 million through an issue of preferred stock. When the deal closed, $20 million of Waterman cash and assets were used to retire $20 million of the loan debt. The newly elected board of Waterman then voted to pay an immediate dividend of $25 million to McLean Industries. [1] Harvard Business School, officially named the Harvard Business School: George F. Baker Foundation, and also known as HBS, is one of the graduate schools of Harvard University. ... Orkin Exterminating Company was founded in Pennsylvania in 1901 by Otto Orkin. ... Waterman Steamship Corporation is an American deep sea ocean carrier, specializing in liner services and time charter contracts. ... A preferred stock, also known as a preferred share or simply a preferred, is a share of stock carrying additional rights above and beyond those conferred by common stock. ... In relation to a company, a director is an officer (that is, someone who works for the company) charged with the conduct and management of its affairs. ... It has been suggested that ex-dividend date be merged into this article or section. ...


Rationale

The purposes of debt financing for leveraged buyouts are two-fold:

  1. The use of debt increases (leverages) the financial return to the private equity sponsor. Under the Modigliani-Miller theorem,[2] the total return of an asset to its owners, all else being equal and within strict restrictive assumptions, is unaffected by the structure of its financing. As the debt in an LBO has a relatively fixed, albeit high cost of capital, any returns in excess of this cost of capital flow through to the equity.
  2. The tax shield of the acquisition debt, according to the Modigliani-Miller theorem with taxes, increases the value of the firm. This enables the private equity sponsor to pay a higher price than would otherwise be possible. Because income flowing through to equity is taxed, while interest payments to debt are not, the capitalized value of cash flowing to debt is greater than the same cash stream flowing to equity.

Germany currently introduces new tax laws, taxing parts of the cash flow before debt interest deduction. The motivation for the change is to discourage leveraged buyouts by reducing the tax shield effectiveness. Private equity is a broad term that refers to any type of equity investment in an asset in which the equity is not freely tradable on a public stock market. ... This article does not cite any references or sources. ... The Modigliani-Miller theorem (of Franco Modigliani, Merton Miller) forms the basis for modern thinking on capital structure. ... It is proposed that this article be deleted, because of the following concern: Article has nothing to do with tax shields, but rather is a brief article about depreciation If you can address this concern by improving, copyediting, sourcing, renaming or merging the page, please edit this page and do... The Modigliani-Miller theorem (of Franco Modigliani, Merton Miller) forms the basis for modern thinking on capital structure. ...


Historically, many LBOs in the 1980s and 1990s focused on reducing wasteful expenditures by corporate managers whose interests were not aligned with shareholders. After a major corporate restructuring, which may involve selling off portions of the company and severe staff reductions, the entity would likely be producing a higher income stream. Because this type of management arbitrage and easy restructuring has largely been accomplished, LBOs today focus more on growth and complicated financial engineering to achieve their returns. Most leveraged buyout firms look to achieve an internal rate of return in excess of 20%. In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. ... The internal rate of return (IRR) is a capital budgeting method used by firms to decide whether they should make long-term investments. ...


Management buyouts

A special case of such acquisition is a management buyout (MBO), which 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. In most cases, the management will then take the company private. MBOs have assumed an important role in corporate restructurings beside mergers and acquisitions. Key considerations in an MBO are fairness to shareholders, price, the future business plan, and legal and tax issues. One recent criticism of MBOs is that they create a conflict of interest—an incentive is created for managers to mismanage (or not manage as efficiently) a company, thereby depressing its stock price, and profiting handsomely by implementing effective management after the successful MBO. < math > Insertformulahere
A management buyout (MBO) is a form of acquisition where a companys existing managers acquire a large part or all of the company. ... Restructuring is the corporate management term for the act of partially dismantling and reorganizing a company for the purpose of making it more efficient and therefore more profitable. ... The phrase mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business... A business plan is a formal statement of a largely enforced business goal, the reasons why they are believed attainable, and the plan for reaching those goals (Fiifi Essel). ...

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Failures

Some LBOs in the 1980s and 1990s resulted in corporate bankruptcy, such as Robert Campeau's 1988 buyout of Federated Department Stores and the 1986 buyout of the Revco drug stores. The failure of the Federated buyout was a result of excessive debt financing, comprising about 97% of the total consideration, which led to large interest payments that exceeded the company's operating cash flow. In response to the threat of LBOs, certain companies adopted a number of techniques, such as the poison pill to protect them against hostile takeovers by effectively self-destructing the company if it were to be taken over. The 1980s refers to the years from 1980 to 1989. ... For the band, see 1990s (band). ... Notice of closure stuck on the door of a computer store the day after its parent company, Granville Technology Group Ltd, declared bankruptcy (strictly, put into administration—see text) in the United Kingdom. ... Robert Campeau is a Canadian financier and real estate developer born in Chelmsford, Ontario (near Sudbury) on August 3, 1923. ... Federated Department Stores, Inc. ... Revco Discount Drug Stores (known simply as Revco or Revco, D.S.), once based in Twinsburg, Ohio, was a major drug store chain operating through the Ohio Valley, the Mid-Atlantic states, and the Southeastern United States. ... Poison pill originally meant a literal poison pill (often a glass vial of cyanide salts) carried by various spies throughout history, and by Nazi leaders in WWII. Spies could take such pills when discovered, eliminating any possibility that they could be interrogated for the enemys gain. ...


Notable leveraged buyout firms

This article does not cite any references or sources. ... Bain Capital LLC is a Boston, Massachusetts-based private equity firm founded in 1984 by Mitt Romney, the late Governor of Massachusetts, and two other partners from the consulting firm Bain & Company: T. Coleman Andrews III and Eric Kriss. ... The Blackstone Group is a private investment and advisory firm founded in 1985 by Peter G. Peterson and Stephen A. Schwarzman. ... The Carlyle Group is a Washington, DC based global private equity investment firm with more than $18 billion of equity capital. ... GS Capital Partners is the private equity arm of Goldman Sachs. ... Kohlberg Kravis Roberts & Co (commonly referred to as KKR) is a New York City-based private equity firm that focuses primarily on late stage leveraged buyouts. ... Providence Equity Partners is a private equity firm headquartered in Providence, Rhode Island that focuses on investments in media and telecommunications. ... Silver Lake Partners is a notable American private equity firm founded in 1999 and headquartered on Sand Hill Road in Menlo Park, California. ... Thomas H. Lee Partners is a private equity firm based in Boston, Massachusetts specializing in management-led buyouts, growth capital, special situations, industry consolidations, and recapitalizations. ... Warburg Pincus is a private equity firm with offices in the United States, Europe and Asia. ...

Europe-based

Company Name: 3i PLC Company Logo: Company Type: Public Founded: 1945 Created by a syndicate of several British banks]] Location: [London]], England| Key people: Philip Yea, CEO Baroness Hogg, Chairman Industry = Venture Capital and Private Equity Homepage = [1] 3i Group PLC is a venture capital and private equity firm quoted... Apax Partners is a private equity and venture capital firm based in the United Kingdom which operates in Hong Kong, China, India, United Kingdom, United States, Europe, and Israel. ... AXA Private Equity is a financial investor that independently manages and advises Private Equity funds with combined assets in excess of € 8. ... Barclays Capital is the Private Equity division of Barclays plc. ... BC Partners is a private equity firm specializing in buyouts and acquisitions financing. ... Candover, established in 1980 and UK based, specialises in arranging and leading large buyouts and buyins. ... Cinven is a European private equity firm founded in 1977 with offices in London, Paris, Frankfurt and Milan. ... CVC Capital Partners is a European private equity firm. ... Permira is an international, private equity firm based in the United Kingdom. ... Terra Firma Capital Partners is an venture capital firm based in London, UK. It was formed as a spin-off company from Nomuras Principal Finance Group in 1994 and has invested £4. ...

See also

Private equity is a broad term that refers to any type of equity investment in an asset in which the equity is not freely tradable on a public stock market. ... Bootstrapping alludes to a German legend about a Baron Münchhausen, who was able to lift himself out of a swamp by pulling himself up by his bootstraps. ...

Notes

  1. ^ Marc Levinson, The Box, How the Shipping Container Made the World Smaller and the World Economy Bigger, pp. 44-47 (Princeton Univ. Press 2006). The details of this transaction are set out in ICC Case No. MC-F-5976, McLean Trucking Company and Pan-Atlantic American Steamship Corporation--Investigation of Control, July 8, 1957.
  2. ^ Franco Modigliani and Merton H. Miller, "The Cost of Capital, Corporation Finance, and the Theory of Investment," American Economic Review, June 1958.

External links

  • High Yield Blog
  • Private Equity Search Engine
  • European Leveraged Finance conference
  • Asian Leveraged Finance conference
  • Private Equity blog
  • Acquisitions Monthly website

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