Leveraged Buyout

10 Key excerpts on "Leveraged Buyout"

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  eBook - ePub

  Private Capital Investing

  The Handbook of Private Debt and Private Equity

  • Roberto Ippolito(Author)
  • 2019(Publication Date)
  • Wiley

    (Publisher)

  CHAPTER 9 Leveraged Buyout

  INTRODUCTION

  A Leveraged Buyout (LBO) is the acquisition of a whole company or a division thereof (the ‘Target’) financed with an above average level of debt (usually secured). Debt is provided by one or more ‘acquisition finance’ houses (usually banks), is repaid by the Target's cash flow (and sometimes also upon the sale of selected Target's assets), and is secured against the Target's assets. Equity is provided by a private equity fund (the ‘Sponsor’), which takes a relatively small equity investment risk; the Sponsor's objective is to realise an adequate return on its equity investment upon exit (typically through a sale or IPO of the Target). Management usually retains a shareholding that is often incentivised.

  There are various types of buyout:

  • management/Leveraged Buyout, also referred to as (M)LBO: managers acquire a business they have been managing and voting control after the buyout lies with the management team;
  • management buy-in (MBI): the management does not already work for the target company, but is taken on by the Sponsor, and will co-invest alongside;
  • leveraged build up/platform buyout/roll on: buyout with the intention of making further synergistic acquisitions;
  • sponsored spin out: a new company is owned by the previous owners;
  • leveraged recap(italisation): a company borrows money in order to make a cash payout to existing shareholders.

  In general narrative terms the elements of a typical LBO can be summarised as follows: the first stage involves raising the necessary funds (debt and equity) and establishing a management incentive system. Normally the investor group (led by the Sponsor and the company's top management) provides 30–50% of the price paid (also called the ‘Transaction Value’), while the remainder is provided by the lenders (banks, specialised debt providers, and/or capital market). At the second stage, the Sponsor purchases all (or the vast majority) of the outstanding shares of the Target or the assets of the company. At the third stage, the management implements operating efficiencies (cost cutting, asset optimisation) and executes eventual growth strategies (mainly via acquisitions) so as to increase profits and cash flow. In the last stage (after the majority or whole acquisition/LBO debt has been repaid), the Sponsor sells the Target. Financial sponsors generally seek to exit in three to five years. There must be a clear route to exit, to be established before the close of the deal: potential exit routes include IPO, trade sale, leveraged recapitalisation, and break-up.

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  Investment Banking

  Valuation, LBOs, M&A, and IPOs

  • Joshua Rosenbaum, Joshua Pearl(Authors)
  • 2021(Publication Date)
  • Wiley

    (Publisher)

  PART Two Leveraged Buyouts 181 CHAPTER 4 Leveraged Buyouts A Leveraged Buyout (LBO) is the acquisition of a company, division, business, or collection of assets (“target”) using debt to finance a large portion of the purchase price. The remaining portion of the purchase price is typically funded with an equity contribution by a financial sponsor (“sponsor”) or equivalent. LBOs are used by sponsors to acquire control of a broad range of businesses, including both public and private companies, as well as their divisions and subsidiaries. The sponsor’s ultimate goal is to realize an acceptable return on its equity investment upon exit, typically through a sale or IPO of the target. Sponsors tend to seek a 15% to 20% annualized return and an investment exit within five years. PE funds range in size from tens of millions to tens of billions of dollars, and some sponsors manage numerous funds. In a traditional LBO, debt typically comprises 60% to 70% of the financing structure with equity comprising the remaining 30% to 40% (see Exhibit 4.12). The relatively high level of debt incurred by the target is supported by its projected free cash flow 1 and asset base, which enables the sponsor to contribute a small equity investment relative to the purchase price. The ability to leverage the relatively small equity investment is important for sponsors to drive acceptable returns. The use of leverage provides the additional benefit of tax savings realized due to the tax deductibility of interest expense. Companies with stable and predictable cash flow, as well as substantial assets, generally represent attractive LBO candidates due to their ability to support larger quantities of debt. Free cash flow is needed to service periodic interest payments and reduce the principal amount of debt over the life of the investment.

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  Structured Finance

  Leveraged Buyouts, Project Finance, Asset Finance and Securitization

  • Charles-Henri Larreur(Author)
  • 2021(Publication Date)
  • Wiley

    (Publisher)

  PART I Leveraged Buyout (LBO)

  An LBO or Leveraged Buyout refers to the acquisition of a company with a combination of equity and debt. It is a financial technique that slowly emerged at the beginning of the twentieth century. LBOs, however, have only really taken off since the early 1980s, around the same time as project finance, asset finance, and securitization.

  Readers with a background in finance are generally more familiar with LBOs than with the other financing techniques analyzed in this book. LBOs are a topic that might have been encountered in previous reading or studied in a course related to business valuation or corporate finance.

  Without ignoring the link between corporate finance and LBOs, we think of the LBO as primarily a financing technique. Debt is indeed used to finance the acquisition – via an SPV – of an asset that generates cash flow. LBOs are in this respect similar to the other structures that we will discuss in this book. The main difference is the nature of the asset that is financed. It is a company in the case of an LBO, rather than an infrastructure asset, as in project finance (Part II ), a moveable asset, as in asset finance (Part III ) or a portfolio of receivables, as in securitization (Part IV ).

  LBOs combine all the elements of structured transactions: (i) use of an SPV; (ii) recourse to financial leverage; and (iii) tax optimization. They tend to get more media attention than other structured finance techniques, probably due to the fact that some companies taken over via LBOs are extremely well known. It is easier to make headlines in the Financial Times with the acquisition of Burger King or Harley‐Davidson than with the financing of a wind farm in Illinois or Colorado.

  LBOs exemplify probably more than any other technique the series of financial revolutions addressed in this book. It is, therefore, only natural to start our journey with a plunge in the intricacies of Leveraged Buyouts. We hope that readers who are not familiar with the concept will discover its mysteries. For others, we hope that they will rediscover the spark – and the fun! – of this technique.

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  Investment Banking

  Valuation, LBOs, M&A, and IPOs

  • Joshua Rosenbaum, Joshua Pearl(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  PART Two Leveraged Buyouts Passage contains an image

  CHAPTER 4 Leveraged Buyouts

  A Leveraged Buyout (LBO) is the acquisition of a company, division, business, or collection of assets (“target”) using debt to finance a large portion of the purchase price. The remaining portion of the purchase price is typically funded with an equity contribution by a financial sponsor (“sponsor”) or equivalent. LBOs are used by sponsors to acquire control of a broad range of businesses, including both public and private companies, as well as their divisions and subsidiaries. The sponsor’s ultimate goal is to realize an acceptable return on its equity investment upon exit, typically through a sale or IPO of the target. Sponsors tend to seek a 15% to 20% annualized return and an investment exit within five years. PE funds range in size from tens of millions to tens of billions of dollars, and some sponsors manage numerous funds.

  In a traditional LBO, debt typically comprises 60% to 70% of the financing structure with equity comprising the remaining 30% to 40% (see Exhibit 4.12 ). The relatively high level of debt incurred by the target is supported by its projected free cash flow1 and asset base, which enables the sponsor to contribute a small equity investment relative to the purchase price. The ability to leverage the relatively small equity investment is important for sponsors to drive acceptable returns. The use of leverage provides the additional benefit of tax savings realized due to the tax deductibility of interest expense.

  Companies with stable and predictable cash flow, as well as substantial assets, generally represent attractive LBO candidates due to their ability to support larger quantities of debt. Free cash flow is needed to service periodic interest payments and reduce the principal amount of debt over the life of the investment. In addition, a large tangible asset base increases the amount of

  secured debt

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  Leveraged Buyouts

  A Practical Guide to Investment Banking and Private Equity

  • Paul Pignataro(Author)
  • 2013(Publication Date)
  • Wiley

    (Publisher)

  PART One Leveraged Buyout Overview A Leveraged Buyout (LBO) is a fundamental, yet complex acquisition commonly used in the investment banking and private equity industries. We will take a look at the basic concepts, benefits, and drawbacks of a Leveraged Buyout. We will understand how to effectively analyze an LBO. We will further analyze the fundamental impact of such a transaction and calculate the expected return to an investor. Last, we will spend time interpreting the variables and financing structures to understand how to maximize investor rate of return (IRR). The three goals of this part are: 1. Understanding Leveraged Buyouts (Leveraged Buyout theory). Concepts. Purposes and uses. 2. Valuation overview (What is value?) Book value, market value, equity value, and enterprise value. Understanding multiples. Three core methods of valuation: i. Comparable company analysis. ii. Precedent transactions analysis. iii. Discounted cash flow analysis. 3. Ability to understand a simple IRR analysis (Leveraged Buyout analysis). a. Purchase price. b. Sources and uses. c. Calculating investor rate of return (IRR). CHAPTER 1 Leveraged Buyout Theory A Leveraged Buyout is an acquisition of a company using a significant amount of debt to meet the cost of the acquisition. This allows for the acquisition of a business with less equity (out-of-pocket) capital. Think of a mortgage on a house. If you take out a mortgage to fund the purchase of a house, you can buy a larger house with less out-of-pocket cash (your down payment). Over time, your income will be used to make the required principal (and interest) mortgage payments; as you pay down those principal payments, and as the debt balance reduces, your equity in the house increases. Effectively, the debt is being converted to equity. And maybe you can sell the house for a profit and receive a return. This concept, on the surface, is similar to a leverage buyout

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  Leveraged Buyouts

  A Practical Introductory Guide to LBOs

  • David Pilger(Author)
  • 2012(Publication Date)
  • Harriman House

    (Publisher)

  Part I: Leveraged Buyouts Explained

  Passage contains an image

  Chapter 1: What Is An LBO?

  If you’re looking for a job or about to start a new job in investment banking or corporate finance you’re probably going to have to know a thing or two about companies buying other companies. You may have picked up this book because you are just curious to know more about the workings of corporate finance and financial transactions. Well, you have come to the right place. But before we get started and dive into the makings of an LBO transaction, we first need to define what exactly an LBO is.

  An LBO or Leveraged Buyout is, simply put, one company buying another company and using a large amount of debt to do it. That’s it. So ‘why all the fuss?’ you might ask. Why does this type of transaction get set aside from other types of mergers and acquisitions? The answer lies in the inherent risks that go along with a transaction that is financed primarily with borrowed money.

  “An LBO is, simply put, one company buying another company and using a large amount of debt to do it.”

  There are a few things that we need to recognize about the debt that is used in a Leveraged Buyout transaction. The first is that the debt used to acquire the target company is often secured by the assets of the target. In other words, a potential buyer does not necessarily need to possess the financial means to purchase a target company. Instead, the target company just needs to have enough available collateral, in the form of its assets, to allow an outside buyer to obtain debt financing (secured by the target’s assets) to pay for the cost of the transaction. Debt financing can also be secured by the assets of the buyer, but naturally using someone else’s assets as collateral is always considered more attractive than pledging one’s own assets as security for debt financing.

  The second point to mention about the debt is that it can come in the form of bonds or bank loans. In the case of bonds, this means that the debt is issued and typically sold to investors in the capital markets. There is a fixed coupon rate that the target company must pay to its creditors (i.e. the purchasers of the bonds), which is dictated under the terms of the bond at issuance. The high levels of debt associated with Leveraged Buyouts, relative to the amount of equity in the target company, often results in the bonds being rated as junk or below investment grade. As credit ratings are used to gauge the risk of default, it should come as no surprise that loading up a company with debt will naturally increase the risk of default – and the higher the risk, the higher the interest rate the market is going to demand for lending.

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  Mergers, Acquisitions, and Corporate Restructurings

  • Patrick A. Gaughan(Author)
  • 2002(Publication Date)
  • Wiley

    (Publisher)

  They con- tain the invested capital of a variety of investors who seek to enjoy the high returns that may be achieved through LBOs. Like most funds, such as common stock mutual funds, LBO funds provide the investor with broad diversification that lowers the risk level of the investment. Leveraged Buyouts offer great opportunities for investors to earn significant gains. However, because of the high debt levels generally associated with these types of transactions, the risk of default may be high. Through the diversification that LBO funds provide, investors may anticipate the possibility of achieving high gains while having a lower degree of risk. During the 1980s a broad range of investors allocated capital to LBO funds. These often included conservative institutional investors such as pension funds and insurance compa- nies. In addition, because these investment opportunities were more of a U.S. phenome- non, LBO funds attracted significant foreign investors. For example, in 1988 the Nippon Life Insurance Company committed several hundred million dollars to Shearson’s LBO fund, and Yamaichi Securities committed $100 million to the Lodestar Corporation Com- pany, which is a boutique LBO fund. 13 Like pension funds, the pace of foreign investment 308 Leveraged BuyoutS 0 2 4 6 8 10 8 7 8 8 8 9 9 0 9 1 9 2 9 3 9 4 9 5 9 6 9 7 9 8 9 9 0 0 0 1 Debt/EBITDA Total Bank Nonbank Figure 7.7. Average debt multiples of highly leveraged loans. Source: The New York Times, 21 March 2001, p. C6. 13. New York Times, 7 August 1988. in LBOs slowed dramatically as the 1980s came to an end. Without the investment capital of these investors, LBO funds declined significantly in 1990 but rose steadily through the mid-1990s as institutional investors such as pension funds began to reconsider buyout funds as a way of realizing sufficient returns to meet the needs of retirees who were living longer.

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  Mergers & Acquisitions

  A Practitioner's Guide to Successful Deals

  • Harvey A Poniachek(Author)
  • 2019(Publication Date)
  • WSPC

    (Publisher)

  Following the financial crisis of 2008, the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (Board), and the Federal Deposit Insurance Corporation (FDIC) issued lending guidance for financing LBOs. Accordingly, these government agencies, in a letter issued on October 2013, stated that “given the high-risk profile of leveraged transactions, financial institutions engaged in leveraged lending need to adopt a risk management framework that has an intensive and frequent review and monitoring process. The framework should have as its foundation written risk objectives, risk acceptance criteria, and risk controls. A lack of robust risk management processes and controls at a financial institution with significant leveraged lending activities could contribute to supervisory findings that the financial institution is engaged in unsafe-and-unsound banking practices”. This letter had a significant impact of how banks lend money to finance LBOs. For one, in order to avoid criticism, the initial Leveraged Ratio of Total Debt/EBITDA needs to be at 6.0× or less, or the transaction model needs to show (to the Regulators’ satisfaction) that 50% of the transaction’s total debt will be repaid in less than 7 years.

  Summary of Key Points

  •An LBO is the acquisition by an investor of a company with mostly borrowed money. The Debt for the acquisition is scheduled to be repaid by the operating cash flows of the company and/or proceeds from selling the company or refinancing the acquisition debt with new debt. The investor is not personally responsible for paying the debt nor is he required to add any other capital to support his or her investment.

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  Private Equity Finance

  Rise and Repercussions

  • J. Morgan(Author)
  • 2008(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Still, the LBO has done what a publicly listed company is unlikely to do: radically concentrate equity through leverage. The leverage has been created to channel returns to the fund. As Chapters 1–4 indicate, as liquidity improves there is a tendency for PEF firms to use an increasing amount of leverage in larger deals. One reason for this is precisely that it enables the more effec- 144 Private Equity Finance tive concentration of equity and enables it for larger and larger firms where the absolute size of the revenues being captured will be higher. The use of gearing is thus one facet of why PEF expands to exploit available liquid- ity and why more debt will be generated, subject to current servicing con- ditions, when lending conditions allow. The very process of a Leveraged Buyout, therefore, immediately raises questions concerning the meaning of performance. Gearing has made the LBO possible and has accelerated and concentrated the returns to equity. This is channelled into the fund. The GP has thus begun the process of meeting his performance based criteria for the fund. But it is an open ques- tion as to whether this is compatible with a broader notion of the per- formance of the acquisition. The debt it is carrying may well be currently serviceable. But this raises two initial questions. First, will credit conditions vary and will this make servicing the debt more difficult? As Chapters 1–4 indicate, this is an ever-present problem and it is more of a problem for larger LBOs using more leverage. Second, will the market conditions of the acquisition change, in turn affecting revenue? The GP may well have clear plans to improve the organisation of the acquisition and improve its profit- ability in one way or another. However, the GP has no control over the business cycle.

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  Value Creation

  Strategies for the Chemical Industry

  • Florian Budde, Utz-Hellmuth Felcht, Heiner Frankemölle(Authors)
  • 2008(Publication Date)
  • Wiley-VCH

    (Publisher)

  403 30 Leveraged Buyout Transactions – Challenges and Learnings Achim Berg, Florian Budde, and Bernd Heinemann In the mid 1990s, buyout firms began to conduct leveraged transactions in the chemical industry. A slew of multi-billion dollar LBOs suggest the trend has inten- sified since the start of the new millennium. This chapter explores the relevance of private equity investors for the chemical sector and describes the value genera- tion levers they apply; it examines what traditional chemical corporations can learn from their financial competitors; and concludes with a description of buyout firms’ challenges in the chemical industry and an outlook. 30.1 Chemical Sector LBOs Show No Sign of Abating In a series of articles in 2001, Butler, Samdani, and McNish described the increase in LBOs in the chemical industry over the second half of the 1990s (Butler, P.; Samdani, G. S. et al.). They labeled this phenomenon the “Alchemy of Leveraged Buyouts” and predicted a natural convergence between traditional chemical cor- porations and their new financial competitors in terms of management proce- dures and skills as well as how they created value. LBOs – the purchase of a controlling stake in a company or division from its owners to be held for a limited time, financed through a combination of equity and a large amount of debt and with strong involvement of a financial investor – certainly gained prominence in the late 1990s. However, the real boom started around the turn of the century, especially in Europe. Over the past four years, buy- out firms have emerged as formidable competitors in many segments of the industry, often outbidding publicly traded chemical companies for acquisitions. As major players in the sector, they compete for capital, corporate control, and management talent. However, the fierce competition within the buyout industry continues to force them to differentiate themselves in order to stay competitive.

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