The Buyout Binge
何德光
MA0N0224
Case study
• Health Management Associated announcing in
beginning of year 2007 that it would take on $2.4
billion in new debt to finance a one-time $10-pershare dividend.
• The move would lower their rate from
Investment grade to junk level.
• The CEO noted that it would drop the company’s
cost of capital from the lower teens to 7.5-8%,
this move make private-equity buyout nearly
impossible.
Case Analysis
• Company conducting “Leverage” by adding
debt to capital structure.
• Stockholder get satisfied because of the
dividend.
• The company prevent the “Leverage Buyout”
from Private equity firms by drop the
company’s Cost of capital
• The consequence of these action:
– Down grade from Investment grade to Junk level.
– Harming to interest of bound.
What is Leverage Buyout?
• Institutional investors and financial
sponsors (like a private equity firm) making
large acquisitions without committing all the
capital required for the acquisition.
• To do this, a financial sponsor will raise
acquisition debt (by issuing bonds or securing
a loan) and also looks to the cash flows of the
acquisition target to make interest and
principal payments.
What effect would a decreased cost of
capital have on a firm’s future
investments?
• Generally, a decreased cost of capital will lead
to the good in future investment.
• However, If the rate of return of investment is
above the cost of capital, it still increase the
value of the firm.
• If the rate of return below the cost of capital,
it will decrease the value of the firm.
Thank you
The purposes of debt financing for
leveraged buyouts are twofold
• The use of debt increases (leverages) the
financial return to the private equity sponsor.
• The tax shield of the acquisition debt. 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.