Leveraged Buyouts and
Management Buyouts
Using OPM to Buy a Firm
(Other People’s Money)
Leveraged Buyout
• Small group of investors borrows money to
buy the stock of a public corporation.
• LBO transaction is expected to be
reversed with a public offering within three
to five years.
• Sometimes only a segment, a division or
subdivision of the firm is bought.
Management
• Buyout:
– An LBO where management plays a
significant role.
• Buyin:
– An LBO where outside management plays a
significant role.
LBO and MBO Sponsors
• Leveraged buyout specialist (KKR)
• Venture capitalists
• Investment bankers
FORBES TOP 25 PRIVATE COMPANIES
Source: www.forbes.com
Rank
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
Name
Cargill
Koch Industries
Mars
Publix Super Markets
PricewaterhouseCoopers
Ernst & Young
Bechtel
C&S Wholesale Grocers
Meijer
HE Butt Grocery
TRW Automotive
Huntsman
Fidelity Investments
Swift & Co
JM Family Enterprises
Enterprise Rent-A-Car
Science Applications Intl
Unisource
Marmon Group
Advance Publications
Menard
SC Johnson & Son
MDFC Holding
International Steel Group
Alticor
State
MN
KS
VA
FL
NY
NY
CA
VT
MI
TX
MI
UT
MA
CO
FL
MO
CA
GA
IL
NY
WI
WI
CA
OH
MI
Industry
Crops
Oil & Gas Operations
Food Processing
Retail (Grocery)
Business Services
Business Services
Construction Services
Retail (Grocery)
Retail (Grocery)
Retail (Grocery)
Auto & Truck Parts
Chemical Manufacturing
Investment Services
Food Processing
Auto & Truck Manufacturers
Business Services
Aerospace & Defense
Forestry & Wood Products
Misc Fabricated Products
Printing & Publishing
Retail (Home Improvement)
Personal & Household Prods
-Iron & Steel
Personal & Household Prods
Revenues ($mil)
Employees
59,894
98,000
40,000
17,000
16,800
31,000
16,027 123,000
15,900 125,000
13,100 106,000
11,600
47,000
11,300
9,000
10,900
84,000
10,700
56,000
10,630
63,000
9,000
15,000
8,937
29,142
8,380
21,300
7,600
3,500
6,900
53,500
5,902
38,700
5,900
8,000
5,756
30,000
5,565
27,585
5,500
33,300
5,372
12,000
5,105
60,500
5,000
11,600
4,900
11,500
THE 25 LARGEST LBOs, Jan 2000 - Dec 2003
Source: Securities Data Corporation
Date
Announced
Target Name
Target Industry Sector
Target
Nation
Acquiror Name
Acquiror
Nation
29-Jul-02
11-Jun-03
4-Sep-03
20-Aug-02
6-Oct-03
2-Oct-00
17-Oct-03
17-Jun-02
26-May-01
23-Jun-00
8-Mar-02
12-Sep-03
20-Mar-02
22-Feb-00
20-Aug-02
25-May-01
24-Nov-03
29-Jun-01
12-May-03
3-Jan-01
7-Aug-00
20-Mar-01
28-Jan-03
12-Sep-01
Legrand SA
Seat Pagine Gialle-Directories
Ondeo Nalco Co
Qwest Commun Intl Inc-QwestDex
Scottish & Newcastle-Ret Bus
IBP Inc
Chelsfield PLC
Jefferson Smurfit Group PLC
Yell Group
Johns Manville Corp
Southern Water(Scottish Power)
Debenhams PLC
Unique Pub Co,Voyager Pub Co
Deutsche Telekom AG-North
Qwest Comm Intl-QwestDex
Le Meridien Hotels
Warner Music Group
Eircom PLC
Debenhams PLC
Messer Griesheim GmbH
VEBA Electronics Inc(VEBA AG)
Fairbar Ltd
Deutsche Telekom-Cable TV Cos
Cognis BV(Henkel KGaA)
Electronic and Electrical Equipment
Printing, Publishing, and Allied Services
Chemicals and Allied Products
Printing, Publishing, and Allied Services
Food and Kindred Products
Food and Kindred Products
Investment & Commodity Firms,Dealers,Exchanges
Paper and Allied Products
Printing, Publishing, and Allied Services
Stone, Clay, Glass, and Concrete Products
Electric, Gas, and Water Distribution
Retail Trade-General Merchandise and Apparel
Retail Trade-Eating and Drinking Places
Radio and Television Broadcasting Stations
Printing, Publishing, and Allied Services
Hotels and Casinos
Electronic and Electrical Equipment
Telecommunications
Retail Trade-General Merchandise and Apparel
Chemicals and Allied Products
Wholesale Trade-Durable Goods
Retail Trade-Eating and Drinking Places
Radio and Television Broadcasting Stations
Chemicals and Allied Products
France
Italy
United States
United States
United Kingdom
United States
United Kingdom
Ireland-Rep
United Kingdom
United States
United Kingdom
United Kingdom
United Kingdom
Germany
United States
United Kingdom
United States
Ireland-Rep
United Kingdom
Germany
United States
United Kingdom
Germany
Netherlands
Investor Group
Silver SpA
Investor Group
Investor Group
Spirit Amber Bidco Ltd
DLJ Merchant Banking Partners
Duelguide PLC
MDP Acquisitions
Investor Group
Investor Group
First Aqua Ltd
Baroness Retail Ltd
Investor Group
Investor Group
Investor Group
Grand Hotels(M)Acquisition Co1
Investor Group
Valentia Group
Laragrove Ltd
Investor Group
Investor Group
Shopgood Ltd(Morgan Grenfell)
Investor Group
Investor Group
France
United Kingdom
United States
United States
United States
United States
United Kingdom
Ireland-Rep
United Kingdom
United States
United Kingdom
United Kingdom
United Kingdom
United States
United States
United Kingdom
United States
Ireland-Rep
United Kingdom
Germany
United States
United Kingdom
United Kingdom
Germany
Value of
Transaction
($mil)
5,059.72
4,367.53
4,350.00
4,300.00
4,173.88
3,766.98
3,413.40
3,315.01
3,043.08
3,028.45
2,927.61
2,912.78
2,865.91
2,784.61
2,750.00
2,675.96
2,600.00
2,560.70
2,492.84
2,467.96
2,350.00
2,327.98
2,282.29
2,266.00
THE 25 LARGEST LBOs, 1980-2003
Target Name
Target Industry Sector
Target
Nation
Acquiror Name
Acquiror
Nation
RJR Nabisco Inc
Beatrice Companies Inc
Safeway Stores Inc
Legrand SA
Hospital Corp of America
Borden Inc
Seat Pagine Gialle-Directories
Ondeo Nalco Co
Qwest Commun Intl Inc-QwestDex
Borg-Warner Corp
Scottish & Newcastle-Ret Bus
Southland Corp
Montgomery Ward & Co Inc
Tobacco Products
Machinery
Retail Trade-Food Stores
Electronic and Electrical Equipment
Health Services
Food and Kindred Products
Printing, Publishing, and Allied Services
Chemicals and Allied Products
Printing, Publishing, and Allied Services
Electronic and Electrical Equipment
Food and Kindred Products
Retail Trade-Food Stores
Retail Trade-General Merchandise and
Apparel
Stone, Clay, Glass, and Concrete Products
United States
United States
United States
France
United States
United States
Italy
United States
United States
United States
United Kingdom
United States
United States
Kohlberg Kravis Roberts & Co
BCI Holdings Corp
SSI Holdings Corp
Investor Group
HCA-Hospital Corp of America
Kohlberg Kravis Roberts & Co
Silver SpA
Investor Group
Investor Group
Borg-Warner Holdings Corp
Spirit Amber Bidco Ltd
JT Acquisition Corp
BFB Acquisition Corp
United States
United States
United States
France
United States
United States
United Kingdom
United States
United States
United States
United States
United States
United States
United States
Owens-Illinois Holdings Corp
United States
3,640.00
Air Transportation and Shipping
Paper and Allied Products
Retail Trade-General Merchandise and
Apparel
Food and Kindred Products
Paper and Allied Products
Health Services
Retail Trade-Food Stores
Printing, Publishing, and Allied Services
Electric, Gas, and Water Distribution
Retail Trade-General Merchandise and
Apparel
United States
United States
United States
Wings Holdings Inc
FH Acquisition Corp
Macy Merger Corp
United States
United States
United States
3,580.00
3,579.40
3,523.30
Australia
Ireland-Rep
United States
United Kingdom
United Kingdom
United Kingdom
United Kingdom
Harlin Holdings Pty Ltd
MDP Acquisitions
IMA Holdings Corp
Isosceles PLC(Gateway Corp)
Investor Group
First Aqua Ltd
Baroness Retail Ltd
Australia
Ireland-Rep
United States
United Kingdom
United Kingdom
United Kingdom
United Kingdom
3,434.34
3,315.01
3,307.85
3,292.36
3,043.08
2,927.61
2,912.78
Owens-Illinois Inc
NWA Inc
Fort Howard Corp
RH Macy & Co Inc
Elders IXL Ltd
Jefferson Smurfit Group PLC
American Medical International
Gateway Corp PLC
Yell Group
Southern Water(Scottish Power)
Debenhams PLC
Value of
Transaction
($mil)
30,598.78
6,095.00
5,335.00
5,059.72
4,915.00
4,643.42
4,367.53
4,350.00
4,300.00
4,202.60
4,173.88
4,055.00
3,800.00
LBO Financing
• Secured Debt
– Secured debt is also called asset-based lending, and it can be
either senior or intermediate term debt.
• Senior Debt
– Comprises loan secured by liens on particular assets of the
company.
– The collateral includes physical assets such as land, plant and
equipment, accounts receivable, and inventories.
• Lenders will usually advance 85% of the value of the accounts
receivable and 50% of the value of the target inventories.
• The process of determining the collateral value of the
LBO candidate's assets is sometimes called qualifying
the assets.
Private companies outperform relative to the market.
Source: McKinsey Quarterly, 2001, n. 2.
LBO companies
remain private only
for a few years.
Financial Acquirers
(LBOs) negotiate
better than
Corporate Acquirors
(Mergers & Tender
Offers).
Intermediate Term Debt
• Is usually subordinate, and often backed
up by fixed assets such as land and plant
and equipment.
• The collateral value of theses assets is
usually based on their liquidation value.
• Debt backed up by equipment typically
has a term of six months to one year.
• Loans backed up by real estate tend to
have a one- to two-year term.
Unsecured Debt Financing
• It is usually referred to as subordinated and
junior subordinated debt.
• The term mezzanine layer financing is often
applied to this financing because it has both
debt and equity characteristics: it is equity like in
that lenders typically receive warrants that may
be converted into equity in the target.
• When the warrants are exercised, the share of
ownership of the previous equity holders is
diluted. It is important to be aware of the role of
the warrants in computing the return to the
providers of mezzanine layer financing.
Buyout Benefits
• Tax savings
– Stepped up asset base.
• Approximately half of the companies involved in LBOs
stepped up their asset base in 1980's (Kaplan, Journal of
Financial Economics, 1989)
– Tax shields from interest payments.
• One should realize, however, that these benefits should be
relatively low when all of the costs and benefits are factored
in. Most likely the LBO companies do not have the optimal
capital structure in the first few years after the LBO - why
would they otherwise not keep those high debt levels?
The next two tables are from Kaplan, S. (1989), “Management Buyouts:
Evidence on Taxes as a Source of Value”, Journal of Finance, 611-632.
Buyout Benefits Continued
• Managerial incentives and other agency issues.
– Managers own a larger fraction of the equity.
– Separation of ownership and control has been
reduced. As a result managers have larger incentives
to worry about shareholders value.
• Often they also get a larger fraction of their compensation
tied to company performance.
– Monitoring benefits.
• Fewer and larger external shareholders (institutional
investors) have an incentive to monitor managerial behavior.
– Debt-bonding effect.
• The debt payments reduce managerial discretion in the
spending of free cash flows. “Debt provides discipline.”
Buyout Benefits Continued
• Expropriation of “old” bondholders
– LBOs increase riskiness of old debt without
increasing their promised interest payments.
– A bond with covenants to protect against this
are said to have “event risk protection.”
• Bonds with event risk protection were common in
the early 1990’s.
– Response to several large investment grade bond issues
that were reduced to high yield status overnight via
leveraged buyouts.
• Few bonds now carry event risk protection.
Buyout Benefits Continued
• Expropriation of employees
– Anecdotal evidence: easier layoffs and
reduction in over-funded pension plans.
Buyout Benefits Continued
• Exploiting undervaluation.
– Management has more information about future cashflows than outside owners. Although selling
shareholders are receiving high premiums, managers
are possibly paying a too low price.
– Evidence:
• Median annualized rate of return on equity to post-buyout
shareholders in a firm that goes public again was 286% in
1980-1987.
– This gain was positively related to managerial ownership.
• However, there also exists evidence that stock prices fall
back to their pre-buyout levels in failed MBOs.
Buyout Benefits Continued
• Reducing costs of being a public company.
– These costs include administrative costs
inside the company as well as regulatory
costs to the stock exchange.
Buyout Costs
• Cost of financial distress.
• Managers become undiversified and may
be less willing to take risks.
• Inappropriate investment policy
(underinvestment) because of high
leverage.
Good LBO Candidates
• High potential benefits:
– Potentially high agency costs:
• Small managerial ownership currently
• Large excess cash
– High marginal tax rate and stable earnings.
• Makes debt financing attractive.
– Low current leverage.
– No need for new equity financing.
Good LBO Candidates Continued
• Low potential costs:
– Low investment needs - underinvestment and
non risk-taking behavior do not pose a threat.
– Parts of the assets can be sold if necessary.