Download Management Buy Outs

Management & Leveraged
Buyouts
Mark Fielding-Pritchard
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LBO = Definition

Buyout: The purchase of a company or a controlling
interest of a company's shares.

Leverage buyout: The acquisition of a company
using debt and equity finance. As the word leverage
implies, more debt than equity is used to finance
the purchase, e.g. 90% debt to 10% equity. Normally,
the assets of the company being acquired are put up
as collateral to secure the debt. (Beatrice Foods by
Esmark, Levis Strauss, etc.)

Going Private: Refers to transformation of a public
corporation into a privately held firm.
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MBOs

Management buy-out (MBO) - A
private equity firm will often provide
financing to enable current operating
management to acquire at least 50% of
the business they manage. In return,
the private equity firm usually receives
a stake in the business.
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Characteristics

LBOs are a way to take a public company private,
or put a company in the hands of the current
management, MBO.

LBOs are financed with large amounts of
borrowing (leverage), hence its name. Debt:Equity
ratio can go more than 90:10

LBOs use the assets or cash flows of the company
to secure debt financing, bonds or bank loans, to
purchase the outstanding equity of the company.

After the buyout, control of the company is
concentrated in the hands of the LBO firm and
management, and there is no public stock
outstanding.
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Methods of achieving an MBO?

Asset Purchase

Stock Purchase
The choice is dictated by balancing
Legal, Financial, Tax and Accounting
advantages and disadvantages.
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Asset Purchase

Suitable for Small and Medium sized transactions.

Allows selection or rejection of assets and
liabilities.

Leads directly to price allocation and stepped up
asset value, that are part of Tax and Accounting
aspects of transactions.
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Stock Purchase

In Stock purchase , the target shareholders simply sell their stock
and all their interest in target corporation to the buying group and
then the two firms may be merged.

This method cannot be used if one or more minority share holders
refused to sell.
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Successful Strategy

Finding cheap assets – buying low and selling
high (value arbitrage or multiple expansion)

Targeting firms with low Q-Ratio


(Market Value/Asset Value)
Unlocking value through restructuring:

Financial restructuring of balance sheet –
improved combination of debt and equity

Operational restructuring – improving
operations to increase cash flows
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Scanning target Company

History of profitability.

Predictable cash flows to service financing.

Low current debt and high excess cash.

Strong management team - risk tolerant.

Known products, strong market position.

Little danger of technological change (high tech?).

Low-cost producers with modern capital.

Take low risk business, layer on risky financing.
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LBO Financing

LBO sponsors have equity funds raised from institutions like
pensions & insurance companies

Balance from commercial banks (bridge loans, term loans, revolvers).

Banks concentrate on collateral of the company, cash flows, level of
equity financing from the sponsor, coverage ratios, ability to repay
(5-7 yr)

Some have “Mezzanine Funds” as well that can be used for junior
subordinated debt and preferred

Occasionally, sponsors bring in other equity investors or another
sponsor to minimize their exposure
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Where do we create value

LBO ‘s are undertaken at high premium price.

The premium paid is 40% or more than average
stock value of last two months.

What are the sources of these gains?

Tax Savings.

Management Incentives.

Asymmetric Information and under pricing.
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Tax Savings

Most of the premium paid is financed by
Tax savings.

New company can operate Tax free for as
long as 4-5 years.

In this time period the debt/equity ratio is
pulled down from 10 to 1.

Often the LBO is sold after this time
horizon or reverse LBO is done.
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Management Incentives

Control and hence stakes are with few people.

Incentives of Management increases.

Dividends are not necessary.

Debt payment is effective substitute for dividend
payment.

To save company from the Bankruptcy.

Restructuring of the acquired firm saves
substantial amount of costs.

Changes in marketing strategies.

Employee reduction

Economies of Scale.
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Underpricing

Investors have more information on the value
of firm than public shareholders.

Investors buy firms that have low Q-Ratio.

Net value of the firm may still be higher than
LBO price paid.

Such firms are generally resold at much
higher price after the new management brings
the firm to its true value by restructuring
activities.

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Example, Kohlberg Kravis Roberts and Thomas H
Lee Company started in 1970’s, seas opportunity
in inefficient and undervalued corporate.
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