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The Current State of Lbos Bachelor Thesis Economics and Business Faculty of Economics and Business Academic year: 2019 – 2020 The Current State of LBOs Specialization: Finance Student Name: Duricu Vlad Marco George Student Number: 11838418 Supervisor: Florencio Lopez de Silanes Molina 1 Statement of Originality This document is written by Student Vlad Marco George Duricu who declares to take full responsibility for this document's contents. I declare that the text and the work presented in this document are original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents. Abstract This paper investigates if trends in the private equity industry and leveraged buyouts established by Stromberg (2007) prior to financial crisis still hold for the last decade. The focus of the research is on three categories sub-deals, regions and industries. It is also investigates what are the common characteristics of an attractive target for a leveraged buyout. The outcome regarding the common trends are different compared the period before the financial crisis. The main reason could be the change in the investor’s behavior (mainly PE). On the other hand, the characteristics of an attractive target for an LBO are in line with the literature. This illustrates that the behavior of the investors only changed in terms of non-financial factors. 2 Table of Contents 1. Introduction ............................................................................................................................................. 4 2. Literature Review ..................................................................................................................................... 8 2.1 Private Equity Funds............................................................................................................................ 8 2.2 Leveraged Buyout ............................................................................................................................... 9 2.3 Economical Role of Leveraged Buyout ................................................................................................ 9 2.4 Value Creation Through Buyout Transactions .................................................................................. 10 2.4.1 Operating Performance ....................................................................................................... 12 2.4.2 Employment ......................................................................................................................... 12 2.4.3 Asymmetric Information ...................................................................................................... 13 2.5 Demography of Transactions& Financial Features of an LBO ........................................................... 13 3. Methodology .......................................................................................................................................... 14 3.1 Data Construction ............................................................................................................................ 14 3.2 Data Visualization .............................................................................................................................. 15 3.3 Constructing Missing Deal Values (Heckman Regression) ................................................................ 18 3.4 Hypotheses ........................................................................................................................................ 19 3.5 Empirical Mdels ................................................................................................................................. 21 4. Results and Discussion ........................................................................................................................... 22 5. Conclusion .............................................................................................................................................. 24 6. References .............................................................................................................................................. 26 7. Appendix ................................................................................................................................................. 28 3 1.Introduction Private equity is one of the most popular alternative asset classes for investors. Cambridge Associates (2019), an investment firm located in the United States, illustrates compelling research about the returns of Private Equity Index compared to the returns of the well-known equity indexes such as S&P 500, Russell 2000, Russell 3000, MSCI World Index, MSCI Europe Index, and MSCI EAFE Index. The research reveals that at the end of 2019, on different timespans ranging from 3, 5, 10, 15, 20, 25 years, the Private Equity Index has higher returns than any other equity index presented above. It is essential to mention that gains from all funds are computed net of fees. The equities overperformed the PE index only on a one-year basis in 2019. The discussion about asset allocation is a relevant topic for investors all over the world, considering the impact of unexpected events, such as the coronavirus pandemic. Alternative asset classes such as Private Equity funds gain higher importance in the asset allocation topic. One apparent reason is the past return success of outperforming the stock markets on a global level. Another reason is related to the increased risk of the stock markets compared to the volatility of a PE fund. Furthermore, the practitioners may also wonder if the industry can find positive return investments due to the high number of competitors and a volatile world economic environment. From general partners (the professionals in charge of a PE fund) point of view, the increased uncertainty is also an important topic on the agenda. The issues of the GPs are more related to the investor's trust, the fundraising, and, nevertheless, the process of finding positive alpha returns. A topic almost attached to the private equity world is leveraged buyout transactions. As a standalone subject, LBOs transactions gained more considerable influence. Probably, one factor that leads to increase notoriety for this topic is the large transactions where companies listed on stock markets were taken private. The leverage became a vital tool over time because it enables investors to perform a higher number of transactions and offers benefits to firms such as an increased value due to the tax shield effect. However, leverage is also a risky tool that can drive a company bankrupt, especially in uncertain periods. The consulting firm Bain & Company (2020), which is highly specialized in PE transactions, issues a report once a year about the state of the PE market. In the latest report, at the beginning of 2020, Bain & Company shows that the global deal value of buyout transactions has been increasing since 2011. However, it has been bouncing from 2015 until 2019, with the peaked reached in 2015 and 2018 (approximately $608 billion). In 2019, the global buyout transactions 4 market dropped to $557 billion, with a total number of deals slightly below 3000. A noticeable aspect is that the global buyouts market was never able to recover to the levels seen before the global financial crisis in 2008 and 2009. The absolute top was registered in 2006 with $804 billion and more than 4000 deals. Understanding the importance of PE market and global buyout transactions, this paper investigates the state of the leveraged buyout transaction deals. Stromberg (2007) conducted a study about the demography of LBOs on a period of 38 years from 1970 to 2007, analyzing more than 19000 deals. An essential insight is that 63% of the transactions were performed between 2001 and 2007, and the value of the transactions corresponds to 68% of the total value of the sample, approximately $2.7 trillion measured by the enterprise value of the acquired firms. Therefore, this shows the hike in popularity for leveraged buyout deals. The transactions were divided into five different categories of sub-deals as Public to Private, Private to Private, Divisional buyouts, Financial vendors, and Financial distress. Furthermore, the deals are also categorized into ten different regions. For instance, regions with the highest number of completed deals are the United States, Continental Europe, and Scandinavia. On the opposite side, regions with the lowest number of completed deals are the Middle East and Africa, Latin America, and Eastern Europe. Moreover, the author also divided the buyouts based on the industries in order to test the hypothesis that most of the transactions are performed in well-established and mature industries where the firms already reached the level of having steady cash flows. The goal of the research is to test if Stromberg's findings, especially from 2001 to 2007, are still representative of leveraged buyouts nowadays, and if there are any significant changes in the demography of the deals. The investigated categories are the sub-deals, regions and industries of the transactions. The Stromberg's study will not be replicated entirely considering that the author also tested, using multivariate regression, the characteristics of the targets that end up having a successful exit at the end of the buyout period. On the other hand, the new addition that
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