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Leveraged Buyout Analysis Journal of Law and Conflict Resolution Vol. 4(6), pp. 85-93, December, 2012 Available online at http://www.academicjournals.org/JLCR DOI: 10.5897/JLCR11.054 ISSN 2006-9804 ©2012 Academic Journals Review Leveraged buyout analysis Pooja Tripathi National Law School of India University, Bangalore, India. E-mail: [email protected]. Accepted 5 December, 2012 This paper provides information in regard to the nature of the leveraged buyout and indicates the positive and negative results of the leveraged buyout operation. To help the better understanding, the author has made the comparative study in respect of UK, USA, and India. Also, this paper has analyzed the mechanism of leveraged buyout by giving the case studies of various leveraged buyouts to value the performance of leveraged buyout accordingly. Key words: Leveraged buyout, equity, debt, acquisition, management, structure. INTRODUCTION There may still be time to at least ameliorate what could of the acquired company but the business of the be the next financial meltdown. But, as the story notes, company may not be run in profit. Then the chain of the four of the last eight Treasury Secretaries — across party business collude will take place not only with the acquired lines — have background in “private equity firms.”- company buy also the bank which has lent the money for Socratic Gadfly such investment. Hence the investors in such leveraged buyout Leveraged Buyout has become a popular vehicle for transaction should have the sufficient equity stability. The business acquisition especially among the private equity experience of the investors is also one important factor firms, management buy-out groups and other "going for the investor to know how to run the business like private" sponsors. Thus this is the new innovation of the management buyout which the insider management team way for the investors to invest even though they may not will run such investment. They know the nature of have the huge amount of equity for the acquisition. An business so they can improve the business contrasting to leveraged buyout (LBO) is the acquisition of a target the management buy in which the business will be run by company by an investor group, which typically includes the outsider investors. They may not have the knowledge the target's own management. The investor group takes on the nature of the business that much. control of the target's finances the acquisition w/ minimal equity capital from LBO 'sponsors' or equity investors. The primary form of financing is debt collateralized with WHAT LEVERAGED BUYOUT IS the assets of the target itself or with its cash flow. In many countries like U.S.A., England in European During the 1980s, leveraged buyout (LBO) became Union or country in Asia like India also have applied such increasingly common and increased substantially in size. investment way to acquire another target company. Jensen (1989) predicted that the leveraged buyout There are many recorded examples of such huge organizations would eventually become the dominant transaction which make the introduction of leveraged corporate organizational form. A leveraged buyout is buyout to more investors to come and invest by such essentially a strategy involving the acquisition of another route. company using a significant amount of borrowed money, Although the investment through leveraged buyout may bonds or loans, to meet the cost of acquisition. There is give the benefit to the investors to invest with a small usually a ratio of 70% debt to 30% equity. The assets of equity, however, there are also risky in respect of the the company being acquired are used as collateral for the failure of the repayment of the borrowing loan. The loans in addition to the assets of the acquiring company. investors expect to return the money from the cash flow The new owner would gain control with a small amount of 86 J. Law Conflict. Resolut. invested capital because he or she is able to secure a to as financial buyers who hold their investments for five- large loan for the balance of the amount needed. seven years. LBOs are designed to force change in Leveraged Buyout – also called as „Highly-Leveraged mature business and are a healthy way to create value Transaction (HLT)‟ or "bootstrap" transactioni. A where control of companies is advocated to promote leveraged balance sheet has a small portion of equity efficiency. They can improve operating performance by capital and therefore a large portion of loan capitalii. restoring strong constructive relationships among the Consequently the debt will appear on the acquired owners, managers and other corporate stockholders. company‟s balance sheet and the acquired company‟s free cash flowiii will be used to repay the debt. The leveraged buyouts nowadays call themselves as private Private equity equity firms. The purpose of leveraged buyoutiv is to allow Kavaljit (2008) had said that private equity is a broad companies to make large acquisitions without having to term means any investment in assets or companies that commit a lot of capital. It may be easier to compare the are not listed on public stock exchanges. Shares are leveraged buyout transaction with the rental of the house bought, sold and issued privately. Leveraged buyout is which you need to mortgage. Just as a mortgage is one of the types of private equity which the company will secured by the value of the house being purchased, use its own equity to acquire another company including some portion of the debt incurred in an LBO is secured the debt from the bank. by the assets of the acquired business. The cash flow Private equity investors of course need an exit route, which is coming from the rental of the house will be paid generally over a three to five-year time span. The exit for the mortgage like the cash flow from the target may come through divestment in a public issue or company which will be paid for the loan taken for the sometimes by sale to another private equity or strategic LBO. investor. Several Indian companies' acquisitions abroad The first LBO may have been the purchase by McLean have comprised purchases from private equity investor. Industries, Inc. of Waterman Steamship Corporation in Private equity funds are typically limited liability May 1955. In Mc Lean Industries, Inc case McLean partnerships. The fund manager secures commitments to borrowed $42 million and raised an additional $7 million invest from outside parties like institutional investors such through issue of preferred stock. When the deal closed, as banks and insurance companies, university $20 million of Waterman cash and assets were used to endowments, pension funds and wealthy individuals, to retire $20 million of the loan debt. The newly-elected invest in the fund. board of Waterman then voted to pay an immediate dividend of $25 million to McLean Industries (Levinson, 2006). CLASSIFICATIONS OF LEVERAGED BUYOUTS Management buyouts (MBOs) LEVERAGED BUYOUT PROCESS The Hindu Business line on Thursday, July 10, 2008 had Stock format stated a management buy-out (MBO) usually involves the acquisition of a divested division or subsidiary or of a LBO is usually done through the stock or asset purchase private family owned firm by a new company in which the format. In the former, target shareholders simply sell their existing management takes a substantial proportion of stock and all interest in the target company to the buying the equity. Such acquisitions take place when owners group and then the two firms may be merged. In the desire to sell off a division or a company or even close or asset purchase format, the target firm sells its assets to liquidate it, while the managers on the other hand the buying group. After the buyout the acquired company envision future growth potential and are willing to place is run as a privately held company for a few years after their bets on improving the performance of the division or which the resale of the firm is anticipated. This buying company by acquiring it. Since managers may not group may be sponsored by buyout specialists or possess adequate resources to effect such an investment bankers that arrange such deals and usually acquisition, they are often compelled to seek financing or includes representation by the incumbent management. even a strategic partnership for this purpose. In place of Buyers of the firm targeted to become an LBO often the LBO association, MBOs usually require the support of consist of managers from the firm being acquired. The a private equity firm. LBO initiated by the target firm's incumbent management Managers may not be able to finance the MBO is called a management buyout (MBO). The buying group transaction by themselves due to having only the small often forms a shell corporation to act as the legal entity sum of money. Thus they can only acquire the small making the acquisition. An MBO or LBO is a defensive stake in the target while the majority of the stake of the measure against takeover. Investors in LBOs are referred transaction will be taken by the private equity who may Tripathi 87 be the partner with the managers. Thereafter the better than outsider how to constitute the stability of the business will be running by the new team of management company again. They may try their best for that but the (Management Buyouts, 2008). lack of confidence on them may be the obstacles for the In many instances, board approval and shareholder management. votes are required before the acquisition can be Traditionally under the corporate opportunity doctrine, consummated. However, the buyout group may bypass the law has prohibited the officers, directors, and senior the board and possibly the voting process by making the managers from the taking personal advantage of tender offer.
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