The Value Creation of Reverse Leveraged Buyouts Transactions to Shareholders An analysis of target companies’ post-IPO stock and operating performance, in comparison to other IPOs from 2000 to 2019. Based on agency theory’s perceptions of value driving mechanisms to Shareholders. Master’s Thesis Master of Science in Economics and Business Administration (Cand. Merc.) Applied Economics and Finance (AEF) Author: Christine Qvist Jensen Student Number: 93466 Supervisor: Victor Lund Department of Operations Management Hand-in date: 15th of January 2020 No. of pages: 71 Characters (incl. spaces): 144,367 - 63.45 standard pages equivalent Abstract Purpose: In the last decades, the volume of Private Equity sponsored leveraged buyout transactions has increased. A Reverse Leveraged Buyout is when the target companies that are subject to such transaction, enter public markets. Therefore, academics argue that these transactions are a unique opportunity to examine the Private Equity firms’ ability to enhance the value of the target compa- nies. Value creation should be reflected in both stock performance and operating performance. The operating performance of Leveraged Buyouts has been widely studies, however not much attention has been made to Reverse Leveraged Buyouts. Therefore, this master thesis has the intend to con- tribute to whether the high leverage ratio, concentrated ownership and the value-adding mecha- nisms that Private Equity provides, can enhance shareholder value and operating efficiency of the target companies. Method: Based on a total sample of 5220 IPOs, that occurred between 2000 and 2016. The methods applied are event studies and regressions. The samples’ monthly abnormal returns relative to the market is calculated. The total sample is divided into three subgroups to investigate the relative performance of Reverse Leveraged Buyouts. Appropriate statistical tests are computed, to test whether these are significantly different from zero. Hereafter, to test how the target companies perform in line with market efficiency, Jensen’s alpha is calculated. An event study on operating efficiency is applied to measure abnormal operating performance. Lastly regressions on perfor- mance within the sample are made to try to find the cause of why some Reverse Leveraged Buyouts performed better than others. Findings: No clear indication of outperformance was found regarding the target companies’ stocks returns. Measuring the relative operating performance, the findings were in line with expected, ac- cording to the mechanisms described in agency theory. However, whether the cause of operating efficiency findings was Private Equity induced value-creation, effects of leverage or due to other properties is not clear. Moreover, there were no strong conclusions on why some target firms have a better stock performance than others. The only clear conclusion from this, was that the target firms with a larger market capitalization performed best. 1 TABLE OF CONTENTS ABSTRACT ................................................................................................................................................................... 1 1 INTRODUCTION ....................................................................................................................................................... 4 1.1 DELIMITATIONS ............................................................................................................................................................ 5 1.2 PROBLEM STATEMENT ................................................................................................................................................... 6 2 PHILOSOPHY OF SCIENCE ......................................................................................................................................... 7 3 METHODOLOGY ....................................................................................................................................................... 9 3.1 THE EVENT STUDY METHOD ........................................................................................................................................... 9 3.2 THE EVENT STUDY METHOD ON STOCK RETURNS ............................................................................................................... 9 3.2.1 The Long-Horizon Event Study on Stock Performance .................................................................................. 11 3.2.2 Firm Matched Approach vs. Calendar Time Portfolio Approach .................................................................. 11 3.2.3 Firm Matched Approach – Abnormal Returns (The CAR and BHAR approach) ............................................ 12 3.2.4 The Jensen’s alpha Approach ......................................................................................................................... 13 3.2.5 Significance tests for BHAR and Jensen’s alpha ............................................................................................ 14 3.3 EVENT STUDY ON ABNORMAL OPERATING PERFORMANCE................................................................................................. 15 3.4 CROSS-SECTIONAL MULTIVARIATE REGRESSION MODEL .................................................................................................... 16 4 LITERATURE REVIEW ...............................................................................................................................................17 4.1 TRADITIONAL IPO PERFORMANCE ................................................................................................................................. 17 4.2 REVERSE LEVERAGED BUYOUTS ..................................................................................................................................... 21 5 PREUNDERSTANDING (PRIVATE EQUITY INVESTMENT BEHAVIOR) .........................................................................28 5.1 PRIVATE EQUITY INVESTMENTS ..................................................................................................................................... 28 5.2 INCENTIVES OF TAKING A PUBLIC FIRM PRIVATE (VALUE CREATION IN PRIVATE EQUITY) ......................................................... 30 5.2.1 The Control Hypothesis .................................................................................................................................. 30 5.2.2 The Incentive Alignment Hypothesis ............................................................................................................. 31 5.2.3 Undervaluation Hypothesis/ Information Asymmetry ................................................................................. 32 5.2.4 The Leveraged Buyout & Incentives driven by Leverage............................................................................... 33 5.2.5 Combining Effects ........................................................................................................................................... 34 5.3 DEFINING REVERSED LEVERAGED BUYOUTS ..................................................................................................................... 35 6 VARIABLES SELECTION ............................................................................................................................................36 6.1 STOCK RETURN PERFORMANCE ..................................................................................................................................... 36 6.2 OPERATING PERFORMANCE .......................................................................................................................................... 38 6.3 CROSS-SECTIONAL INVESTIGATION OF VALUE DRIVERS ...................................................................................................... 41 7 DATA ......................................................................................................................................................................44 7. 1 IDENTIFICATION OF THE RLBO SAMPLE .......................................................................................................................... 44 7.2 IDENTIFICATION OF THE BENCHMARK SAMPLES ................................................................................................................ 47 7.3 SAMPLE DESCRIPTION .................................................................................................................................................. 47 7.2.1 Operating Performance (accounting measures) ........................................................................................... 52 7.2.2 RLBO Governance statistics ........................................................................................................................... 54 8. ANALYSIS AND RESULTS .........................................................................................................................................55 2 8.1 LONG-HORIZON STOCK PERFORMANCE .......................................................................................................................... 56 8.1.1 RLBO Returns Distribution ............................................................................................................................. 57 8.1.2 Equally Weighted Raw Returns ..................................................................................................................... 58 8.1.3 Equally Weighted Buy-and-Hold Returns .....................................................................................................