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    Going PVT and Lbo

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    bharat
    This document summarizes leveraged buyouts (LBOs) and going private transactions. It discusses: 1) Characteristics of LBOs including the use of high levels of debt financing by financial buyers to purchase companies and improve operations through cost cutting and performance improvements. 2) Typical stages of an LBO including planning, acquiring the company privately, increasing cash flows, and conducting a reverse IPO to realize returns. 3) Factors that fueled the growth of LBOs in the 1980s including favorable economic and financial conditions. 4) Empirical evidence on the performance and returns of LBOs after being taken private and subsequent public offerings.

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    Going PVT and Lbo

    Uploaded by

    bharat
    91 views13 pages
    This document summarizes leveraged buyouts (LBOs) and going private transactions. It discusses: 1) Characteristics of LBOs including the use of high levels of debt financing by financial buyers to purchase companies and improve operations through cost cutting and performance improvements. 2) Typical stages of an LBO including planning, acquiring the company privately, increasing cash flows, and conducting a reverse IPO to realize returns. 3) Factors that fueled the growth of LBOs in the 1980s including favorable economic and financial conditions. 4) Empirical evidence on the performance and returns of LBOs after being taken private and subsequent public offerings.

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    Going Pvt and Lbo

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    This document summarizes leveraged buyouts (LBOs) and going private transactions. It discusses: 1) Characteristics of LBOs including the use of high levels of debt financing by financial buyers to purchase companies and improve operations through cost cutting and performance improvements. 2) Typical stages of an LBO including planning, acquiring the company privately, increasing cash flows, and conducting a reverse IPO to realize returns. 3) Factors that fueled the growth of LBOs in the 1980s including favorable economic and financial conditions. 4) Empirical evidence on the performance and returns of LBOs after being taken private and subsequent public offerings.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    91 views13 pages

    Going PVT and Lbo

    Uploaded by

    bharat
    This document summarizes leveraged buyouts (LBOs) and going private transactions. It discusses: 1) Characteristics of LBOs including the use of high levels of debt financing by financial buyers to purchase companies and improve operations through cost cutting and performance improvements. 2) Typical stages of an LBO including planning, acquiring the company privately, increasing cash flows, and conducting a reverse IPO to realize returns. 3) Factors that fueled the growth of LBOs in the 1980s including favorable economic and financial conditions. 4) Empirical evidence on the performance and returns of LBOs after being taken private and subsequent public offerings.

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    of 13

    GOING PRIVATE AND LEVERAGED

    BUYOUT
    Going Private:
    Transformation of public company into
    privately held firm
    Leveraged buyout (LBO):
    Purchase of company by small investor group
    using high percentage of debt financing
    Management buyout (MBO):
    An LBO executed mainly by the firm’s
    managers

    E.g. Berg Electronics


    Hicks, Muse, Tate & Furst pays $4.11 per
    share to buy Berg from DuPont in 1993
    HMTF improves firm, acquires related firms
    1996 – Berg has public offering ($21/share)

    LBO Characteristics
    Investors are outside financial group or
    managers or executives of company
    Results in significant increase of equity share
    ownership by managers
    Turnaround in performance is usually
    associated with formation of LBO
    Typical LBO operation
    Financial buyer purchases company using high
    level of debt financing
    Financial buyer replaces top management
    New management improves operations
    Financial buyer makes public offering of
    improved firm

    Characteristics of 1980s LBOs


    Economic and financial environments
    favorable to M&A activity and LBOs
    Sustained economic growth
    Availability of debt
    Financing innovations (e.g. high yield bonds
    made financing available to firms below
    investment grade)
    Favorable legislation (especially taxes)
    Previous inflation caused low q-ratio – cheaper
    for firms to buy capacity in financial markets
    1986-1989: height of LBOs – 20.5% of M&As,
    33.9% avg. premium, 20.5 avg. P/E
    Elements of a typical LBO operation
    First stage: planning and fund raising
    Financing: 10% cash from investor group,
    50-60% bank loans, balance from senior
    and junior subordinated debt
    Management incentives – stock price-based
    incentives (options, etc.)

    Second stage: firm taken private


    Stock-purchase (buy outstanding shares),
    or asset-purchase (buy assets and form
    new privately held corporation)
    New owners usually sell off parts of
    acquired firm to reduce debt

    Third stage: attempt to increase cash flows


    Cut operating costs and spending
    When possible, delay capital expenditures
    Try new marketing to increase revenues

    ourth stage: reverse LBOs increase liquidity


    Investor group may take improved
    company public again through public
    equity offering (secondary initial public
    offering - SIPO)
    Investors reaching SIPO realized 268.4%
    annual return on LBO investment
    (Muscarella and Vetsuypens, 1990)

    Typical target industries


    Basic, non-regulated industry – stable
    earnings, predictable/low financing
    requirements
    High-tech industry less appropriate – more
    risk, no track record, fewer assets, high P/Es
    Half of LBOs in 5 industries – retail, textiles,
    food, apparel, soft drinks (Lehn, Poulsen,
    1988)

    Target firm characteristics


    Capable management – willing to bet
    personal wealth on success
    Strong market position within industry
    Liquid balance sheet (with undervalued
    assets)

    Empirical Results of 1980s LBOs


    Multiple bid auctions had premiums higher
    than 50%
    High premium levels appear to compensate
    shareholders for added risk in LBO
    More insider trading before MBOs than 3rd party
    LBOs (Harlow, Howe, 1993)
    Of 136 highly leveraged transactions from
    1980-9, 31 had defaulted by 1996, 8 others
    distressed (Andrade, Kaplan, 1998)
    LBO firms divesting while in financial distress
    had negative wealth effects (Easterwood,
    1998)

    Sources of Gains in LBOs


    Tax Benefits
    Interest tax shelter, asset step-up (esp. in
    1980s)
    Can enhance already viable transaction
    Lowenstein (1985) found most of premium
    financed by tax savings
    Kaplan (1989) – there are large, predictable
    tax benefits from buyout, but they can be
    captured by pre-buyout shareholders
    Depending on assumptions (tax rate,
    maturity of debt) value of tax benefit
    between 1.297 and 0.263 times premium
    Step-up of basis can add another 0.304
    Management incentives and agency cost
    effects
    Increased ownership stake may provide
    increased incentives for improved
    performance
    Better aligns manager / shareholder
    interests
    Lower agency costs of free cash flows: debt
    from LBO commits cash flows to debt
    Debt puts pressure on managers to
    improve firm performance to avoid
    bankruptcy
    Empirical evidence supports:
    Increased ownership share of
    management
    Management incentive plans
    Operating performance of firms improved

    Wealth transfer effects


    Wealth transfer from existing bondholders
    and preferred stockholders to new
    shareholders
    Covenants may not protect from control
    changes and debt issue
    Wealth transfer from current employees to
    new investors – low management turnover
    (but sometimes new mgmt. team), slower
    growth in number of employees

    Asymmetric information and under-


    pricing
    Managers, investor groups have better
    information on value of firm than
    shareholders
    Large premium signals that future operating
    income will be larger than expectations –
    investor group believes new company worth
    more than purchase price
    But, failed MBO proposals are not followed by
    higher returns (Smith, 1990)

    Other efficiency considerations


    More efficient decision process as private
    firm
    Influence of favorable economic environment

    POST-BUYOUT EQUITY VALUES


    Comparison of LBO firm value and SIPO
    (Muscarella and Vetsuypens, 1990)
    Median change in firm value was 89%
    Median annualized rate of return was 36.6%
    Correlated with ownership share of
    management

    Comparison with S&P (Kaplan, 1991)


    Median excess return 26.1% higher in LBO
    Excess return similar to premium earned
    by pre-buyout shareholders
    Excess return relates to change in
    operating income, not to potential tax
    benefits

    Performance (Degeorge, Zeckhouser, 1993)


    Year before SIPO, 6.9% rise in industry-
    adjusted operating performance
    Year following, 2.59% decline
    Evidence of information asymmetries –
    management will SIPO in exceptional
    years
    CAR of 4.7%, 22.0%, 21.1% in first 3 years
    after SIPO – most of gains due to firms
    taken over (Mian, Rosenfeld, 1993)
    Firms outperform industries in 4 years
    following SIPO (Holthausen, Larcker,
    1996)
    Reduction of leverage loosened cash
    constraints
    Capital expenditures increased

    LBO CORRECTION PERIOD (1991-92)


    LBOs in late 1980s did not perform as well
    (Opler, 1992; Kaplan, Stein, 1993)
    Higher premiums extracted
    More LBO funds, fewer prospects
    Numerous cases of winner’s curse
    Weaker deal structure and incentives
    More cash required up front
    Immediate asset sales and profitability
    improvement were required to cover
    outlays
    Legislative changes regarding S&Ls caused
    high-yield debt prices to fall
    Economic downturn of 1990-91
    THE ROLE OF JUNK BONDS
    Junk bonds – high-yield bonds rated below
    investment grade (below BBB, Baa3)
    Financing innovation allowing high risk firms to
    obtain public financing

    Size of junk bond market


    3-4% of public straight debt for most of
    1970s – usually “fallen angels” ratings were
    lowered
    Firms began issuing below investment grade
    bonds – almost 20% of new bonds by 1985
    1986, Drexel Burnham Lambert had 45%
    share
    Legislation caused temporary setback
    By 1993, junk bond market achieved record
    highs

    Return on junk bonds


    Promised yield spread between 10.5% and
    2.8% over 10-year treasuries (1978-2001)
    Realized return spread approximately 2%
    Between 1980-6, 25% of proceeds used for
    acquisitions, 75% for internal growth (Yago,
    1991)
    Often blamed for collapse of S&L industry, but
    S&Ls were troubled before junk bonds (junk
    bonds were 1% or less of total assets)

    The influence of Michael Milken


    Main player in Drexel junk bonds
    One view: Milken acted wrongly (Saul, 1993)
    Engaged in securities parking – violation of
    Williams Act
    Milken guaranteed against high yield
    investment losses while markets absorbed
    new issues
    Milken monopolized the high yield market
    Alternate view (Fischel, 1995)
    Milken was a tough competitor
    Actions against him were part of a hysteria
    against “excesses of the 1980s”

    LBOS DURING 1992-2000


    1999 LBO level ($62billion) close to 1989 high

    Reasons for resurgence


    Sustained economic growth helped drive
    growth of M&As and LBOs
    Changed financial structure – prices fell from
    7-10 times EBITDA (late 1980s) to 5-6 times
    Restructuring of intermediaries – LBOs no
    longer dominated by Drexel
    Other innovations: more sponsor equity, joint
    deals with strategic buyers
    LBOs applied beyond mature, slow-growing
    industries

    VALUATION OF LBOS
    Key issue: leverage ratio changes over time
    Basic DCF method: must recalculate WACC to
    reflect leverage changes
    CCF or APV better reflect changing leverage

    Capital Cash Flows (CCF)


    Free cash flow (FCF) same as in DCF method
    Interest tax shield (TS) = actual tax rate
    times interest expense
    FCF + TS is referred to as capital cash flow
    CCFs are discounted at the expected asset
    return rate (ka) [kb = before-tax cost of
    debt]
    Adjusted Present Value (APV)
    Free cash flow is calculated as in DCF
    method
    Interest tax shield (TS) is calculated as actual
    tax rate times interest expense
    FCF discounted at cost of equity of an
    unlevered firm (expected asset return rate
    [ka])
    TS discounted at the before-tax cost of debt
    (kb)

    APV method versus CCF method


    Equivalent if TS is discounted at the
    expected asset return rate (ka)
    CCFs assume that interest tax shields are
    subject to same uncertainties as cash flows
    from assets

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