Leveraged Buyout Structures and Valuation
M&A and Other Res tructuring Ac tivities
Alternative Restructuring Strategies
Motivations for M&A
Business & Acquisition Plans
Public & Private Company Valuation
D ivestitures , Spin-Offs, & Carve-Outs
Common Takeover Tactics and Defenses
Search Through Closing ActivitiesFinancial Modeling Techniques
Bankruptcy & Liquidation
Tax & Accounting Issues
• Primary Learning Objective: To provide students with a knowledge of how to analyze, structure, and value highly leveraged transactions. • Secondary Learning Objectives: To provide students with a knowledge of – The motivations of and methodologies employed byfinancial buyers; – Advantages and disadvantages of LBOs as a deal structure; – Alternative LBO models; – The role of junk bonds in financing LBOs; – Pre-LBO returns to target company shareholders; – Post-buyout returns to LBO shareholders, and – Alternative LBO valuation methods – Basic decision rules for determining the attractiveness of LBO candidates
In a leveraged buyout,all of the stock, or assets, of a public corporation are bought by a small group of investors (“financial buyers”), usually including members of existing management. Financial buyers: • Focus on ROE rather than ROA. • Use other people’s money. • Succeed through improved operational performance. • Focus on targets having stable cash flow to meet debt service requirements. – Typical targets are inmature industries (e.g., retailing, textiles, food processing, apparel, and soft drinks)
LBO Deal Structure
• Advantages include the following: – Management incentives, – Tax savings from interest expense and depreciation from asset write-up, – More efficient decision processes under private ownership, – A potential improvement in operating performance, and – Serving as a takeover defense byeliminating public investors • Disadvantages include the following: – High fixed costs of debt, – Vulnerability to business cycle fluctuations and competitor actions, – Not appropriate for firms with high growth prospects or high business risk, and – Potential difficulties in raising capital.
Classic LBO Models: Late 1970s and Early 1980s
• Debt normally 4 to 5 times equity. Debt amortized overno more than 10 years. • Existing corporate management encouraged to participate. • Complex capital structure: As percent of total funds raised – Senior debt (60%) – Subordinated debt (26%) – Preferred stock (9%) – Common equity (5%) • Firm frequently taken public within seven years as tax benefits diminish
Break-Up LBO Model (Late 1980s)
• Same as classic LBO but debt serviced from operatingcash flow and asset sales • Changes in tax laws reduced popularity of this approach – Asset sales immediately upon closing of the transaction no longer deemed tax-free – Previously could buy stock in a company and sell the assets. Any gain on asset sales was offset by a mirrored reduction in the value of the stock.
Strategic LBO Model (1990s)
• Exit strategy is via IPO • D/E ratios lower soas not to depress EPS • Financial buyers provide the expertise to grow earnings – Previously, their expertise focused on capital structure • Deals structured so that debt repayment not required until 10 years after the transaction to reduce pressure on immediate performance improvement • Buyout firms often purchase a firm as a platform for leveraged buyouts of other firms in the same industryRole of Junk Bonds in Financing LBOs
• Junk bonds are non-rated debt. – Bond quality varies widely – Interest rates usually 3-5 percentage points above the prime rate • Bridge or interim financing was obtained in LBO transactions to close the transaction quickly because of the extended period of time required to issue “junk” bonds. – These high yielding bonds represented permanent financing for...
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