Corporate

restructuring

Other forms:
Acquisitions,
Divestitures LBO,
mergers
Privatization

2
 The acquisition of another company using a significant amount of
borrowed money (bonds or loans) to meet the cost of acquisition.
Often, the assets of the company being acquired are used as
collateral for the loans or bonds in addition to the assets of the
acquiring company. The purpose of leveraged buyouts is to allow
companies to make large acquisitions without having to commit a
lot of capital.

 Typical LBO operation

 Financial buyer purchases company using high level of
debt financing
 Financial buyer replaces top management
 New management makes operating improvements
 Financial buyer makes public offering of improved
company at higher price than originally purchased
 In an LBO, there is usually a ratio of 90% debt to
10% equity. Because of this high debt/equity ratio,
the bonds usually are not investment grade and are
referred to as junk bonds.

Corporate
Finance

LBO

Debt
 Leveraged Buyout activity
 Management buyouts (MBOs)
 LBO transaction may be reversed with future public offering
Buyout group seeks to harvest gain within three- to five-year
period
 Aim to increase profitability of company and thereby increase
market value of firm
 Buyout group may include incumbent management and may be
associated with :
 Buyout specialists, e.g., Kohlberg Kravis Roberts & Co.
 Investment bankers
 Commercial bankers
 The 1980s
 The 1990s
 The Post 1990s
 Characteristics
◦ Debt financing
 Highly leveraged — up to 90% of purchase price
 Debt secured by assets of acquired firm or based on
expected future cash flows
 Paid off either from sale of assets or from future cash
flows generated by operations
◦ Acquired company became privately held
◦ Firm expected to go public again after three to five
years
 General economic and financial factors
◦ Sometimes LBOs and MBOs were responses to
threat of unwanted takeovers
◦ Sustained economic growth between 1982-1990
◦ Earlier inflation
◦ Financing innovations — high-yield bonds (junk
bonds) made public financing available to
companies below investment grade
◦ Legislative factors, especially taxes
◦ Change in antitrust climate - beginning in 1980
 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 the LBO
 Junk bond financing for LBOs dried up due to the following:
◦ A series of defaults of over-leveraged firms in the late
1980s
◦ Insider trading and fraud at such companies a Drexel
Burnham, the primary market maker for junk bonds
 Junk bond financing is highly cyclical, tapering off as the
economy goes into recession and fears of increasing default
rates escalate
 Tax benefits — can enhance already viable
transaction
 Management incentives and agency cost effects
 Wealth transfer effects
 Asymmetric information and underpricing
 Other efficiency considerations
 Background
◦ 1992-2000: Sustained economic growth —
resurgence of LBOs
◦ Size of aggregate LBO transactions moved to $62.0
billion in 1999 — almost as high as the peak of
$65.7 billion in 1989
 Resurgence of LBOs
◦ Favorable economic environment
◦ Change in LBO financial structure
◦ Restructuring of intermediaries
◦ Innovative approaches developed by investment
banking-sponsoring firms