Lbo mbo

Lbo mbo

• 1.
  LBO – LeveragedBuy out • Borrowed funds used to pay for all or most of the purchase price of the acquisition of the company • In a typical LBO, a group of investors purchase an underperforming firm by raising an unusually large amount of debt relative to the equity • Investors could be firm’s managers with P.E. players and a Venture Capital firm • The strategy is to restructure the firm, improve its performance and increase the cash flows in order to repay a large part of the initial debt within a certain amount of time • It is also a kind of a Arbitrage operation since one buys an undervalued company improves its short term performance and then selling it at a higher price
• 2.
  • Investors inLBOs are Financial investors • LBO firms are generally taken to the public or divested to corporate buyer Typical Capital structure – a) Senior Bank debt (secured by target’s assets ) b) Subordinated (Unsecured debt ) c) Preference stock Common stock / equity
• 3.
  • In recenttimes a few common strategies have evolved : High technology buyouts Joint venture LBOs in which the buyout specialist shares equity ownership with a strategic buyer Consortium buyouts where several PE firms buy out target PIPE – Private equity firms take minority stake in Public Listed companies
• 4.
  • LBOs areeither asset based or cash flow based • Asset based ones – sale of assets by the target to the acquiring company or merger of the target into the acquiring company or into a W.O.S. of the acquiring company • Starts with a LOI between buyer and seller • Acquirer is asked for a Commitment letter from a recognized lender for loans required to fund the acquisition • This letter allows the lender to have access to the target company’s records for credit evaluation • Closing is conditioned upon the acquirer’s ability to obtain financing
• 5.
  • A properlystructured LBO should have a Balance Sheet that indicates solvency at the time of the closing • Cash flows should be enough and Off-balance sheet items cash impact needs to be quantified and included in the projections • Important feature in a LBO is the SPV • Here the acquiring company could float a SPV which is a 100 % subsidiary with a minimum equity capital • This SPV leverages this equity to gear up significantly higher debt to buyout the target company • This debt is paid off by the SPV thru the target company’s own cash flows
• 6.
  • MBOs –Special type of LBO which occurs when the management of a company decides to take over its publicly held company or a division of the company and consequently make it private • To convince stockholders to sell managers must be able to offer them a premium above the current market price
• 7.
  • Reasons foran MBO – a) Opportunity to control own business B) Long term faith in the company C) Better financial rewards D) Opportunity to develop own talent E) Absence of HO constraints F) Fear of redundancy
• 8.
  • Process ofa LBO – a) Decision to divest b) Decision to purchase – managers of the division attempt to buyout c) Financial analysis of division – book value, liquidation value, replacement value of assets d) Determination of purchase price e) Investment by the division management f) Group of investors – lenders put together for providing finance for the LBO g) External equity investment – done in conjunction with the division management , investors, cash flow analysis h) Cash flow analysis i) Financing is committed
• 9.
  • Features ofa LBO candidate –  Stable cash flows  Stable management  Scope for cost reduction  Equity interest of owners – act as a cushion to protect the lenders  Debt capacity – lower the debt on the Balance sheet of the firm, greater may be the borrowing capacity of the firm  Non core business – if this can be sold to pay off a large part of the firm’s post LBO debt, it is easier to finance such a deal  Intangible factors – Dynamic, innovative and growing co. is preferable
• 10.
  • Major sourcesof target companies – Family run (sale) of private companies Divestiture of SBUs by large companies Conversion of public company to private company Bankruptcy
• 11.
  • Financial andRisk evaluation – An LBO transaction makes sense when the Present value (PV) of the FCF (Future Cash flows) to the firm – (PV fcff) discounted at the WACC equals to exceeds the total of the investment comprising Id (Debt), Ie (Common equity), Ip (Preference stock) i.e. • ((PV fcff – (Id+Ie+Ip)) >= 0
• 12.
  LIST OF BUYOUTSBY INDIAN COMPANIES Acquirer Company Target Company Country of Target Deal Size Dr. Reddy's Lab. Betapharm Arzneimittel Germany USD 570 mn Suzlon Energy EVE Holding Belgium USD 565 mn Tata Coffee Eight o'clock coffee USA USD 220 mn Tata Steel Corus Anglo-Dutch USD 12.9 billion UB Group Whyte & Mackay Glasgow 270 mn Sterling
• 13.
  • In anLBO it is possible to do justice to the common equity investors but not to other investors like debt, preference • An LBO deal makes sense to common equity investors if the PV of the FCFE exceeds the value of the equity investment in the deal and the PV of FCFF exceeds the total cost of the deal, equity plus debt and preferred stock • These conditions suggest that the firm has achieved returns which exceed the minimum returns required by equity investors as well as debt and preferred stock holders • Hierarchy of funding / financing alternatives – 1. Senior Debt (Secured by firm’s assets – Accounts receivable, fixed assets) 2. Mezzanine financing – unsecured 3. Junior debt / subordinated debt 4. Equity
• 14.
  Case Study –Tata Corus • On Jan 30 2007 Tata Steel acquired 100 % stake in Anglo- Dutch steelmaker at 608 pence per share (cumulatively valued @ US $ 12.9 billion) • It was a all-cash deal • Motivation – Tata steel may become the world’s 5 th largest steel manufacturer from 56 th. • Some of the synergies which were present between Tatas and Corus were : - i) Corus was facing a situation of high costs due to inc. raw material prices and Tata was one of the lowest cost steel producers of the world ii) Expectation of technology transfer and R & D capabilities iii)Strong cultural fit between two organizations
• 15.
  • For acquisitionpurposes a SPV, a wholly owned subsidiary called Tata Steel UK was set up by Tata Steel. • Tata Steel appointed Credit Suisse, ABN Amro and Deutsche Bank to arrange bridge financing • Sources of finance for the acquisition – a) Equity capital (Tata Steel) – USD 4.10 billion B) Long term debt from a Consortium of banks – USD 6.14 billion C) Quasi-Equity funding at Tata Steel Asia Singapore – USD 1.25 billion D) Long term capital funding at Tata Steel Asia Singapore – USD 1.41 billion
• 16.
  • Post acquisitionin 2011 the company started deleveraging. It repaid Rs. 4200 crores of borrowings • In the same year there was reduction in interest on term loans arising out of repayments • Also the D/E went up from 0.84 in 2006-07 to 1.55 in 2010-11 • Int. coverage ratio went down from 16.38 in 2006-07 to 4.58 in 2010-11 • Corus (Europe) continued to do well in 2011 despite a domestic slowdown in India • Conclusion – i)LBOs essentially magnifies returns to shareholders and reduces WACC as interest is tax deductible ii) It could also add to the risk if in case the company is not able to pay interest & principal, in such cases the LBO may fail and the company may go bankrupt if the cash flows are insufficient to meet the interest payments