What is the role of the buyout funds ?
- Raise capital from wealthy individuals, pension funds, institutional investors
- Acquire troubled firms or divisions of theirs
- Restructure activities of acquired firms
- Exit successful investments through IP, MBO, sellout to corporate bidders
- Exit unsuccessful investments through liquidation
What are the sources of value of buyout funds ?
- Restructuring of operating activities
* Redesign financial policy
What is the structure of a buyout fund ?
Classical limited partnership
What is the difference from VC’s ?
Finance public firms
With what do buyout funds finance large fraction of bid ?
Variety of debt securities
What is the difference between LBO and ordinary acquistion ?
- Large fraction of purchase price = debt financed
* LBO goes private = no shares traded on open market
What are the main characteristics of LBOs ?
• High debt
o Not permanent, supposed to be paid down
• Incentives
o Greater stake business given to managers via stock options or shares
o Generate cash for debt service, managers, employees work harder
o Private ownership
• LBO goes private
o Owned by partnership of private investors who directly monitor performance
o Most successful LBOs go public again as soon as debt = paid down sufficiently and improvements in performance achieved
What are the implications of buyout activity for target shareholders ?
Receive offers with premium of 37% vs pre-bid stock price
What are the likely targets of an LBO ?
Firms with high levels of FCF, low market to book ratios, conglomerates
What are the operational changes induced by LBOs ?
- Lower CAPEX
- Higher operating income
- Better utilization of employment and capital
- No slashing of R&D
- Focus of research in core activities
What are the Governance changes in LBOs ?
- Old management ousted with p = 50%
- New management higher incentives
- BoD is smaller
- Independent directors chosen by LBO sponsors
What happens when an LBO is announced ?
Buyout fund informs target shareholders about plan of reorganization
What does the reorganization plan involve ?
High usage of leverage comprising many different types of debt securities
What does one need to take into account when assessing NPV associated with LBO deal ?
Change of leverage over time
What does the change of leverage goign to imply ?
Time varying cost of capital
What is the idea behind the fact that some of the activity of buyout funds is concentrated on conglomerates ?
Inefficiently run division would be worth more as a stand alone company with its own specialized management
How to find out the cost of capital used for the valuation of the divested segment of the firm ?
Need to combine time varying leverage with beta of unlevered assets
