Financial Engineering and Structuring in Leveraged Buyouts
Finanzmanagement, Band 94
Hamburg 2012, 216 Seiten
ISBN 978-3-8300-6825-9 (Print/eBook)
Financial Engineering, Fremdkapitalfinanzierung, Fusion, Heuschrecken, Institutionelle Investoren, Investoren, Kapitalismus, Leveraged Buyouts, Mergers & Acquisitions, Private Equity, Übernahme, Value Creation
In a Leveraged Buyout, a Private Equity investor finances the purchase price of a company to a substantial fraction with debt in addition to the equity contribution out of his fund and from the participating management. The rationale for this financing structure is the substitution of equity, as an expensive source of capital, with comparably cheap debt in order to increase the expected returns on the individual equity investment and, thus, the returns of the whole fund.
Under perfect capital market conditions the sources of finance and the composition of a company’s capital structure are irrelevant. Hence, substituting equity with debt creates no additional value.
When analyzing the value of financial leverage and ist relevance to increase the returns of LBOs, it has to be distinguished at which point in time this value is measured. From an ex-ante perspective the capitalized value of future debt tax shields – after incorporating implied costs of debt – solely matters. This ex-ante perspective is the one that forms the basis of the research question in the following chapter. Chapter two empirically analyzes the present value of additional future tax savings implied by increased interest expenses following an LBO, with respect to the detailed characteristics of the new capital structure.
From an ex-post perspective that doesn’t capitalize tax shields or higher expected returns on equity anymore, as well as incorporates the enterprise and equity value concept following the Private Equity inherent buyto- sell approach, the return contribution of financial leverage appears in a very different light. Chapter three develops a formal model to quantify this value by using a certain set of input parameters, such as details on the capital structure as well as information about the expected or achieved growth in earnings and the valuation multiple at exit after a certain holding period.
The steadily increasing and finally excessive activity of Private Equity between 2004 and 2007 showed certain similarities to the first large LBO wave in the later 1980s. Both periods are characterized by increasing volumes of fundraising and deal activity as well as a final collapse in the debt capital markets. However, there are also a number of differences that were characteristic for each period. For instance, takeover premia were about twice as high for public-to-private LBOs in the 1980s. At the same time, the invested equity pieces of Private Equity sponsors were much smaller two decades ago. Both in the light of a substantially higher interest base rate that made debt financing and leveraging returns on equity far more expensive. Further, the author empirically analyzes characteristics and structures of large public-to-private LBOs in the United States during both periods. Starting with the exploration of higher takeover premia in conjunction with the overall lower level of equity investments in the 1980s, the development of the bought-out companies after the LBO is analyzed. The focus lies on the improvement of the companies’ EBITDA and EBITDA margins, the level of Capital Expenditures (Capex) and, as a result, the ability to meet interest payments on the issued debt as well as the speed of debt principal repayment after the closing of the deals. With respect to the 1980s sample, special attention is paid to two attributes of these transactions. On the one hand, we differentiate between LBOs whose underlying deal rationale was the sale of a substantial fraction of a company’s assets. This “asset stripping? strategy was very popular two decades ago. However, it rarely occurred in recent years’ transactions. As many of the LBOs in the 1980s ended-up in bankruptcy we try to identify characteristics of defaulted companies at the time of their LBO in general, as well as during the period between the LBO and a company’s bankruptcy –with respect to the development of the U.S. economy– in particular. A final conclusion regarding similarities and differences is drawn, and an assessment on the future development of recent years’ LBOs is given, regarding the current economic difficulties.
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