SURAJ PRAKASH

Anatomy of a Leveraged Buyout:

Leverage + Control + Going
Private
 Leveraged Buyouts: The Three Possible Components
Increase financial leverage/ debt

Leverage Control

Leveraged Buyout

Take the company Change the way the

private or quasi company is run (often with
private existing
managers)

Public/ Private
A leveraged buyout (or LBO, or highly-leveraged transaction (HLT), or
"bootstrap" transaction) occurs

when a financial sponsor acquires a controlling interest in a company's

equity and where a significant percentage of the purchase price is financed
through leverage (borrowing).

The assets of the acquired company are used as collateral for the
borrowed capital, sometimes with assets of the acquiring company.
The bonds or other paper issued for leveraged buyouts are commonly
considered not to be investment grade because of the significant risks
involved.[1]

Companies of all sizes and industries have been the target of leveraged
buyout transactions, although because of the importance of debt and the
ability of the acquired firm to make regular loan payments after the
completion of a leveraged buyout,
some features of potential target firms make for more attractive
leverage buyout candidates, including:
1.Low existing debt loads;

2.A multi-year history of stable and recurring cash flows;

Hard assets (property, plant and equipment, inventory, receivables)
that may be used as collateral for lower cost secured debt;

3.The potential for new management to make operational or other

improvements to the firm to boost cash flows;

4.Market conditions and perceptions that depress the valuation or

stock price.
Leveraged buyouts involve financial sponsors or
private equity firms making large acquisitions without
committing all the capital required for the acquisition.

To do this, a financial sponsor will raise acquisition debt

which is ultimately secured upon the acquisition target and
also looks to the cash flows of the acquisition target to make
interest and principal payments.

Acquisition debt in an LBO is therefore usually non-recourse

to the financial sponsor and to the equity fund that the
financial sponsor manages.

LBO transaction's financial structure is particularly attractive

to a fund's limited partners, allowing them the benefits of
leverage but greatly limiting the degree of recourse of that
leverage.
This kind of acquisition brings leverage benefits to an LBO's financial
sponsor in two ways:
(1) the investor itself only needs to provide a fraction of the capital for the
acquisition, and
(2) assuming the economic internal rate of return on the investment (taking
into account expected exit proceeds) exceeds the weighted average interest
rate on the acquisition debt, returns to the financial sponsor will be
significantly enhanced.

As transaction sizes grow, the equity component of the purchase price can
be provided by multiple financial sponsors "co-investing" to come up with
the needed equity for a purchase.

Likewise, multiple lenders may band together in a "syndicate" to jointly

provide the debt required to fund the transaction. Today, larger transactions
are dominated by dedicated private equity firms and a limited number of
large banks with "financial sponsors" groups.

Typically the debt portion of a LBO ranges from 50%-85% of the purchase
price, but in some cases debt may represent upwards to95% of purchase
price. Between 2000-2005 debt averaged between 59.4% and 67.9% of total
purchase price for LBOs in the United States.
 Private Equity Firms
The typical private equity firm is organized as a partnership or
limited liability corporation.
The PE firm raises equity capital through a PE fund.
Most PE funds are “closed-end vehicles in which investors
commit to provide a certain amount of money to pay for
investments in companies as well as management fees to the
private equity firm.
The PE funds are organized as limited partnerships in which
the general partners manage the fund and the limited partners
provide most of the capital.
Limited Partners- institutional investors, insurance cos,
wealthy individuals.
General Partner- PE Firm
 Types of Private Equity:

Leveraged buyout (LBO)

Venture capital
Growth capital
 Leveraged Buyouts (LBO)
A leveraged buy-out (LBO) is an acquisition of a public or
private company in which the takeover is financed
predominantly by debt with minimum equity investment.
The acquisition is carried out by a specialized investment firm.
These firms are referred to as private equity firms.
The PE firm buys majority control of the company it has
acquired.
The debt includes a combination of bank loans, loans from
other financial institutions and high-yield bonds.
Assets of the acquired company act as collateral for the debt
and interest and principal obligations are met through cash
flows of the refinanced company.
 Venture Capital
VC is a type of private equity capital typically provided to
early-stage, high-potential, growth companies in the
interest of generating a return through an eventual
realization event such as an IPO or trade sale of the
company.
Venture capital investments are generally made as cash in
exchange for shares in the invested company.
Venture capital typically comes from institutional
investors and HNW individuals and is pooled together by
dedicated investment firms.
 Growth capital
Refers to equity investments, most often minority
investments, in more mature companies that are
looking for capital to expand or restructure
operations, enter new markets or finance a major
acquisition without a change of control of the
business
These companies are likely to be more mature
than VC funded companies, able to generate revenue
and operating profits but unable to generate sufficient
cash to fund major expansions, acquisitions or other
investments. 
 LBO
The acquisition by a small group of investors of a public or
private company, financed primarily with debt.
“Taking the company private.”
Shares in “pure” LBO no longer trade on the open market.
There have been some public LBOs called leveraged
recapitalizations.
For most LBOs, remaining equity in the LBO is usually
privately held by a small group of investors (usually
institutional, or management).
A large fraction of debt that finances LBO transactions tends to
be “junk” debt
Cont…
Mezzanine capital, in finance, refers to a subordinated debt or
preferred equity instrument that represents a claim on a company's
assets which is senior only to that of the common shares. Mezzanine
financings can be structured either as debt (typically an unsecured and
subordinated note) or preferred stock.

subordinated debt (also known as subordinated loan, subordinated

bond, subordinated debenture or junior debt) is debt which ranks
after other debts should a company fall into receivership or be closed.
Such debt is referred to as subordinate, because the debt providers
(the lenders) have subordinate status in relationship to the normal debt.
A typical example for this would be when a promoter of a company
invests money in the form of debt, rather than in the form of stock. In
the case of liquidation (e.g. the company winds up its affairs and
dissolves) the promoter would be paid just before stockholders --
assuming there are assets to distribute after all other liabilities and
debts have been paid.
 LBO Criteria
Steady and predictable cash flow
 Divestible assets
Clean balance sheet with little debt
Strong management team
 Strong, defensible market position
Viable exit strategy
 Limited working capital requirements
Synergy opportunities
Minimal future capital requirements
Potential for expense reduction
Heavy asset base for loan collateral
 Industry Players
The 10 largest private equity firms in the world are:
The Carlyle Group (US)
Goldman Sachs principal Investment area (US)
TPG
Kohlberg Kravis Roberts (US)
CVC capital partners (European)
Apollo Management
Brain Capital (US)
Permira (European)
Apax partners (European)
The Blackstone Group (US)
 Typical LBO Transaction Structure
Offerings Percent Of Cost Of Lending Likely Source
Transaction Capital Parameters

Senior 50-60% 7-10% •5-7 years payback •Commercial banks

Debt •2.0x -3.0 •Credit companies
EBITDA •Insurance
•2.0x interest companies
coverage
Mezzanine 20-30% 10-20% •7-10 years Public market
Financing payback Insurance companies
•1.0-2.0x EBITDA LBO/mezzanine
Funds
Equity 20-30% 25-40% 4-6 years exit •Management
strategy •LBO funds
•Subordinated debt
holders
•Investment banks
 Valuation
Market Comparison :
These are metrics such as multiples of revenue, net
earnings and EBITDA that can be compared among public
and private companies
 A discount of 10% to 40% is applied to private companies
due to the lack of liquidity of their shares.
Discounted cash flow (DCF) analysis:
An appropriate discount rate is used to calculate a net
present value of projected cash flows.
Option Approach :
Using put call parity equation
 Exit Strategies
Exit Strategy Comments

Sale Often the equity holders will seek an outright

sale to a strategic buyer, or even another
financial buyer

Initial Public Offering While an IPO is not likely to result in the

sale of the entire entity, it does allow the
buyer to realize a gain on its investment

Recapitalization The equity holders may recapitalize by re-

leveraging the entity, replacing equity with
more debt, in order to extract cash from the
company
 Advantage
Independent future development of the company,
Management best knowing the business and its
potential,
Conducting business in a more simple and efficient
manner,
Tax shield,
Flexible structure of financing (various manners of
accomplishment),
High potential yield of investment in LBO.
 Disadvantage
1. Bankruptcy risk –
Excessive debt financing, comprising about 97%
of the total consideration
Large interest payments that exceeded the

company's operating cash flow

2. Leverage can induce firms to choose overly risky
projects
Over-optimistic forecasts of the revenues of the

target company
Example
 Example
 Firm can take on one of two projects, project A or B.
 Project A can pay off either $50 or $150, each
with probability 1/2.
Project B always pays off $110.
Neither project costs anything to invest . NPV of
project A is $100, NPV of project B is $110.
 Project B is higher NPV and should be chosen.
 However, suppose that the firm has pre-existing,
outstanding debt with fact value of $100. Which
project will the owners of the firm choose?
 Cont…
If choose project B, payment to shareholders will be $10
with certainty, after paying off debt.
 If choose project A, shareholders receive $150 -$100 =
$50 in good state, which occurs with prob. 1/2 ==>
shareholders receive expected value of $25.
Owners would choose project A, the riskier one (and
Lower return), gambling with “other people’s money”
i.e. “bag the bondholder.”
 Problem with LBO
Rising interest rates
Higher asset valuation - overpayment
Political backlash
More regulation of Industry
“US private equity shaken by revelation of price collusion
probe” October 11, 2006
Economic slowdown
Failure of exit strategy

25
 The LBO Deal of Tata & Tetley
Summer 2000, Tata Tea acquired the UK heavyweight brand
Tetley  for a staggering 271 million pounds .
This deal which happened to be the largest cross-border
acquisition by any Indian company,
Objective :
 Aggressive growth and worldwide expansion. 
Instant access to Tetley’s worldwide operations,
combined turnover at Rs 3000 crs
The major challenge was financing
The value of Tata tea was $114m
Tetley was valued at $450m
The solution was provided by Leverage Buy Outing the deal
 Finance
Tata Tea created a Special Purpose Vehicle (SPV)-christened
Tata Tea (Great Britain) to acquire all the properties of Tetley.
The SPV was capitalised at 70 mn pounds, of which Tata tea
contributed 60 mn pounds; this included 45 mn pounds raised
through a GDR issue.
The US subsidiary of the company, Tata Tea Inc. had
contributed the balance 10 mn pounds. 
The SPV leveraged the 70 mn pounds equity 3.36 times to
raise a debt of 235 mn pounds, to finance the deal
The tenure of debt varied from 7 years to 9.5 years, with a
coupon rate of around 11% which was 424 basis points above
LIBOR(London Interbank Offered Rate).
THANK YOU