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Chapter 11 Leveraged Buyout Structures and Valuation
Chapter 11 Leveraged Buyout Structures and Valuation
M & A an d O th er
R e s tr u c t u ri n g
A c ti v i ti e s
M & A
E n v ir o n m e n t
M & A P roce ss
Deal
S t ru c tu r i n g
A lte r n a t iv e
R e s tr u c t u r in g
S tr a t e g ie s
M o ti v a ti o n s
fo r M & A
B u s in e s s &
A c q u i s itio n P l a n s
P u b l ic &
P r iv a t e C o m p a n y
V a l u a ti o n
D iv e s t i t u r e s ,
S p i n - O ff s , &
C a rv e - O u t s
C o m m o n T a ke o ver
T a c ti c s a n d
D e fe n s e s
S e a r c h T h ro u g h
C l o s i n g A c t i v it i e s
F in a n c ia l
M o d e lin g
T e c h n iq u e s
A l t e r n a t iv e
S t r u c tu r e s
T a x & A c c o u n ti n g
Is s u e s
Learning Objectives
Financial Buyers
In a leveraged buyout, all of the stock, or assets, of a public
corporation are bought by a small group of investors
(financial buyers), usually including members of
existing management. Financial buyers:
Focus on ROE rather than ROA.
Use other peoples money.
Succeed through improved operational performance.
Focus on targets having stable cash flow to meet debt
service requirements.
Typical targets are in mature industries (e.g., retailing,
textiles, food processing, apparel, and soft drinks)
Valuing LBOs
A LBO can be evaluated from the perspective of
common equity investors or of all investors and lenders
LBOs make sense from viewpoint of investors and
lenders if present value of free cash flows to the firm is
greater than or equal to the total investment consisting of
debt and common and preferred equity
However, a LBO can make sense to common equity
investors but not to other investors and lenders. The
market value of debt and preferred stock held before the
transaction may decline due to a perceived reduction in
the firms ability to
Repay such debt as the firm assumes substantial
amounts of new debt and to
Pay interest and dividends on a timely basis.
Recalculate each successive periods with the D/E ratio for that period,
and using that periods , recalculate the firms cost of equity for that period.
Things to Remember
LBOs make the most sense for firms having stable cash flows,
significant amounts of unencumbered tangible assets, and strong
management teams.
Successful LBOs rely heavily on management incentives to improve
operating performance and a streamlined decision-making process
resulting from taking the firm private.
Tax savings from interest expense and depreciation from writing up
assets enable LBO investors to offer targets substantial premiums
over current market value.
Excessive leverage and the resultant higher level of fixed expenses
makes LBOs vulnerable to business cycle fluctuations and
aggressive competitor actions.
For an LBO to make sense, the PV of cash flows to equity holders
must equal or exceed the value of the initial equity investment in the
transaction, including transaction-related costs.