Going Private and LBOs

Costs of Staying Public

Cost of reporting Disclosures Self- dealings Inactive market, low price Control

Going private: transformation of a public company into privately held firm Mainly through repurchasing of some/all of firms equity by private investors Issues: justice to minority shareholders Sourcing of funds for the transaction Methods: Through merger directly with target company Tender/ public offer to purchase shares from shareholders Reverse stock split: reduces number of stockholders

Leveraged Buyout (LBO)

Financing technique where primarily debt is used to purchase a companys stock Is normally followed by taking public company, private Elements of a typical LBO operation: A portion of funding in the form of equity is provided by the managers/ owners Loans are arranged for the balance amount Acquire the company and make it private Overhaul firms operations to increase profitability Again take the firm (now with higher valuation), public through SIPO/ reverse LBO

Financing for LBOs

Secured LBO financing/ asset based lending: Is against pledge of assets used as collateral Assets are mostly of target firm Specially applicable to capital intensive/ asset rich firms Debt could be senior or subordinate Unsecured LBO Financing/ cash flow based lending: May use mezzanine financing: debt with warrants Are cash flow LBOs since cash flows of the target company, and not its assets, provide comfort to the lenders Especially useful for service industries with strong cash flows

Structuring LBOs

Bust-up LBOs: Depend upon sale proceeds of assets to generate returns to equity investors/ to retire the debt Normally used when value of sub units is higher than valuations given by the market These are sold off after the acquisition, to exploit the discrepancy Cash flow LBOs: Servicing of debt from cash flows from operations Hybrid LBOs: Servicing partly from sale of select portion of assets Balance from operating cash flows

Characteristics of an ideal LBO Candidate

Since high level of debt is involved, a small error can lead to default and bankruptcy Experienced management team Strong and secure cash flows: to service debt Strong asset base: as collateral Low operating/ business risk: since financial risk is high, so need to contain overall risk Limited existing debt on firms balance-sheet Sufficient equity interest of owners/ management Separable, non-core businesses Other intangible factors

Timing:

Companies that lack strategic fit with parent: acquirer may see more value in it than the parent Retiring owner situations: with no heirs willing to takeover Companies that must be sold because of regulators Subsidiaries that lack attention of the parent company: due to size, lack of foreseeable potential

Sources of Gain

Taxes: Tax shield on higher interest costs Higher depreciation benefit on asset set ups Management incentives: Can be better structured after LBO/MBO Unification of ownership and management reduces agency costs Efficiency considerations: due to faster decision process and secrecy in private firm Wealth transfer effects: through payment of premiums Signals that target company is considered to be underpriced by acquirer

Types of LBO risk:

Higher financial risk Interest rate risk: higher sensitivity to interest rate fluctuations

LBOs as White Knights: as an alternative to a hostile bid

Other Types

Management Buyout: When existing management buys out the company Agency problems are avoided Management Buy-in: When outside management buys the controlling stake Leveraged Cash Out: Also called leveraged recapitalization Outside shareholders receive large one time cash dividend, mostly by raising debt (not permissible in India) Inside shareholders receive new stock, instead Increases ownership stake of management/ promoters

Leveraged Joint Venture:

Company (mostly public), alongwith a passive financial partner in JV, acquires a firm through LBO Public firm may not show debt on its B/S

Leveraged Sell Out: seller retains interest in equity of the divested business, arranges debt to facilitate the sell out

Indian Scenario

Underdeveloped corporate debt market Limited availability of control transactions and professional management: managers lack resources to engineer a buyout Regulatory Restrictions:

RBI restriction on banks to lend money to buy shares FIPB press note 9 bars a foreign investment company from borrowing money from an Indian bank for buying equity Public companies to comply with provisions of SEBI/ listing agreement, on delisting Restrictions relating to exit (for SIPO): promoters contribution and lock in period, domestic listing a precondition to foreign listing Companies Act restrictions on share buyback provisions