Chapter 16


Going Private and Leveraged Buyouts

©2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 1

• Going private — transformation of a public corporation into a privately held firm • Leverage buyout (LBO) — purchase of a company by a small group of investors using a high percentage of debt financing
– Investors are outside financial group or managers or executives of company – Management buyout (MBO) — leveraged buyout performed mainly by managers or executives of the company
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– Results in significant increase of equity share ownership by managers – Turnaround in performance is usually associated with formation of LBO – Typical LBO operation
• Financial buyer purchases company using high level of debt financing • Financial buyer replaces top management • New management makes operating improvements • Financial buyer makes public offering of improved company at higher price than originally purchased
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4 .6 million – Total purchase price of 20 largest LBOs formed during 1983-1995 was $76.5 billion ©2001 Prentice Hall Takeovers.Characteristics of Leveraged Buyouts • Leverage buyout activity – Reached peak during 1986-1989 – Largest LBO was RJR Nabisco in 1988 with purchase price of $24. Restructuring. 3/e Weston . and Corporate Governance.

5 .. 3/e Weston .• Buyout group may include incumbent management and may be associated with – Buyout specialists. and Corporate Governance. Kohlberg Kravis Roberts & Co. – Investment bankers – Commercial bankers ©2001 Prentice Hall Takeovers. e.g. Restructuring.

6 . Restructuring.to five-year period ©2001 Prentice Hall Takeovers. and Corporate Governance.• Management buyouts (MBOs) – Investor group dominated by incumbent management – Segment acquired from parent company • LBO transaction may be reversed with future public offering – Aim is to increase profitability of company and thereby increase market value of firm – Buyout group seeks to harvest gain within three. 3/e Weston .

Three Major Stages of Leveraged Buyouts • The 1980s – Economic and financial environments favorable to M&A activity and LBOs – For 1986-1989.7 . 3/e Weston .9% and median of 26.5 ©2001 Prentice Hall Takeovers.5% • Price earning ratios paid — mean of 20. Restructuring. • LBO activity reached peak • LBOs accounted for 20. and Corporate Governance.5% of total dollar value of completed mergers • Premiums paid were at highest levels — mean of 33.

6% and median of 19.• Early 1990s – LBOs declined from peak total of $65.9% • Sharp decline in price earning ratios paid — mean of 14.8% of total dollar value of completed mergers • Sharp decline in relative premiums paid — mean of 27. and Corporate Governance. Restructuring.7 billion in 1989 to $6. 3/e Weston .8 . • LBOs accounted for 6.8 billion in 1991 – Decline due to • Economic and legislative changes • Unsound LBO transactions of late 1980s – For 1990-1992.6 ©2001 Prentice Hall Takeovers.

• LBOs accounted for 1.8 ©2001 Prentice Hall Takeovers. Restructuring. and Corporate Governance.5% and median of 24.0 billion in 1999 – Revival of LBOs due to new developments in nature of LBO transactions and market participants – For 1993-1998.9 . 3/e Weston .6% of total dollar value of completed mergers • Relative premiums paid for LBOs slightly below 1986-1989 levels — mean of 33.• Post-1992 – LBOs reached $62.2% • Price earning ratios paid — mean of 23.

10 . and Corporate Governance. 3/e Weston . Restructuring.LBOs in the 1980s • Characteristics – Debt financing • Highly leveraged — up to 90% of purchase price • Debt secured by assets of acquired firm or based on expected future cash flows • Paid off either from sale of assets or from future cash flows generated by operations – Acquired company became privately held – Firm expected to go public again after three to five years ©2001 Prentice Hall Takeovers.

11 . and Corporate Governance. 3/e Weston . Restructuring.• General economic and financial factors – Same as factors stimulating mergers – Sometimes LBOs and MBOs were responses to threat of unwanted takeovers – Sustained economic growth between 19821990 – Earlier inflation • GNP implicit price deflator during 1968-1982 increased by no less than 5% • Caused q-ratio to decline sharply — cheaper to buy capacity in financial markets than in real asset markets • Provided opportunities to realize tax savings through recapitalization ©2001 Prentice Hall Takeovers.

especially taxes • Succession of laws that deregulated financial institutions • Economic Recovery Tax Act (ERTA) of 1981 • General Utilities doctrine • Legislative changes affecting ESOPs — encouraged MBOs – Change in antitrust climate .beginning in 1980 ©2001 Prentice Hall Takeovers. 3/e Weston .12 . Restructuring. and Corporate Governance.– Financing innovations — high-yield bonds (junk bonds) made public financing available to companies below investment grade – Legislative factors.

insurance companies.13 . venture capital firms • Public offerings of "high-yield" notes or bonds (junk bonds) ©2001 Prentice Hall Takeovers. 3/e Weston . Restructuring.• Elements of a typical LBO operation – First stage — raise cash required for buyout and devise management incentive systems • Financing – About 10% of cash is put up by investor group headed by company's top managers and/or buyout specialist – About 50-60% of required cash through secured bank loans – Rest of cash by issuing senior and junior subordinated debt • Private placement with pension funds. and Corporate Governance.

Restructuring. and Corporate Governance.14 .• Management incentives – Managers receive stock price-based incentive compensation in form of stock options or warrants – Incentive compensation plans based on measures such as operating performance – Second stage — organizing sponsor group takes company private • Stock-purchase — buys all outstanding shares of company • Asset-purchase — purchases all assets of company and forms new privately held corporation • New owners sell off parts of acquired firm to reduce debt ©2001 Prentice Hall Takeovers. 3/e Weston .

– Third stage — management strives to increase profits and cash flows • Cut operating costs • Cut spending in research and development • Cut new plants and equipment as long as provisions for capital expenditures are adequate and satisfy lenders • Increase revenues by changing marketing strategies ©2001 Prentice Hall Takeovers. 3/e Weston . and Corporate Governance. Restructuring.15 .

– Fourth stage — reverse LBOs • Investor group may take improved company public again through public equity offering (secondary initial public offering . and Corporate Governance.4% on equity investment by time of SIPO – Median length of time between LBO and SIPO was 29 months ©2001 Prentice Hall Takeovers. Restructuring.SIPO) • Create liquidity for existing stockholders • Muscarella and Vetsuypens (1990) – 72 reverse LBOs in 1976-1987 – 86% of firms use offering proceeds to lower company's leverage – Equity participants realized median annualized rate of return of 268.16 . 3/e Weston .

Restructuring.17 . and Corporate Governance.• Conditions and circumstances of goingprivate buyouts in the 1980s – Typical target industries • Basic. nonregulated industries – Predictable and/or low financing requirements – Predictable/stable earnings • High-tech industry less appropriate – – – – Shorter history of profitability Greater business risk Fewer leveragable assets Command high P/E multiples well above book value ©2001 Prentice Hall Takeovers. 3/e Weston .

and Corporate Governance.• Lehn and Poulsen (1988) – Half of 108 LBOs during 1980-1984 were in five industries: • Retailing • Textiles • Food processing • Apparel • Soft drinks – Consumer nondurable goods • Low income elasticity of demand • Sales fluctuate less with GNP – Mature industry with limited growth opportunities ©2001 Prentice Hall Takeovers. 3/e Weston . Restructuring.18 .

3/e Weston .19 . and Corporate Governance. Restructuring.– Other target characteristics • Track record of capable management • Strong market position within industry to enable it to withstand economic fluctuations and competition • Highly liquid balance sheet – Little debt. either short or long term – Large unencumbered asset base — for collateral – High proportion of tangible assets with fair market value above net book value ©2001 Prentice Hall Takeovers.

and Corporate Governance.– Leverage factors • Increase return on equity (ROE) and cash flows to retire debt • Attractions for lenders – Interest rates only 3-5 points above prime rate – Company and collateral characteristics • Large amounts of cash/cash equivalents • Undervalued assets (hidden equity) • Could liquidate some subsidiaries to raise funds – High prospective rates of return on equity especially for lenders such as venture capitalists and insurance companies with equity participation – Confidence in management group spearheading LBO ©2001 Prentice Hall Takeovers. 3/e Weston .20 . Restructuring.

3/e Weston . and Corporate Governance.– Management factors • Record of capability • Betting reputation and personal wealth on success of LBO • Highly motivated by potential large personal gains from stock ownership – Sources of MBO targets • Divestitures of divisions by public companies • Private companies with low growth records • Public corporations selling at low P/E multiples representing large discounts from book values ©2001 Prentice Hall Takeovers. Restructuring.21 .

• Empirical results
– DeAngelo, DeAngelo, and Rice (1984)
• 72 firms making 72 initial and 9 subsequent going-private proposals during 1973-1980 • Relatively small firms measured by median market value of total equity
– $6 million for 45 pure going-private sample – $15 million for 23 LBOs

• Pre-offer management ownership high
– Mean of 45% and median of 51% for 72 going-private sample – Mean of 32% and median of 33% for 23 LBOs

©2001 Prentice Hall

Takeovers, Restructuring, and Corporate Governance, 3/e

Weston - 22

• Stockholder wealth effects
– At announcement: +22%, significant – CAR for window [-40,0]: over +30% – Measured as average premium over market (two months before proposal): Over +56% for 57 cash payment proposals

• Withdrawal of going-private announcements (18 firms)
– Negative return at announcement: -9% – Offset by positive 13% return (Days -40 through 0) for net effect of +4% – Cumulative effect rises to +8% (Days 0 through +40) – Explanations for positive impact of withdrawal:
• Information effect — permanent upward revaluation of firm's prospects • Probability that management might revive proposal • Possibility that another acquirer might step in to make offer
©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 23

– Lowenstein (1985)
• 28 MBOs during 1979-1984 • Each valued at over $100 million at winning bid • Management ownership fraction very small
– Pre-offer: 3.8% (median); 6.5% (mean) – Post-offer: 10.4% (median); 24.3% (mean)

• Premium over market price 30 days before announcement:
– 58% (median); 56% (mean) – Premiums rose with number of bids — three or more bids, premium = 76% (median), 69% (mean) – Premium over management bid in 11 successful thirdparty bids relatively small — 8% (median), 14% (mean)
©2001 Prentice Hall Takeovers, Restructuring, and Corporate Governance, 3/e Weston - 24

and Corporate Governance.25 . significant • Average premium (relative to stock price 20 days before announcement) = 41% for 72 all cash-offer LBOs ©2001 Prentice Hall Takeovers. Restructuring. 3/e Weston .– Lehn and Poulsen (1988) • Sample of LBOs in 1980-1984 • Substantial leverage increases in 58 firms – Average pre-LBO debt/equity ratio of 46% – Average post-LBO debt/equity ratio of 552% • Wealth effect for 92 LBOs (Days -20 through +20) = over +20%.

– Hite and Vetsuypens (1989) • 151 divisional MBOs • Small but significant wealth gain to parent company shareholders – Mean abnormal return during two-day period surrounding announcement = 0. and Corporate Governance. Restructuring.3% for full LBO (mean sale price of division about 16.6% of market value of average seller) – Gains lower than those found for LBOs • Interpretation – Divisional MBOs reallocate ownership of corporate assets to higher-valued uses – Parent company shareholders share in expected benefits of change in ownership structure ©2001 Prentice Hall Takeovers. 3/e Weston .55% – Abnormal return translates into 3.26 .

and Corporate Governance. Restructuring. 3/e Weston .27 .98% to seller in two days around announcement ©2001 Prentice Hall Takeovers.– Muscarella and Vetsuypens (1990) • 45 divisional buyouts which subsequently went public • Average period from buyout to public offering was 34 months • Mean abnormal return of 1.

28 . and Corporate Governance. 3/e Weston . especially accelerated depreciation on assets involving little recapture — more difficult under Tax Reform Act of 1986 – Tax advantages of using ESOP as LBO vehicle • Lowenstein (1985) – Most of premium paid is financed from tax savings – New companies may operate tax-free up to six years (LBO often sold at this point anyway when debt/equity ratio declines from 10 times to 1 or under) ©2001 Prentice Hall Takeovers.• Sources of gains in LBOs during the 1980s – Tax benefits — can enhance already viable transaction • Specific tax benefits – Interest tax shelter from high leverage – Asset step-up provides higher asset value for depreciation expenses. Restructuring.

297 times premium • 30% tax rate and new debt with maturity of eight years. 3/e Weston . and Corporate Governance.262 times premium • For firms that used step-up basis of their assets — median value of tax benefit at 0.29 . median value of tax benefit at 1. median value of tax benefits at 0.b) – Value of tax benefits • Assuming a 46% tax rate and permanent new debt.304 times premium – Large and predictable tax benefits result from buyout • Small portion attributed to unused debt capacity or inefficient use of tax benefits prior to buyout • Implies that large portion of tax benefits attributable to buyout – Prebuyout shareholders capture most of tax benefits – ESOP loans infrequently used due to nontax costs ©2001 Prentice Hall Takeovers.• Kaplan (1989a. Restructuring.

reducing agency costs of free cash flows – Debt puts pressure on managers to improve firm performance to avoid bankruptcy ©2001 Prentice Hall Takeovers. Restructuring.30 . and Corporate Governance. reducing agency costs – Debt from LBO commits cash flows to debt payment. 3/e Weston .– Management incentives and agency cost effects • Argument for: Increased ownership stake provides increased incentives for improved performance – Profitable investments that require disproportionate effort of managers may only be undertaken if managers are given disproportionate share of profits – Concentrated ownership aligns managers and shareholders' interest.

Restructuring. study.31 . management already held large stake before buyout – Internal and external controls are sufficient to align managers' interests to shareholders • Empirical evidence consistent with management incentive rationale – Increased ownership share of management – Management incentive plans – Operating performance of LBO firms improved ©2001 Prentice Hall Takeovers. and Corporate Governance. 3/e Weston .• Arguments against: – In DeAngelo et al.

32 . "absolute priority rule" for senior security may not be strictly followed ©2001 Prentice Hall Takeovers. and Corporate Governance.– Wealth transfer effects • Payment of premiums in LBO transactions may represent wealth transfer to shareholders from other stakeholders • Wealth transfer from existing bondholders and preferred stockholders – Reduction in value of firm's outstanding bonds and preferred stock due to • Large increase in debt • Bond covenants may not protect existing bondholders in event of control changes and debt issue • In bankruptcy proceedings. Restructuring. 3/e Weston .

Restructuring. and Corporate Governance.– Lehn and Poulsen (1988) — no evidence that bondholders and preferred stockholders lose value at time of LBO announcement – Travlos and Cornett (1993) • Significant bondholder losses at announcement of going-private proposals • Losses small relative to gains to prebuyout shareholders – Anecdotal evidence • Lawsuit filed against RJR Nabisco by large bondholders • Charged that $5 billion in highly rated bonds lost nearly 20% in market value ©2001 Prentice Hall Takeovers. 3/e Weston .33 .

3/e Weston . but losses account for a very small percentage of shareholder gains ©2001 Prentice Hall Takeovers. Restructuring.34 . and Corporate Governance.– Warga and Welch (1993) • Empirical results greatly influenced by source of bond price data • Use trader-quoted data from major investment bank as opposed to exchange-base data • Properly aggregated returns among correlated bonds using S&P data source find no significant loss to bondholder wealth • Using trader-quoted data. there is a risk-adjusted bondholder loss of 6%.

3/e Weston . sometimes new management team is brought in after LBO – Number of employees grows more slowly in LBO firm than others in same industry and sometimes even decreases — may result from postbuyout divestitures and more efficient use of labor ©2001 Prentice Hall Takeovers. and Corporate Governance.35 .• Wealth transfer from current employees to new investors – Management turnover in buyout firms lower than in average firm. Restructuring.

• Tax benefits in LBO constitute subsidy from public and loss of revenue to government – Premia paid in LBOs positively related to potential tax benefits – Net effect of LBO on government tax revenues may be positive • Shareholders pay capital gains taxes on sale of their stock in LBO tender offer • LBO investor group pays capital gains taxes when firm goes public at a later date • Improved profitability — firms pay more corporate taxes – Many of tax benefits from increased leverage could be realized without LBOs ©2001 Prentice Hall Takeovers. 3/e Weston .36 . Restructuring. and Corporate Governance.

– Asymmetric information and underpricing • Managers or investor groups have more information on value of firm than public shareholders • Large premium in buyout proposal signals that future operating income will be larger than previously expected or firm is less risky than previously perceived • Investor group believes new company worth more than purchase price — prebuyout shareholders receive less than adequately informed shareholders ©2001 Prentice Hall Takeovers.37 . and Corporate Governance. Restructuring. 3/e Weston .

withdrawal. and Corporate Governance.67% held by management participants) • Smith (1990) – MBO proposals that fail due to board/stockholder rejection. 3/e Weston .• Kaplan (1991) — informed persons (managers and directors) do not participate in buyout even though they typically hold large stakes (median share of 10% compared to 4. or higher outside bid are not followed by increase in operating returns – Indirect evidence that asymmetric information cannot explain improved performance of bought-out firms ©2001 Prentice Hall Takeovers.38 . Restructuring.

Restructuring. 3/e Weston .– Other efficiency considerations • More efficient decision process as private firm – No need to justify new programs with detailed studies and reports to board of directors. and Corporate Governance.39 . more speedy actions can be taken – Public firms have to publish reports that can disclose valuable information to competitors • Stockholders' servicing costs and other related expenses do not appear to be a major factor in going private • Alternatively. perhaps LBOs performed well because of favorable stock market/economic conditions ©2001 Prentice Hall Takeovers.

7% • Median annualized rate of return was 36. Restructuring.• Evidence on postbuyout equity values – Muscarella and Vetsuypens (1990) • Median change in firm value for 41 reverse LBOs was 89% for entire period between LBO and subsequent SIPO — mean rate was 169. 3/e Weston .40 . and Corporate Governance.6% • Total shareholder wealth change positive and significantly correlated with fraction of shares owned by officers and directors • Correlation between size-adjusted measure of salary and shareholder wealth positive and significant • Change in equity values were associated with improvement in accounting measures of performance ©2001 Prentice Hall Takeovers.

3/e Weston . median excess return to postbuyout investors (both debt and equity) is 26. and Corporate Governance. not to potential tax benefits • Prebuyout shareholders capture most of tax benefits that become publicly known at time of LBO ©2001 Prentice Hall Takeovers.41 . Restructuring.– Kaplan (1991) • For 21 buyouts.1% above return on S&P 500 • Excess return close to premium earned by prebuyout shareholders • Excess return to postbuyout investors significantly related to change in operating income.

3/e Weston . Restructuring.9% during year before SIPO • Same firms experience industry-adjusted decline in operating performance of 2. and Corporate Governance.59% in year following SIPO • Reason: Information asymmetries and pure selection – Managers take firm public only during exceptional years – Managers have incentive to improve current performance at expense of future profitability – Purchasers look at strength of current performance and future growth — only strong companies had ability to go public and experience normal mean reversion following SIPO ©2001 Prentice Hall Takeovers.42 .– Degeorge and Zeckhauser (1993) • Reverse LBO experienced industry adjusted rise in operating performance of 6.

96%. and 21. 21.– Mian and Rosenfeld (1993) • 85 reverse LBOs during 1983-1989 • Significant positive CAR measured for three-year period beginning one day after SIPO • CARs using Comparable Firm Index for first three years was 4. Restructuring.43 . CAR nearly zero • 79% of acquired firms had gone public with an active investor — reflects desire of main investor to liquidate ownership ©2001 Prentice Hall Takeovers. 3/e Weston . and Corporate Governance.65%.05% • 39% of sample firms taken over within three years after SIPO • Most takeovers during second year • Firms taken over outperformed comparable investments over 100% • Sample not taken over.

– Holthausen and Larcker (1996) • 90 reverse LBOs during 1983-1988 • Firms outperformed their industries for four years following reverse LBO • Firm increased capital expenditure subsequent to offering — firms were cash constrained while under LBO but reduced leverage after SIPO facilitated efficient investments • Working capital increased after offering • Firm performance decreased with declines in level of equity ownership by management and other insiders ©2001 Prentice Hall Takeovers. 3/e Weston .44 . Restructuring. and Corporate Governance.

45 . 3/e Weston .• No evidence that performance after SIPO related to changes in leverage • Firms still public three years after SIPO experienced median decline in ownership by management insiders of 15% and by nonmanagement insiders of 20% • Board structure moved toward standard patterns of non-LBO firms after SIPO ©2001 Prentice Hall Takeovers. and Corporate Governance. Restructuring.

8 billion.Correction Period 1991-1992 • Background – LBO activity in 1991 dropped to $6. l0.46 . and Corporate Governance. 3/e Weston .4% of $65. Restructuring.7 billion in 1989 – Opler (1992) — LBOs in 1985-1989 period had operating improvements comparable to those in earlier period – Kaplan and Stein (1993) • LBOs formed in latter half of 1980s did not perform as well • Many experienced financial distress ©2001 Prentice Hall Takeovers.

weakening structure and incentives of later LBOs ©2001 Prentice Hall Takeovers. Restructuring.47 . 3/e Weston . and Corporate Governance.• Deteriorating quality of LBOs in second half of 1980s – Relatively high prices paid • Dollar volume of funds available exceeded number of good prospects • Multiples of price to expected cash flows rose sharply • Extreme winner's curse — substantial difference between winning price and next highest bid – Weakened financial structure • Deal promoters required more cash up front.

reduced commitments.• Public high-yield debt substituted for both private subordinated debt and "strip" financing — raised costs of reorganizing • Commercial banks took smaller positions. and Corporate Governance. shortened maturities. required accelerated principal repayments • Coverage of debt service requirements declined — less than 1 in some cases • Asset sales and immediate improvement of profitability margins were required to cover interest and other financial outlays in first year of the LBO ©2001 Prentice Hall Takeovers. Restructuring. 3/e Weston .48 .

and Corporate Governance. 3/e Weston .49 .• High-yield bonds with either zero-coupons or interest payments consisting of more of same securities (payment-in-kind) were utilized • Cash requirements for debt service were postponed for several years – Legislative and regulatory changes — FIRREA • Required S&Ls to liquidate high-yield bonds from portfolio holdings and prohibited further investment in high-yield bonds • Prices of high-yield debt were impacted downward – Economic downturn of 1990-1991 ©2001 Prentice Hall Takeovers. Restructuring.

Restructuring.Role of Junk Bonds • Junk bonds are high-yield bonds either rated below investment grade or unrated – S&P ratings: rated below BBB – Moody's ratings: rated below Baa3 ©2001 Prentice Hall Takeovers. 3/e Weston . and Corporate Governance.50 .

2% through November 1987 ©2001 Prentice Hall Takeovers. and Corporate Governance.51 . Restructuring. high-yield bonds were "fallen angels. junk bonds represented 3-4% of total public straight debt bonds – Prior to 1977.” investment grade bonds whose ratings had been subsequently lowered – First issuer of bonds rated below investment grade was Lehman Brothers in 1977 • By 1985 share had risen to 14.• Characteristics – Size of market • Between 1970 and 1977. 3/e Weston .4% of total public straight debt bonds – Drexel Burnham Lambert became industry leader in junk bond issues – Drexel had 45% of market in 1986 and 43.

52 . 3/e Weston .• Share of yearly new public bond issues had risen from 1. and Corporate Governance.1% in 1977 to almost 20% by 1985 • FIRREA. Restructuring.5% during 1978-1994 – Realized return spread about 2% ©2001 Prentice Hall Takeovers. caused temporary losses but by 1993 junk bond market achieved record high returns and size of market reached new highs – Default rates 10 years after issuance as high as 20-30% – Average recovery rate after default about 40% of original par value – Promised yield spread over 10-year Treasury bonds about 4. enacted in 1989.

3/e Weston .53 . and Corporate Governance.• Use of high-yield bonds – Make financing available to high risk. Restructuring. growth firms – Finance takeovers – Yago (1991) • One-fourth of proceeds from issuing junk bonds in 1980-1986 used for acquisition financing • Three-fourth of proceeds used to finance internal corporate growth ©2001 Prentice Hall Takeovers.

• Savings and loan industry – High-yield financing was not fundamental cause of problems in S&L industry during the 1980s – Total investment in junk bonds amounted to 1% or less of total assets in industry – S&L basic problems due to • Changing nature of financial markets • S&L industry had negative net worth of over $100 billion by 1980. Restructuring. 3/e Weston . prior to era of high-yield financing • 90% of firms in S&L industry suffered losses in 1980 and 1981 ©2001 Prentice Hall Takeovers. and Corporate Governance.54 .

3/e Weston . and Corporate Governance. Restructuring.55 .• Role of Michael Milken – Saul (1993) set forth his views of illegal acts by Milken • Securities parking – Violation of Williams Act – Entails having associates hold securities in their accounts to avoid triggering Rule 13(d) filing requirement • Market stabilization – Milken guaranteed investment participants against losses on their high-yield bond investment during time required for markets to absorb them – He did not make public disclosure in high-yield offerings of securities taken as underwriting compensation – He made side payoffs to portfolio managers for investing institutional funds in his issues ©2001 Prentice Hall Takeovers.

and Corporate Governance. 3/e Weston .• Market monopolization — Milken became dominant player of high-yield bond market – Financial competitors did not have Milken's network to be "highly confident" that it could successfully place a high-yield offering – No other firm was prepared to commit so much capital to inventory high-yield bonds in secondary market trading – Milken developed close relationships with client issuers. and employees ©2001 Prentice Hall Takeovers.56 . Restructuring. institutional customers.

3/e Weston .– Fischel (1995) presented a defense of Milken • Milken was guilty only of being a tough and formidable competitor • Milken was not guilty of breaking any security law violations • Action against Milken as result of – Hysteria against "excesses of the 1980s" – Ability of government to invoke RICO • After most thorough investigations.57 . government came up with nothing ©2001 Prentice Hall Takeovers. and Corporate Governance. Restructuring.

58 .0 billion in 1999 — almost as high as the peak of $65. Restructuring. 3/e Weston .7 billion in 1989 ©2001 Prentice Hall Takeovers.LBOs in the 1992-2000 Period • Background – 1992-2000: Sustained economic growth — resurgence of LBOs – Size of aggregate LBO transactions moved to $62. and Corporate Governance.

and Corporate Governance.59 . 3/e Weston . Restructuring.• Resurgence of LBOs – Favorable economic environment – Change in LBO financial structure • Price to EBITDA ratios paid moved down to 5-6 times compared to 7-10 multiples of late 1980s • Percentage of equity in initial capital structure moved up to 20-30% compared with equity ratios of 5-10% in late 1980s • Interest coverage ratios moved up — ratio of EBITDA to interest and other financial requirements moved to standard of 2 times ©2001 Prentice Hall Takeovers.

– Restructuring of intermediaries • LBO activity no longer dominated by Milken-Drexel • Main players were other investment banking houses. 3/e Weston . and Corporate Governance. Restructuring. large commercial banks.60 . and traditional LBO sponsors such as Kohlberg Kravis Roberts – Innovative approaches developed by investment banking-sponsoring firms • Strategy of substituting sponsor equity for bank debt • Less pressure for immediate performance improvement or asset sales — deals structured so principal repayments sometimes not required until 10 years after deal ©2001 Prentice Hall Takeovers.

Restructuring. 3/e Weston .61 . and Corporate Governance.• Partnership structures with members who had considerable previous managerial experience • Joint deals between financial buyers and corporate strategic buyers to purchase companies on leveraged basis • Increased use of syndication among banks to sponsor highly leveraged transactions • Development of highly liquid secondary loan trading market • Continuing close client-focused relationship by commercial banks • Capital structure strategies tailored to characteristics of transactions ©2001 Prentice Hall Takeovers.

and Corporate Governance.62 .• Leveraged buildups – Identify fragmented industry characterized by small firms – Buyout firms purchase firm as platform for further leveraged acquisitions in same industry – Buyout firms include partners with industry expertise • LBOs applied beyond mature slow-growing industries to high-growth technology-driven industries ©2001 Prentice Hall Takeovers. 3/e Weston . Restructuring.

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