private equity lbo

8/8/2019 Private Equity Lbo

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SURAJ PRAKASH


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Anatomy of a Leveraged Buyout:

Leverage + Control + GoingPrivate


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Increase financial leverage/ debt

Leverage Control

Take the company

private or quasi

private

Change the way the

company is run (often with

existing

managers)

Public/ Private

Leveraged Buyout

Leveraged Buyouts: The Three Possible Components


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A leveraged buyout (orLBO, or highly-leveraged transaction (HLT), or

"bootstrap" transaction) occurs

when a financial sponsoracquires 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,


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some features of potential target firms make for more attractiveleverage 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 orstock price.


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Leveraged buyouts involve financial sponsors orprivate

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.


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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, th

e equity component of th

e purch

ase price canbe 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 oflarge 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.


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Private Equity Firmsy The typical private equity firm is organized as a partnership or

limited liability corporation.

y The PE firm raises equity capital through a PE fund.

y 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.

y The PE funds are organized as limited partnerships in which

the general partners manage the fund and the limited partnersprovide most of the capital.

y Limited Partners- institutional investors, insurance cos,

wealthy individuals.

y

General Partner- PE Firm


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Types of Private Equity:

y Leveragedbuyout (LBO)

y Venturecapitaly Growthcapital


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Leveraged Buyouts (LBO)

y 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.

y The acquisition is carried out by a specialized investment firm.

These firms are referred to as private equity firms.

y The PE firm buys majority control of the company it has

acquired.

y The debt includes a combination of bank loans, loans from

other financial institutions and high-yield bonds.

y 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.


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Venture Capitaly 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 thecompany.

y Venture capital investments are generally made as cash in

exchange for shares in the invested company.

y Venture capital typically comes from institutionalinvestors and HNW individuals and is pooled together by

dedicated investment firms.


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Growth capital

y Refers to equity investments, most often minorityinvestments, in more mature companies that arelooking for capital to expand or restructure operations,

enter new markets or finance a major acquisitionwithout a change of control of the business

y These companies are likely to be more mature than VCfunded companies, able to generate revenue and

operating profits but unable to generate sufficient cashto fund major expansions, acquisitions or otherinvestments.


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LBO

y The acquisition by a small group of investors of a public or

private company, financed primarily with debt.

y Taking the company private.

y Shares in pure LBO no longer trade on the open market.

There have been some public LBOs called leveraged

recapitalizations.

y For most LBOs, remaining equity in the LBO is usually

privately held by a small group of investors (usually

institutional, or management).

y A large fraction of debt that finances LBO transactions tends to

be junk debt


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Cont


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Mezzanine capital, in finance, refers to a subordinated debt orpreferred 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) orpreferred stock.

subordinated debt (also known as subordinated loan, subordinatedbond, subordinated debenture orjunior 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 ofstock. 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.


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LBO Criteriay Steadyandpredictablecashflow

y Divestibleassets

y Cleanbalancesheetwithlittledebt

y

Strongmanagementteamy Strong,defensiblemarketposition

y Viableexitstrategy

y Limitedworkingcapitalrequirements

y Synergyopportunitiesy Minimalfuturecapitalrequirements

y Potentialforexpensereduction

y Heavyassetbaseforloancollateral


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Industry Players

The 10 largest private equity firms in the world are:y The Carlyle Group (US)

y Goldman Sachs principal Investment area (US)

y TPG

y Kohlberg Kravis Roberts (US)

y CVC capital partners (European)

y Apollo Management

y Brain Capital (US)

y Permira (European)

y Apax partners (European)

y The Blackstone Group (US)


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Typical LBO Transaction Structure

Offerings Percent OfTransaction

Cost OfCapital

LendingParameters

Likely Source

Senior

Debt

50-60% 7-10% 5-7yearspayback

2.0x-3.0

EBITDA

2.0x interestcoverage

Commercialbanks

Creditcompanies

Insurance

companies

Mezzanine

Financing

20-30% 10-20% 7-10years

payback

1.0-2.0x EBITDA

Publicmarket

Insurancecompanies

LBO/mezzanine

Funds

Equity 20-30% 25-40% 4-6yearsexit

strategy

Management

LBOfunds

Subordinateddebt

holders

Investmentbanks


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Valuationy Market Comparison :

y These are metrics such as multiples of revenue, net

earnings and EBITDA that can be compared among public

and private companies

y A discount of 10% to 40% is applied to private companiesdue to the lack of liquidity of their shares.

y Discounted cash flow (DCF) analysis:

y An appropriate discount rate is used to calculate a net

present value of projected cash flows.y Option Approach :

y Using put call parity equation


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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 PublicOffering 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


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Advantage

y Independent future development of the company,

y Management best knowing the business and its

potential,

y Conducting business in a more simple and efficientmanner,

y Tax shield,

y

Flexible structure of financing (various manners ofaccomplishment),

y High potential yield of investment in LBO.


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Disadvantagey 1.Bankruptcyrisk

y Excessivedebtfinancing,comprisingabout 97%

ofthetotalconsideration

y Largeinterestpaymentsthatexceededthecompany'soperatingcashflow

y 2.Leveragecaninducefirmstochooseoverlyrisky

projects

y Over-optimisticforecastsoftherevenuesofthe

targetcompany

y Example


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Example

y Firm can take on one of two projects, project A or B.

y Project A can pay off either $50 or $150, each with

probability 1/2.

y Project B always pays off $110.yNeither project costs anything to invest . NPV of

project A is $100,NPV of project B is $110.

y Project B is higherNPV and should be chosen.

y However, suppose that the firm has pre-existing,

outstanding debt with fact value of $100. Which

project will the owners of the firm choose?


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Conty If choose project B, payment to shareholders will be $10

with certainty, after paying off debt.

y If choose project A, shareholders receive $150 -$100 =

$50 in good state, which occurs with prob. 1/2 ==>shareholders receive expected value of $25.

y Owners would choose project A, the riskier one (and

Lower return), gambling with other peoples money

i.e. bag the bondholder.


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Problem with LBO

y Rising interest rates

y Higher asset valuation - overpayment

y Political backlash

y More regulation of Industry

y US private equity shaken by revelation of price collusion

probe October 11, 2006

y Economic slowdown

y Failure of exit strategy


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The LBO Deal ofTata & Tetley

y Summer 2000, Tata Tea acquired the UK heavyweight brand

Tetley for a staggering 271 million pounds .

y This deal which happened to be the largest cross-border

acquisition by any Indian company,

y Objective :

y Aggressive growth and worldwide expansion.

y Instant access to Tetleys worldwide operations,

combined turnover at Rs 3000 crs

y The major challenge was financing

y The value of Tata tea was $114m

y Tetley was valued at $450m

y The solution was provided by Leverage Buy Outing the deal


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Finance

y Tata Tea created a Special Purpose Vehicle (SPV)-christenedTata Tea (Great Britain) to acquire all the properties of Tetley.

y The SPV was capitalised at 70 mn pounds, of which Tata tea

contributed 60 mn pounds; this included 45 mn pounds raised

through a GDRissue.y The US subsidiary of the company, Tata Tea Inc. had

contributed the balance 10 mn pounds.

y The SPV leveraged the 70 mn pounds equity 3.36 times to raise

a debt of 235 mn pounds, to finance the deal

y 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).


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THANK YOU

private equity lbo

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