Investment
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Leveraged buyout
A leveraged buyout (or LBO, or highly-leveraged transaction (HLT), or “bootstrap” transaction) occurs when a financial sponsor gains control of a majority of a target companys equity through the use of borrowed money or debt.
A leveraged buyout is a strategy involving the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. Often, the assets of the company being acquired are used as collateral for the loans, in addition to the assets of the acquiring company. The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital. In an LBO, there is usually a ratio of 70% debt to 30% equity, although debt can reach as high as 90% to 95% of the target companys total capitalization. The equity component of the purchase price is typically provided by a pool of private equity capital.
Typically, the loan capital is borrowed through a combination of prepayable bank facilities and/or public or privately placed bonds, which may be classified as high-yield debt, also called junk bonds. Often, the debt will appear on the acquired companys balance sheet and the acquired companys free cash flow will be used to repay the debt.
Management buyouts
A special case of such acquisition is a management buyout (MBO), which occurs when a companys managers buy or acquire a large part of the company. The goal of an MBO may be to strengthen the managers interest in the success of the company. In most cases, the management will then take the company private. MBOs have assumed an important role in corporate restructurings beside mergers and acquisitions. Key considerations in an MBO are fairness to shareholders, price, the future business plan, and legal and tax issues.
Mergers and acquisitions
The phrase mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and merging of different companies.
Overview
Merger is a tool used by companies for the purpose of expanding their operations often aiming at an increase of their long term profitability. Evidence on the success of M&A however is mixed: 50-75% of all M&A deals are found to fail adding value.
Usually mergers occur in a consensual setting where executives from the target company help those from the purchaser in a due diligence process to ensure that the deal is beneficial to both parties. Acquisitions can also happen through a hostile takeover by purchasing the majority of outstanding shares of a company in the open market against the wishes of the targets board. In the United States, business laws vary from state to state whereby some companies have limited protection against hostile takeovers. One form of protection against a hostile takeover is the shareholder rights plan, otherwise known as the “poison pill”. See Delaware corporations.
Historically, mergers have often failed to add significantly to the value of the acquiring firms shares (King, et al., 2004). Corporate mergers may be aimed at reducing market competition, cutting costs (for example, laying off employees), reducing taxes, removing management, “empire building” by the acquiring managers, or other purposes which may not be consistent with public policy or public welfare.
Types of acquisition
An acquisition can take the form of a purchase of the stock or other equity interests of the target entity, or the acquisition of all or a substantial amount of its assets.
Share purchases – in a share purchase the buyer buys the shares of the target company from the shareholders of the target company. The buyer will take on the company with all its assets and liabilities.
Asset purchases – in an asset purchase the buyer buys the assets of the target company from the target company. In simplest form this leaves the target company as an empty shell, and the cash it receives from the acquisition is then paid back to its shareholders by dividend or through liquidation. However, one of the advantages of an asset purchase for the buyer is that it can “cherry-pick” the assets that it wants and leave the assets – and liabilities – that it does not. This leaves the target in a different position after the purchase, but liquidation is nevertheless usually the end result.
The terms “demerger”, “spin-off” or “spin-out” are sometimes used to indicate the effective opposite of a merger, where one company splits into two, the 2nd often being a separately listed stock company if the parent was a stock company.
Financing M&A
Mergers are generally differentiated from acquisitions partly by the way in which they are financed and partly by the relative size of the companies. Various methods of financing an M&A deal exist:
Payment by cash. Such transactions are usually termed acquisitions rather than mergers because the shareholders of the target company are removed from the picture and the target comes under the (indirect) control of the bidders shareholders alone.
Financing
Financing cash will be borrowed from a bank, or raised by an issue of bonds. Acquisitions financed through debt are [[known as leveraged buyouts]], and the debt will often be moved down onto the balance sheet of the acquired company.
Furthermore, a cash deal would make more sense during a downward trend in the interest rates, i.e. the yield curves are downward sloping. Again, another advantage of using cash for an acquisition is that there tends to lesser chances of EPS dilution for the acquiring company. But a caveat in using cash is that it places constraints on the cash flow of the company.
Hybrids
Acquisitions can involve a cash and debt combination, or a combination of cash and stock of the purchasing entity, or just stock. The Sears-Kmart acquisition is an example of a cash deal.
Examples
In a 1985 the purchasing company issues debentures to the public and money received on issue of debentures is paid to the selling company
Motives behind M&A
These motives are considered to add shareholder value:
Economies of scale: