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THE LBO PHENOMENON : SHAREHOLDER VALUE THROUGH FINANCIAL STRATEGY.

SHAREHOLDER VALUE-BASED MANAGEMENT IS  STILL INCREASINGLY SPOKEN OF, BUT LITTLE UNDERSTOOD.

THIS POST PROVIDES SOME GROUNDING.

LBOs ARE BASED ON FINANCIAL LEVERAGE.

AS THE NAME IMPLIES, A LEVERAGED BUYOUT IS AN ACQUISITION USING DEBT AS THE MAJOR FUNDING SOURCE. UNLIKE CONVENTIONAL ACQUISITIONS, WHERE DEBT IS OFTEN USED BUT IN MODERATE AMOUNTS, THE LBO USES IT AS MUCH AS 95% OF THE TRANSACTION COST.

IN AN LBO, A SMALL GROUP OF EQUITY INVESTORS, USUALLY INCLUDING CURRENT MANAGEMENT, ACQUIRES A FIRM IN A TRANSACTION FINANCED LARGELY BY DEBT. THE DEBT IS SERVICED WITH FUNDS GENERATED BY THE ACQUIRED COMPANY’S OPERATIONS AND, OFTEN, BY THE SALE OF SOME OF ITS ASSETS.

GENERALLY, THE ACQUIRING GROUP PLANS TO RUN THE ACQUIRED COMPANY FOR A NUMBER OF YEARS, BOOST ITS SALES AND PROFITS, AND THEN TAKE IT PUBLIC AGAIN AS A STRONGER COMPANY.

NATURALLY, THE ACQUIRING GROUP EXPECTS TO MAKE A SUBSTANTIAL PROFIT FROM THE LBO, BUT THE INHERENT RISKS ARE GREAT DUE TO THE HEAVY USE OF FINANCIAL LEVERAGE.

A NUMBER OF CONCERNS REGARDING LBOs BECAME THE SUBJECT OF INCREASING DEBATE ALL OF THE AFFECTED PARTIES :

1. WAS THE MARKET  TAKING ON TOO HEAVY A DEBT LOAD ?

2. WAS MANAGEMENT ACTING IN THE BEST INTEREST OF ITS SHAREHOLDERS BY SPENDING LARGE AMOUNTS OF MONEY TO FIGHT HOSTILE TAKEOVERS ?

3. WERE THE COMPANIES BEING TAKEN OVER IN LBOs FOREGOING THEIR LONG-RANGE COMPETITIVE POSITION BY CUTTING CAPITAL EXPENDITURES AND RESEARCH IN ORDER TO SERVICE THEIR DEBT ?

4. WERE THE ENORMOUS FEES BEING PAID TO INVESTMENT BANKERS AND LAWYERS IN THESE TRANSACTIONS COMPROMISING THEIR PROFESSIONAL JUDGMENT ?

5. WERE THE INSIDER-TRADING ABUSES ASSOCIATED WITH HOSTILE TENDERS MAKING IT IMPOSSIBLE FOR THE AVERAGE INVESTOR TO GET TREATED FAIRLY IN THE STOCK MARKET ?

6. WERE THE PRIOR BONDHOLDERS OF LBO COMPANIES BEING DISADVANTAGED AS HUGE AMOUNTS OF ADDITIONAL DEBT DILUTED THEIR POSITION ?

NEW FORMS OF SUBORDINATED DEBENTURES AND SUBORDINATED DEBENTURES, WERE CREATED TO HELP FINANCE THE DEALS.

A NEW TYPE OF INVESTMENT FIRM EMERGED TO SPECIALIZE IN LBOs.

LBOs CAN BE SUCCESSFUL OR UNSUCCESSFUL DEPENDING ON THE VALUATION, FINANCIAL STRUCTURING, AND IMPLEMENTATION OF A BUSINESS PLAN.

PHLDUCX