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LEVERAGED BUYOUT INTRODUCTION A Leveraged Buy-Out can be defined as a transaction in which group of private investors, typically including management, purchases a significant and controlling equity stake in a public or non public corporation or a corporate division, using significant debt financing, which it raises by borrowing against the assets and/or cash flows of the target firm taken private. CONCEPT In a leveraged buyout, a company is acquired by a specialized investment firm using a relat
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  LEVERAGED BUYOUT INTRODUCTIONA Leveraged Buy-Out can be defined as a transaction in whichgroup of private investors, typically including management, purchases asignificant and controlling equity stake in a public or non publiccorporation or a corporate division, using significant debt financing,which it raises by borrowing against the assets and/or cash flows of thetarget firm taken private.CONCEPTIn a leveraged buyout, a company is acquired by a specializedinvestment firm using a relatively small portion of equity and arelatively large portion of outside debt financing.The assets of the acquired company are used as collateral for theborrowed capital, sometimes with assets of the acquiring company.Typically, leveraged buyout uses a combination of various debtinstruments from bank and debt capital markets.CHARACTERISTICS OF LBO y   Primary high debtHigh debt often implicates high interest payment and henceLBO transaction prefers mature company which has stable cash flowgeneration. y   Incentive and private ownershipDuring the period of LBO, company would be privateownership, even though it used to be the listed stock company, theirstock would be stopped trade. After a few years, PE funds wouldconsider to exit, company going public again, trade sales, and merger& acquisition are normally chose as happy ending of LBOtransaction.   MOTIVATION/RATIONALE FOR LBO y   Tax shieldIf company has more debt, they would gain more tax benefit. y   Conglomerate discountIt provides sufficient financial support and high qualitymanagement team to company for business division development. y   Free cash flowEach company needs free cash flow to support new profitableproject, when company is impossible to gain internal financing, debtwill be the optimal choice due to cheaper cost.STAGES OF LBOInitial stages    Identification of investment funds.    Construction of an in-house team with all the requiredcompetencies.    Meeting between management team and selected investmentfund.After the fund has been selected    Construction of business plan through an iterative consultationprocedure.    Refinement and computation of acquisition price parameters    Definition of target valuation range.Post-valuation    Financial engineering and search for the right equity-debt mix onbasis of valuation range and cash-flow and EBIT forecasts.    Search for lead bank to manage debt syndication.     Debt packaging and structuring into senior debt and mezzaninedebt.    Negotiation of lending rates with banks.Negotiation with seller    Negotiation, usually via a bank.    Agreements on acquisition price and financial arrangements    Signing of deal at the closing meeting.LBO CANDIDATE CRITERIASpecific criteria for a good LBO candidate include: y   Steady and predictable cash flow y   Divestible assets y   Clean balance sheet with little debt y   Strong management team y   Strong, defensible market position y   Viable exit strategy y   Limited working capital requirements y   Synergy opportunities y   Minimal future capital requirements y   Potential for expense reduction y   Heavy asset base for loan collateralSUCCESSFUL FACTORS FOR LBOSuccessful LBO depend on some key factors such as y   The prospect firms of LBO only focus on mature companies whohave steady cash flow generation but few profitable opportunitiesfor long-term development.  y   LBO candidates should be checked by financial statement, inorder to figure out whether company has capability to fulfill debtobligation. y   Furthermore LBO target firm should hold tangible assets muchmore than intangible, because company with a lot of tangibleassets could be gain more tax benefit from high debt capitalstructure, and tangible asset would be much easier to sell underany buyout intention. y   A qualified management team is another crucial factor for asuccessful LBO. Because managers diligence would positivelyaffect company financial performance which is relative to sustainstable cash flow for high interest payment and debt obligation y   The selection of exit strategy is relative to managers diligenceeffect as well, there are many ways to exit LBO transactionNEGATIVE IMPACT OF LBO y   The most obvious risk associated with a leveraged buyout is thatof financial distress. y   W eak management at the target company or misalignment of incentives between management and shareholders can also posethreats to the ultimate success of an LBO. y   Leverage can induce firms to choose overly risky projects as theyOver-optimistically forecasts of the revenues of the targetcompany y   In addition, an increase in fixed costs from higher interestpayments can reduce a leveraged firms ability to weatherdownturns in the business cycle. y   Too much debt would bring high interest payment, and companywould be much easier to meet financial distress or bankruptcy inthis kind of capital structure.
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