Leveraged Buyout (LBO

Presented by: Gopal Krishan 09BS0002792 Vikalp Chaudhary 09BS0002685

Leveraged Buyouts
Special purpose vehicle to carry on buyout Acquisition of a mature company With objective to exit after 3-7 years Realizing very high returns Significant use of debt for financing Very less amount of capital Assets of target company used as collateral for debt ‡ Highly structured debt instruments ‡ Managers are given stake in business ‡ ‡ ‡ ‡ ‡ ‡ ‡

‡ ‡ ‡ ‡ ‡ Less reliance on debt after Great Depression 1960s: Conglomerate building began ³Corporate Raiders´ Advantage of undervalued assets Prior to 1980, LOB was obscure financial technique ‡ LBO was existing in past with the name Bootstrap ‡ Merits of debt financing attracted businessmen

‡ Started with 4 deals worth $1.7billion ‡ Reaching peak in 1988 with 410 deals of worth $188 billion



‡ Average equity contribution to LBO was 9.7%


‡ Average equity contribution increased to 38% ‡ In first 3 quarters of 2001 the average increased to 40%

Why mature company?
‡ Operating Characteristics
‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ Leading market position Strong management team Portfolio of strong brand names Strong relationship with key customers Steady cash flows Low operating leverage Low capital intensity Debt capacity

‡ To ensure financial characteristics

Structure of financing for LBO
Component Senior Debt Revolving Term Subordinate Debt Notes Traditional Mezzanine Preferred stock/Mezzanine Preferred stock Pay-In-Kind Bond Common Equity Vendor Loan notes 25%-40% 3-7 Years 10-12 Years 0%-35% 7-10 Years Investment Banker Mezzanine Fund Private equity fund Vendor loan notes 10%- 25% 7-8 Years 9-10 Years 30%-60% 5-8 years Investment Bank Commercial Bank Investment Bankers Mezzanine Fund % of total capital Tenure Traditional Suppliers of capital

Structured financing instruments
‡ ‡ ‡ ‡ ‡ ‡ Revolving credit facility: Used for working capital Bank debt: Senior to all debts Mezzanine debt: Middle of capital structure Subordinate debt or junk bonds or high yield notes: issued at LIBOR plus some percentage points Embedded options in bonds 70-90% of the common equity is held by private equity and rest by management and former shareholders Preferred shares issued as Pay-in-kind Cash Sweep

‡ ‡

Very high returns
‡ Tax advantage ‡ Large interest and principal payments call for increase in efficiency ‡ Amortization of transaction fee ‡ Restructuring
‡ Management initiatives like downsizing, cutting costs, divesting non-core businesses

‡ Management is given a stake and they get personal interest in the business

Exit Strategy

‡ Sold as individual or as a portfolio ‡ IPO ‡ Recapitalization: an acquisition and relevering of the company by another LBO firm

Structure of buyout firm
General Partner Limited Partner 1 Limited Partner 2

‡General partner makes investment decision ‡Limited partner is responsible for transfer of funds ‡Other Concepts ‡Minimum commitment ‡Investment and commitment period ‡Term

Revenue generation
‡ Carried interest
‡ General partner¶s share is 20% after payment of limited partners¶ share ‡ 8% of limited partners¶ capital has to be returned before general partners¶ share accrues

‡ Management fee

Valuation of LBO

Initially risk is high so cost of equity is high As debt is paid every year risk reduces Cost of equity also reduces on an annual basis Discounting rate changes every year High debt equity ratio is temporary and decrease over time ‡ Unlevered beta also changes over time ‡ ‡ ‡ ‡ ‡

Problems for LBO in India
‡ Restrictions on Foreign Investments in India
‡ Limits on FII investment ‡ Restrictions, caps and Foreign Investment Promotion Board (FIPB) approval ‡ Regulatory developments in FDI

‡ Limited Availability of Control Transactions and Professional Management ‡ Underdeveloped Corporate Debt Market ‡ Prohibition on Borrowing from Indian Banks - FIPB press Note 9 (dated April 12, 1999) ‡ Restrictions on Public Companies from Providing assistance to Potential Acquirers ‡ Reserve Bank of India Restrictions on Lending

Management Buyout Strategies
Management Buyout ‡ Sponsored (Co. is valued at 5X times free cash flows) ‡ Non-Sponsored Typical management buyout transaction * Sponsor ± Generally Private Equity Firm * Management Offered to invest for ownership stake 5 -10 % of the co.¶s stock (max. 20%) * PE firms also charge significant fee for the deal and for operating the company (avg. annual management fee 1.5 to 2.5%

Non Sponsored

Advantages of Non Sponsored Buyout
Higher ownership stake for management Higher company valuation for the seller Greater control for both management and seller Highly vested management team and continued role for the owner ‡ Significant liquidity to the owner ‡ ‡ ‡ ‡

Requirements for the Non Sponsored Buyout
‡ ‡ ‡ ‡ ‡ Quality company and team Proactive and Committed management team Target Purchase Price Maintain flexibility with owners Strong business plan

Understanding of financing options Most common buyouts require debt financing beyond bank financing through mezzanine or subordinated debt financing. These products are offered by insurance, corporate development co.¶s, hedge funds and other specialty financing firms. The intent is to provide flexible source of financing, this while minimizing dilution without increasing the risk to the owner, increases the amount a co. can borrow.

Tata Tea ± Tetley
Tata Tea Inc. (US Subs) 10 M

70 M Went to Tata Tea Great Britain (SPV)


Debt / Equity ratio = 3.36

235 M

Tata Tea 60 M

Debt * 235 M were broken into 4 trenches and floated with the coupon rate of LIBOR + 400 basis points * Rabo Bank Lead financing agency ± 215 M * Venture Capital funds ± 20 M * Entire debt was non-recourse to Tata Tea and was secured against Tetley¶s Physical and intangible assets * Purchase consideration 271 M
Note: Every thing is in Great Britain Pounds

Tata Steel ± Corus
All figures in dollars
Total 12.1 B

LBO structure 8B

Tata Steel 3.5 B

Tata Steel Gave 2B to SPV

Bridge Loan 1.5 B

Break up of 3.5 B

Breakup of 8 B 1. ABN Amro bank, Deutsche bank and Credit Suisse loaned the amt. 2. The debt was non recourse to Tata steel 3. Entire debt was broken up into 50% into senior bank loan and 50% into Subordinate mezzanine loan 4. SPV was Tata Steel UK

1. Out of 3.5 B, 1.5 B was financed by syndicate of banks involving ABN Amro and SCB in form of bridge loan 2. Out of 2 B Tata steel financed by own cash and liquid investments; 700 M was from promoter holding company and remaining was a loan taken on its own balance sheet

‡ Under this LBO structure the loan was to be serviced out of the future cash flows from corus and later Tata Steel UK (SPV) after it had been loaned all the amount from the Singapore based SPV, was supposed to pay off all the share holders of corus and file for merger; As per the UK law the transaction can be either of acquisition or merger type.

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