[자료 ,발췌] Leveraged Buyouts

1. Leveraged Buyouts (from Inc. Encyclopedia)

※ 발췌 (excerpts):

A leveraged buyout (LBO) is the acquisition of a company in which the buyers puts up only a small amunt of money and borrows the rest. The buyer's own equity thus “leverages” a lot more money from others. The buyer can achieve this desirable result because the targeted acquisition is profitable and throws off ample cash used to repay the debt. Such transactions are also known as “bootstraps” or HLTs, i.e., “highly leveraged transactions.” Since they first appeared in the 1960s and took hold in the 1970s, LBOs have had mixed reviews from business people and other observers. Some see them as tools to streamline corporate structures, to rationalize meaninglessly diversified companies, and to reward neglected stockholders. Others see the LBO as a destructive force destroying economic and social values, the activity motivated by greed-driven predation.

TYPES OF LBOS

LBOs are typically used for three purposes, each in the category of corporate acquisitions generally. These are 1) taking a public company private, 2) financing spin-offs, and 3) carrying out private property transfers frequently related to ownership changes in small business.

Public to Private

The situation arises when an investor (or investment group) buys all the outstanding stock of a publicly traded company and thus turns the company into a priately-held entreprise ("taking priate" inreverse of "going public"). These deals may be friendly or hostile, the two terms related to management's point of view. Friendly cases typically involve the management buying the company for itself with plans to operate it thereafter as a privately-held entity. Hostile cases involve an investor or investor group intent on buying, reorganizing, and then reselling the company again to realize a high return. The sale of the company may be to another company or may be to the public in a stock offering. In the last case the situation actually amounts to a transactio more aptly labeled ^public-to-private-to-publc^. There are other variants in the disposition or in the payback of a third-party investor, although they tend to be rare, such as very high dividend payments and recapitalization by other groups.


Spin-Offs

Public or private companies often wish to sell off elements of their business to get cash. In some cases the seller may itself have been bought in an LBO and is spinning off assets to pay the investors back. ( ... ... )


Private Deals

The last situation concerns cases where a privately held operation is bought by an investor group. Such cases often arises when a smal businesses owner, having reached retirement age, wishes to divest him- or herself of the company and either cannot find a corporate buyer or does not wish to sell to a company. The buying group itself may be the company's employees or individuals associated in some way with the owner. These peope organize an LBO because they only have limited equity.


FINANCING AN PAYBACK

The target of an LBO must, almost by definition, be profitable, growing, and produce a suitably large cash flow. In acquisition jargon this is often abbreviated as EBITDA, meaning earnings before interest, taxes, depreciation, and amortization─the component elements of cash flow as ordinarily defined. Why cash flow? Because repayment of the large, leveraged debt is ^from^ future cash flows of the company. Other assets, of course, are also taken into consideration. If cash flow cannot keep race with repayment, it is desirable that the company has saleable components (e.g., potential spin-ofs) or liquid assets. ( ... ... )

The leveraged portion of the LBO may be as high as 90% of the deal but can be lower. In periods of unusual frenzy, the percent has even climbed above 90%. The rest is in the form of equity. Multiple "layers" of financing are involved : senior debt, senior subordinated debt, subordinated debt, mezzanine debt, bridge financing, and finally purchaser's own equity. The instruments described here are listed in increasing order of risk. In the case of default, those holding senior debt will be paid first, owners of equity last (if at all); these security relationships are contractually built into the instruments themselves. Mezzanine financing is a hybrid between straight equity and debt, structured so that "mezzanine" holders are just barely paid something in an extremen case where equity holders lose everything. ( ... ... )

LBO risks are high because ( ... ... ) Healthy, growing, cash-rich companies purchased by an LBO therefore may lose their flexibility by losing their cash and simultaneousl acquiring a huge load of debt [??] small shocks in the past become large shocks in the present. For these reasons investors expect returns above 20% per annum.

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2. Private Equity Industry Overview (Street of Walls)


※ 발췌 (excerpt):

Private equity (PE) is an asset class for investing in public and non-public companies or physical assets, such as real estate. These investments typically result in either a majority or substantial minority ownership stake in a company. The investments can offer very strong return streams that are frequently much less correlated with indices than the returns available in classic public market investment opportunities.

However, the tradeoff is that these investments are much less liquid and require a longer investment period. Depending on the fund size and investment strategy, a private equity firm may seek to exit its investments in 3-5 years in order to generate a multiple on invested capital of 2.0-4.0x and an internal rate of return (IRR) of around 20-30%.

In order to amplify returns, private equity firms typically raise a significant amount of debt to purchase the assets they invest in, in order to minimize their initial equity requirement (i.e. they use leverage). This investment strategy has helped coin the term “Leveraged Buyout” (LBO). LBOs are the primary investment strategy type of most Private Equity firms.


History of Private Equity and Leveraged Buyouts

After laying fairly dormant on Wall Street for a while, private equity became explosively popular during the 1980s, with famous large buyouts being attributed to equally famous PE investors. Two examples are Jerome Kohlberg, Jr. and Henry Kravis, who formed Kohlberg Kravis Roberts (KKR), and famously purchased RJR Nabisco in a leveraged buyout by beating the CEO in a bidding war over the company. This transaction is immortalized in the book (and later made-for-TV movie), Barbarians at the Gate, which details the famous transaction. This transaction is but one of the many famous LBOs and hostile takeovers that were part of the merger and acquisition mania of the late 1970s and 1980s.

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Types of Private Equity Investments

1) Venture Capital

2) Growth Capital (also referred to as Growth Equity)

3) Mezzanine Financing: A private equity firm may offer mezzanine financing in the form of subordinated debt (junior to senior debt) or preferred equity, where return expectations are typically around 15%-20% per year. Mezzanine financing, in general, usually involves investor compensation in the form of interest combined with upside participation (i.e., equity or options/warrants on equity). Companies will often search for other sources of capital before turning to mezzanine capital, because it is expensive. However, this type of capital can help fill the gap between senior debt and equity when a private equity firm considers a leveraged buyout—mezzanine financing effectively lowers the required amount of equity capital invested in a leveraged buyout, and the equity capital has a higher required rate of return. Therefore, mezzanine financing, while expensive, can help reduce the overall required rate of return on the capital used to execute the LBO, by lowering the required equity investment, and thereby make some LBO deals feasible that otherwise were not.

4) Leveraged Buyout ("LBO"): A leveraged buyout is the acquisition of a publicly or privately-held company, typically characterized by the significant amount of debt financing used for the acquisition relative to the equity financing used. LBOs are the bread-and-butter investment strategy for most Private Equity firms. In an LBO transaction, a PE firm (also called a financial sponsor) or a group of firms (called a consortium or investor group) acquire the target company using debt instruments for the majority of the purchase price (debt typically represents about 60-75% of the total price). The leveraged buyout relies heavily on the future cash flows of the acquired business to service the interest expense on the debt and, additionally, pay down the outstanding debt as quickly as possible. (This pay-down is usually small at first, because the initial interest expense burden is substantial, but typically the pay-down amount grows each year as the company’s cash flow grows and as the outstanding debt balance decreases from previous pay-downs.) As the debt balance is lowered and the company’s value increases, the equity very quickly grows as a proportion of the company’s capital structure. It is this deleveraging process that can help lead to substantial gains for the equity holders in a successful LBO investment.

( ... ... ) Well-known LBO firms include KKR, Blackstone, The Carlyle Group, TPG Capital, Goldman Sachs Private Equity, and Bain Capital.

5) Distressed Buyout

Private Equity Fund Structure

A private equity fund, also known as a general partner, consists of an investment team that raises committed capital from outside passive investors known as limited partners. Limited partners typically are made up of endowments, pensions, high net worth individuals, and institutional capital.  ( ... ... )

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Typical Fees

Due to the specialized expertise of private equity firms, they are able to charge fees to their limited partners when managing their investments. They do so through two primary sets of fees: annual management fees across total assets under management (AUM), and a performance incentive fee based on a hurdle rate. While this varies by firm and possibly by fund, typical management fees consist of 2% of the total assets under management annually, and performance fees of 20%, which are taken from exited (“realized”) investments.

A PE firm’s performance fees are also called incentive fees, carried interest or carry. There is typically a hurdle rate (an annual required return of 7-10%) that general partners must achieve before performance fees are allowed to be taken. ( ... ... )