Lbo Financing

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Prof. Ian GiddyNew York University

Structuring

LBO Financing


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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 2

Leveraged Buy-Outs

LBO is a transaction in which an investor group acquiresa company by taking on an extraordinary amount ofdebt, with plans to repay the debt with funds generatedfrom the company or with revenue earned by selling offthe newly acquired company's assets

Leveraged buy-out seeks to force realiation of thefir!" potential value by taking control #also done bypro$y fights%

Leveraging-up the purchase of the co!pany is a&te!porary& structure pending realiation of the value

Leveraging !ethod of financing the purchase per!its&de!ocracy& in purchase of o'nership and control--youdon(t have to be a billionaire to do it) !anage!ent canbuy their co!pany.


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Leveraged Financing

Leveraged Financeis the provision ofbank loans and the issue of high yieldbonds to fund ac*uisitions of co!panies

or parts of co!panies by an e$isting internal !anage!ent tea!

#a !anage!ent buy-out%+

an e$ternal !anage!ent tea! #a!anage!ent buy-in%+ or

a third party #a leveraged ac*uisition%.


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M&A and Leverage

Leveragedbuyout?

Companyhas

unuseddebt

capacity Leveraged

recapitalization?

Takeover?


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Corporate Restructuring

Divestiture,a reverse ac*uisition,isevidence that &bigger is not necessarilybetter&

Going private,the reverse of an I#initial public offering%,contradicts thevie' that publicly held corporations are

the !ost efficient vehicles to organieinvest!ent.


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Going Private

A public corporation is transor!ed into a privately"eld ir!

/he entire e*uity in the corporation is purchased by!anage!ent+ or !anag!ent plus a s!all group ofinvestors

/hese account for about 20 of public takeoveractivity in recent years in the 1nited tates.

Can be done in several 'ays3 &*ueee-out&,controlling shareholders of the fir! buy up

the stockholding of the !inority public shareholders 4anage!ent 5uy-ut,!anage!ent buys out a division or

subsidiary+ or even the entire co!pany+ fro! the publicshareholders

Leveraged 5uy-ut #L5%


7/33Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 7

LBOs# Agency Costs

and Free Cas" Flo$

&6ree cash flo'& is cash-co' typeearnings in e$cess of a!ounts re*uiredto fund all positive-78 pro9ects

ayout of free cash flo'+ to stockholders+reduces the a!ount of resources under!anag!ent(s discretion. 6orces!anage!ent to go out into the !arkets

and 9ustify raising funds /hus debt has a disciplining role. :afe;

!anagers choose less debt.



Seagate

. Ho' 'ould they realie that value=



Seagate

1998

!"G"T!

#!$%T"

&'( )or *1+8b



Seagate

,'''

!"G"T!

#!$%T"

&'( -orth *,,b

1''( -orth *1.b

eagate

shareholders

Distribution

ta/able at09+,(?



Seagate

ov ,'''

#!$%T"

eagate

shareholders

!"G"T!

Disk drivebusiness

1'9m #eritasshares

2-orth *18+3b4

!5C61,8m #eritas

shares

2-orth *,,b4

*,b cash

7anagement

Chase

Goldman

ilver Lake

artners

Cost *1+.:b

a)ter ta/



Seagate

!5C6

Disk

drive

business

!;uity *1b

Debt *1b

7anagement

ChaseGoldman



%ypical LBO Seuence

Company gets bloatedor slack and stockprice )alls

L3 years

%6 or sale o)company



Can t"e Financing 'or()

< 2 > ? @ A

Bebt #!% @.@ @ ?.@ ? >.@ >

D*uity #!% <



Can t"e Financing 'or()

=ree Cash =lo- "nalysis o) L ? @ A

6C66 InterestJ# ? @ A

=C== 220000 2@>000 2E0E@0 >>?@E2.@ >?F0000 >00000 2F0000 2?0000 2



LBO Financing

!5C6

Disk

drive

business

!;uity *'+,:b

eniordebt *1b 5hat securities?

5hat returns?

5hat investors?7ezzanine



%"e Financing Spectru!

!

/pected$eturn

$isk

enior secured debtenior secured debt

!;uity!;uity

enior unsecured debtenior unsecured debt

ubordinated debtubordinated debt

re)erred e;uityre)erred e;uity

Convertible debtConvertible debt



'"at Are %"e Alternatives)

sset-backed or cash flo'-backed debt enior debt ubordinated debt ubordinated debt 'ith upside

participation ubordinated debt 'ith e*uity option

referred e*uity estricted shares Co!!on stock



Subordinated *ig" +ield ,ebt

:unk bonds; M like e*uity+ but allo' increasedfinancial leverage

/a$ advantage over e*uity

5ig !arket in 1 #institutional investors% andincreasing in Durope

Leveraged loans favored by certainco!!ercial banks

ften used in connection 'ith 4N and L5s

5ehave like e*uity M and often have e*uityparticipation


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Sub ,ebt -- Motivations

pti!iation of financial leverage egulatory-driven capital re*uire!ents ated asset securitiations #senior-sub

structure in asset-backed securities% Insider or supplier-credit subordination

#eg in pro9ect finance%

Oork-outs and restructurings #e$istingborro'ers agree to seniority of ne'loans+ to buy ti!e%


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Sub ,ebts Big Proble!. *ig" /nterest0

olutions

Beep discount subordinated debt

ubordinated debt 'ith e*uity 'arrants

Convertible subordinated debt

articipating subordinated debt

uttable subordinated debt


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Convertibles

ConversionValue

StraightBond Value

MarketValue

Market Preiu

Value

of

Converti!

le

Bond

"#$ %

Pri&e Per Share of Coon Sto&k


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'arrants

'heoreti&alValue

MarketValue

Market Preiu

Value

of

(arrant

"#$

%Pri&e Per Share of Coon Sto&k "#$


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Preerred 1uity

Legally a for! of e*uity

Clai! senior to ordinary e*uity

4ay have fi$ed dividend+ or !ay be:participating;

5ut cannot trigger li*uidation if pay!ent!issed

ar value deter!ines li*uidation clai!


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Convertible Preerred

1sed by venture capital fir!s er!it investors to participate in gro'th 5ut give preference in li*uidation if the

venture failsnd disguise share value #ta$P% variant M DCJ give issuer right to

convert into co!!on stock

Jreferred e*uity rede!ption cu!ulative stock


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Preerred Stoc(. Pros and Cons

"dvantages

7o dilution of control

Bividends

conditional onavailability ofearnings

!ission cannotforce li*uidation

Disadvantages

Higher after-ta$ costthan debt

Lo'er return one*uity

Li!ited investorinterest


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Motivations or /ssuing *ybrid Bonds

Co!pany has a vie'

/here are constraints on 'hat theco!pany can issue

/he co!pany can arbitrage to save!oney

l'ays ask3 given !y goal+ is there analternative 'ay of achieving the sa!eeffect #e.g.+ using derivatives=%


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'"y 2se a *ybrid)

7otivations )or ybrids

Linked to

business risk

Linked to

market risk

Cannot hedge

-ith derivatives

Driven by investor

needs

Companyhedges

Companydoes not

hedge

Debt or

e;uity are

ot good enough


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Case Study. Le Meridien

Ohat kind of financing package 'ould enable oyal5ank to beat other co!!ercial and invest!ent banksin the 4eridien deal= Oho are potential rivals+ and'hat strengths !ight give the! a co!petitive edge=

If 5 offers sale-and-leaseback financing+ 'hatshould be the structure and ter!s of the deal+ ter!sthat !ake sense for the client as 'ell as for the bank=

If 5 offers e*uity participation+ 'hat for! shouldthis take= Co!!on stock or !eanine finance= r

should the bank avoid the risks of an e*uityinvest!ent= Oould asset-backed securities be suitable as a

financing source for this ac*uisition=


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Case Study

/he ohn Case L5 roposal

evise a recommended financing plan

@ohn Case 2o-ner4


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