subject: Leveraged Buyout (LBO) to Make Large Acquisitions by:David E Simpson [print this page] A leveraged buyout (LBO) occurs when a financial sponsor gains a controlling interest in a firm's equity and where a major % (percentage) of the buying value is financed through borrowing. The possessions of the obtained firm are often used as collateral for the borrowed money, sometimes with assets of the acquiring company. The bonds issued for leveraged buyouts normally have several trenches ranging from barely investment grade to high coupon 'junk' because of the major risks involved. In today's financing markets, even the most prestigious LBO firms have had difficulty financing transactions leading to a dearth of deals and some say the death of the LBO industry as we know it.
Historically, LBO funds made huge acquisitions of global behemoths valued at tens of billions of dollars borrowing as much as 90% of the value from banks. The banks would syndicate the loans and sell them to other sophisticated financial institutions such as pension funds and endowments. The bank financing the transaction would justify the debt levels based on the cash flows of the acquisition target and their ability to make interest and principal payments. Senior more secured 'mezzanine debt' might be offered to investors at LIBOR (London Interbank Offer Rate) + 700 basis points while the longer term unsecured tranches (the junk) might be sold at LIBOR + 1200 basis points.
In the halcyon days of yore (circa 2006), the LBO funds would often quickly take operating profits of the company and pay themselves a dividend covering their investment, effectively leaving them with a free call option and all the risk transferred to the bondholders - and the employees and taxpayers. Like most examples of excess in the capital markets, the pendulum has dramatically swung the other way. Gone are the days of inebriated, covenant-light debt. In fact, the banks aren't lending at all. The best of the breed have gone out of business forever altering the LBO landscape.
About the author
David E Simpson is a Director Investment at Starling Group
