The leveraged buyout (LBO), or the use of debt to purchase the stock of a corporation has been popular for decades now. In the United States, the value and number of LBOs peaked between 2006 and 2007. After that declined, and then significantly rose again in the following years.
Although there were very few LBOs in Europe in the 1980s, the volume of these deals increased in the 1990s. These had their value exceeding US LBOs’ from 2001 up until 2005.
Europe vis-a-vis the United States
The number of LBOs in Europe was almost double the number in the US by 2005. Also, in many years the average value of European LBOs was below that of the United States,. Indicating that more LBOs were completed in Europe but they were smaller than the LBOs that took place in the US. But although the LBO deal value increased in Europe during 2006-2007, the US was experiencing more dramatic growth.
Considering that 7 of the 10 largest LBOs took place in 2006-2007 and were all American deals, LBOs in both areas declined during the subprime crisis and rebounded afterward. Although the slower European economy dampened somewhat the rebound in Europe. Moreover, some of the LBOs that took place in the United States were significantly larger than in Europe.
From public to private
LBOs occur when the management of a company decides to take a publicly-held company or a division, private is called a management buyout. These are deals where a unit of a public company is bought by managers of that division. In the past ten years, both the volume of the dollar and the number of unit MBOs have risen.
Some trends that are visible in the total LBO data are also visible in the management buyout data. Both numbers and values fell after the fourth merger wave ended but made a comeback while in the fifth wave. But the dollar value of MBOs never returned to the levels witnessed in the fourth wave. While the number of these did come close to the mid 80s levels in 2012.
Greatest buyout in history
One great example, the greatest one in history, is the management buyout of pipeline company Kinder Morgan. This buyout costs $13.5 billion. Management proposed to contribute just under $3 billion of the total acquisition price. This equity contribution was augmented by a $4.5 billion investment by a group of private-equity investors. Investors were led by Goldman Sachs Capital Partners and the Carlyle Group.
The buyers planned to assume over $14.5 billion in debt, giving the deal an enterprise value of over $22 billion. Kinder Morgan was formed in late 1996 by a collection of assets. That was disposed of by Enron for approximately $40 million. These assets rose markedly in value due to its strong acquisition program in 1999, while Enron fell.
Management Investments
Investments may be made by the managers in an MBO using their own capital in the deal. But another equity capital is sometimes provided by investors and the bulk of the funds are borrowed. This deal often entails a sponsor working with the group, providing capital and access with investment banks. All this will work to raise the debt capital. The purchased company becomes separated from its own shareholders, the board of directors, and the management team.
The process is typical when the buying group is insiders in an MBO and the outsiders in an LBO. The former, however, has better access to information about the company’s potential profitability than an outside buying group. This is considered to be one factor that might give a management buyout more chances of being successful than a leveraged buyout. However, better information is still not enough. If the parent company has been seeking to sell the division due to poor performance, the management is assumed to be blamed for this attribute.
MBO vis-a-vis LBO
An MBO leaves the company still in the hands of the same managers, whereas in an LBO the new owners may install their own managers. These new ones may be less tied to prior employees and other assets are more willing to implement the changes that are important to make the company a more profitable one.
Companies should normally sell divest divisions to outside parties when they do and only a few of the time do they sell them to managers. For instance, between 2007–2016, only 2.3% of all divestitures were unit MBOs.
Still, the numbers are significant. On the other hand, the total dollar value of unit MBOs was $769 million in 2016, down from $3 billion in 2015, with the average deal size in 2016 is $154 million. By merger and acquisition standards, these are considered smaller transactions.
Secure Financing
When managers come to a decision of pursuing an MBO, they can work to make sure that they can finance themselves securely, typically with their investment bank’s help or a private equity firm they work with which can offer a fair percentage of the financing.
Fidrmuc, Palandri, Roosenboom, and Van Dijk’s study of 129 PTP transactions from 1997-2003 in the United Kingdom, they were able to present that managers tended to turn the private equity route when they cannot secure the financing by themselves. They do this since managers may give up control in exchange for the assistance of private equity partners.
Thriving Buyout
As previously mentioned, the company Kinder Morgan announced the biggest buyout in history, resulting in the diverging fates of Kinder Morgan and Enron. This all happened because of the strategies they used. Enron, a pipeline company, became a risky energy-trading enterprise. Meanwhile, Kinder Morgan, a company founded in 1927 in Houston as K N Energy, just stayed in the pipeline business and just thrived within the limits of his industry. With its acquisitions, it became an increasingly larger player in the less risky segment of the industry, lowering its risk profile due to the steady performance, and therefore enabling management to attract private equity investors.
© Image credits to Zaksheuskaya