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$y fights%
Leveraging-up the purchase of the co!pany is a&te!porary& structure pending realiation of the value
Leveraging !ethod of financing the purchase per!its&de!ocracy& in purchase of o'nership and control--youdon(t have to be a billionaire to do it) !anage!ent canbuy their co!pany.
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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 3
Leveraged Financing
Leveraged Financeis the provision ofbank loans and the issue of high yieldbonds to fund ac*uisitions of co!panies
or parts of co!panies by an e$isting internal !anage!ent tea!
#a !anage!ent buy-out%+
an e$ternal !anage!ent tea! #a!anage!ent buy-in%+ or
a third party #a leveraged ac*uisition%.
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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 4
M&A and Leverage
Leveragedbuyout?
Companyhas
unuseddebt
capacity Leveraged
recapitalization?
Takeover?
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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 5
Corporate Restructuring
Divestiture,a reverse ac*uisition,isevidence that &bigger is not necessarilybetter&
Going private,the reverse of an I#initial public offering%,contradicts thevie' that publicly held corporations are
the !ost efficient vehicles to organieinvest!ent.
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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 6
Going Private
A public corporation is transor!ed into a privately"eld ir!
/he entire e*uity in the corporation is purchased by!anage!ent+ or !anag!ent plus a s!all group ofinvestors
/hese account for about 20 of public takeoveractivity in recent years in the 1nited tates.
Can be done in several 'ays3 &*ueee-out&,controlling shareholders of the fir! buy up
the stockholding of the !inority public shareholders 4anage!ent 5uy-ut,!anage!ent buys out a division or
subsidiary+ or even the entire co!pany+ fro! the publicshareholders
Leveraged 5uy-ut #L5%
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LBOs# Agency Costs
and Free Cas" Flo$
&6ree cash flo'& is cash-co' typeearnings in e$cess of a!ounts re*uiredto fund all positive-78 pro9ects
ayout of free cash flo'+ to stockholders+reduces the a!ount of resources under!anag!ent(s discretion. 6orces!anage!ent to go out into the !arkets
and 9ustify raising funds /hus debt has a disciplining role. :afe;
!anagers choose less debt.
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Seagate
. Ho' 'ould they realie that value=
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Seagate
1998
!"G"T!
#!$%T"
&'( )or *1+8b
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Seagate
,'''
!"G"T!
#!$%T"
&'( -orth *,,b
1''( -orth *1.b
eagate
shareholders
Distribution
ta/able at09+,(?
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Seagate
ov ,'''
#!$%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/
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Seagate
!5C6
Disk
drive
business
!;uity *1b
Debt *1b
7anagement
ChaseGoldman
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%ypical LBO Seuence
Company gets bloatedor slack and stockprice )alls
L3 years
%6 or sale o)company
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Can t"e Financing 'or()
< 2 > ? @ A
Bebt #!% @.@ @ ?.@ ? >.@ >
D*uity #!% <
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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
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LBO Financing
!5C6
Disk
drive
business
!;uity *'+,:b
eniordebt *1b 5hat securities?
5hat returns?
5hat investors?7ezzanine
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%"e Financing Spectru!
!
/pected$eturn
$isk
enior secured debtenior secured debt
!;uity!;uity
enior unsecured debtenior unsecured debt
ubordinated debtubordinated debt
re)erred e;uityre)erred e;uity
Convertible debtConvertible debt
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'"at Are %"e Alternatives)
sset-backed or cash flo'-backed debt enior debt ubordinated debt ubordinated debt 'ith upside
participation ubordinated debt 'ith e*uity option
referred e*uity estricted shares Co!!on stock
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Subordinated *ig" +ield ,ebt
:unk bonds; M like e*uity+ but allo' increasedfinancial leverage
/a$ 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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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 20
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$istingborro'ers agree to seniority of ne'loans+ to buy ti!e%
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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 21
Sub ,ebts Big Proble!. *ig" /nterest0
olutions
Beep discount subordinated debt
ubordinated debt 'ith e*uity 'arrants
Convertible subordinated debt
articipating subordinated debt
uttable subordinated debt
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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 22
Convertibles
ConversionValue
StraightBond Value
MarketValue
Market Preiu
Value
of
Converti!
le
Bond
"#$ %
Pri&e Per Share of Coon Sto&k
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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 23
'arrants
'heoreti&alValue
MarketValue
Market Preiu
Value
of
(arrant
"#$
%Pri&e Per Share of Coon Sto&k "#$
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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 24
Preerred 1uity
Legally a for! of e*uity
Clai! senior to ordinary e*uity
4ay have fi$ed dividend+ or !ay be:participating;
5ut cannot trigger li*uidation if pay!ent!issed
ar value deter!ines li*uidation clai!
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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 25
Convertible Preerred
1sed by venture capital fir!s er!it investors to participate in gro'th 5ut give preference in li*uidation if the
venture failsnd disguise share value #ta$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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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 26
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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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 27
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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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 28
'"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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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 29
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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Copyright 2002 Ian H. Giddy Corporate Financial Restructuring 30
Case Study
/he ohn Case L5 roposal
evise a recommended financing plan
@ohn Case 2o-ner4
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