LEVERAGED BUYOUT

Meaning

• A Leveraged buyout is a takeover of a company, or of a controlling interest in a company, using borrowed money, usually amounting to 70% or more of the total purchase price (with the remainder being equity capital)

• The goal of a Leveraged buy-out can be of a dual nature: a strategic-industrial nature and a financial-speculative nature

SUMEET AKEWAR

History

The leverage buyout market rose to prominence in the late 1980s

• Private equity firms such as Kohlberg Kravis & Roberts (KKR) and Fortsmann were making headlines with large buyouts including KKR’s $25 billion buyout of RJR Nabisco in 1988

• The success of these financial sponsors (i.e. PE firms) and others earning favorable returns, attracted many other parties to the industry

SUMEET AKEWAR

Theory of LBO• The Company / Private equity firm acquiring the target company will finance the acquisition with a combination of debt and equity• Portion of the debt incurred in an LBO is secured by the assets of the acquiredbusiness• The bought-out business generates cash flows that are used to service the debt incurred in its buyout• In essence, an asset acquired using leverage helps pay for itself SUMEET AKEWAR

Theory of LBO• In a successful LBO, equity holders often receive very high returns because the debt holders are predominantly locked into a fixed return

• Financial buyers invest in highly leveraged companies seeking to generate large equity returns

• An LBO fund will typically try to realize a return on an LBO within three to five years

SUMEET AKEWAR

Types of LBO• LBO: When a company is bought by another company made just for this purpose. Stocks of the acquired company are hold by a partnership of investors (usually institutional)

• MBO: It occurs when the operation is set up by the managers of the company and the objective being to take control of the company. It is the company management buying back its shares, Management buyout

• Family buyout: it occurs when the shares of the company are held by a family group which retains control of the company as a result without actually having the financial means to make the purchase

SUMEET AKEWAR

LBO Candidate Criteria•Steady and predictable cash flow

•Clean balance sheet with little debt

•Strong, defensible market position

•Limited working capital requirements

•Minimal future capital requirements

•Heavy asset base for loan collateral

•Divestible assets

•Strong management team

•Viable exit strategy

•Synergy opportunities

•Potential for expense reduction SUMEET AKEWAR

Valuation• Market Comparisons - Metrics such as multiples of revenue, net earnings and EBITDA that can be compared among public and private companies. Usually a discount of 10-40% is applied to private companies due to lack of liquidity of their shares

• DCF Analysis - Is based on the concept that the value of a company is based on the cash flows it can produce in the future. An appropriate discount rate is used to calculate NPV SUNNY SANCTIS

LBO Transaction Structure

Offering % of Cost of Lending Parameters Likely

Sources

Transaction Capital

Senior 50 – 60 % 7 – 10 % 5 – 7 Years Payback Commercial

Banks

Debt 2x – 3x EBITDA Credit Companies

Mezzanine 20 – 30 % 10 – 20 % 7 – 10 Years Payback Public

Market

Financing 1x – 2x EBITDA Insurance Co’s

LBO Funds

Equity 20 – 30 % 25 – 40 % 4 – 6 Years Exit Management

Strategy LBO Funds

Investment banksSUNNY SANCTIS

Sources & Uses of Funds

• Capitalization - Most leveraged buyouts make use of multiple tranches of debt to finance the transaction

• Bank Debt - is usually provided by one of more commercial banks lending to the transaction

- Revolving Credit Facility: Source of funds that the bought-out firm can draw upon as its working capital needs dictate

- Term Debt: Secured by the assets of the bought-out firm, is also provided by banks & insurance companies in the form of private placement investments

SUNNY SANCTIS

Sources & Uses of Funds

• Mezzanine Financing - It exists in the middle of the capital structure and generally fills the gap between bank debt and the equity

• Equity Component

- Private equity firms typically invest alongside management to ensure the alignment of management and shareholder interests

- Preferred equity is attractive because of dividend interest & equity ownership component

SUNNY SANCTIS

Leverage Statistics• Balance Sheet Transaction Adjustments : “Actual” & “Adjustments”

• Pro Forma Financial Statements : Company’s revised financial projections post-LBO

- Transaction Fee Amortization

- Management Fees

- Interest Expense

- Transaction Goodwill

• Equity Sponsor IRR CalculationSUNNY SANCTIS

Exit StrategiesSale Often the equity holders will seek an outright sale to a strategic buyer, or even another financial buyer

Initial While an IPO is not likely to result in Public the sale of the entire entity,Offering it does allow the buyer to realize a gain on its investment

Recapital The equity holders may recapitalize by re-

ization leveraging the entity,replacing equity with more debt, in order to extract cash from the company

SUNNY SANCTIS

FINANCIALANALYSIS

LBO Analysis

ABC CO

• Transaction Summary @ Deal Equity

• Equity Purchase Price per Share 32.00

• Common Shares Outstanding 113.5

• Equity Value 3,631.0

• Plus: Total Debt 694.5

• Less: Cash (148.6)

• Transaction Value 4,176

JAIKISHAN PARMAR

Sources of Funds INTEREST

• Debt & Preferred Stock Amount Percent Cash

Bank Revolver 5.0 0.1% 6.5%

Acquisition Senior Debt 2,205.8 50.0% 6.5%

Acquisition Mezzanine Financing 661.8 15.0% 15.0%

Total Debt & Preferred Stock 2,872.6 65.1%

Equity Amount Percent % Equity

Management 10.0 0.2% 0.6%

Equity Sponsor 1,529.0 34.7% 99.4%

Total Equity 1,539.0 34.9% 100.0%

Total Sources of Funds 4,411.7 100.0%

JAIKISHAN PARMAR

Use of FundsUses of Funds Amount Percent

Purchase Common Equity 3,631.0 82.3%

Refinance Short-term Debt 5.0 0.1%

Refinance Senior Debt 689.5 15.6%

Refinance Mezzanine Debt 0.0 0.0%

Transaction Fees 86.2 2.0%

Total Uses of Funds $4,411.7 100.0%

Refinance Short-term Debt 5.0 0.1%

JAIKISHAN PARMAR

Balance Sheet AdjustmentsActual Adjustments LBO06/29/03 Sources Uses Pro Forma

• AssetsCash and Cash Equivalents 148.6 4,411.7 (4,411.7) 148.6Accounts Receivable 96.5 0.0 0.0 96.5Inventory 49.8 0.0 0.0 49.8Other Current Assets 21.8 0.0 0.0 21.8• Total Current Assets 316.6 4,411.7 (4,411.7)

316.6Net Property,P & M 1948.3 0.0 0.0 1,948.3Transaction Goodwill 0.0 0.0 0.0 0.0Transaction Costs 0.0 0.0 86.2 86.2Goodwill 279.5 0.0 0.0 279.5Intangibles 47.1 0.0 0.0 47.1Other Assets 193.3 0.0 0.0 193.3• Total Assets 2,784.8 4,411.7 (4,325.5) 2,871.0

JAIKISHAN PARMAR

Balance Sheet AdjustmentsLiabilities and Shareholders' Equity ADJUSTMENT LBO

ACTUAL SOURCE USEPROFORMA

Bank Revolver 5.0 5.0 (5.0) 5.0

Accounts Payable 91.0 0.0 0.0 91.0

Other Current Liabilities 218.8 0.0 0.0 218.8

• Total Current Liabilities 314.8 5.0 (5.0) 314.8

Other Liabilities 201.0 0.0 0.0 201.0

Senior Debt 689.5 2,205.8 (689.5) 2,205.8

Subordinated Debt 0.0 661.8 0.0 661.8

• Total Liabilities 1,205.3 2,872.6 (694.5) 3,383.5

Existing Preferred Stock 0.0 0.0 0.0 0.0

Acquisition PIK Preferred 0.0 0.0 0.0 0.0

Common Equity 1,579.5 1,539.0 (3,631.0) (512.5)

• Total Liabilities and Equity 2,784.8 4,411.7 (4,325.5) 2,871.0

JAIKISHAN PARMAR

Income statementPro Forma Income StatementEstimated Projected

Fiscal Year End 2003 2004 2005 2006 2007 2008

Sales 3,139.8 3,532.3 3,973.8 4,410.9 4,852.0 5,288.7

Cost of Goods Sold 1,591.2 1,766.1 1,947.2 2,117.2 2,304.7 2,512.1

Gross Profit 1,548.6 1,766.1 2,026.6 2,293.7 2,547.3 2,776.6

SG&A 273.4 282.6 317.9 352.9 388.2 423.1

Other Operating Expenses 664.5 706.5 755.0 838.1 921.9 1,004.9

EBITDA 610.7 777.1 953.7 1,102.7 1,237.3 1,348.6

Depreciation 309.9 398.2 497.6 607.8 729.1 782.9

Amortization 5.9 5.9 5.9 5.9 5.9 5.9

EBIT 294.9 373.0 450.2 489.0 502.2 559.8

Amortization of Transaction Fees 12.3 12.3 12.3 12.3 12.3 12.3

Management Fees 1.0 1.0 1.0 1.0 1.0 1.0

Interest Expense (net) 236.0 236.0 229.2 216.4 198.1 175.3

Other (Income) / Expense 6.9 6.9 6.9 6.9 6.9 6.9

Pre-Tax Income 38.7 116.8 200.8 252.3 283.9 364.4

Provision for Taxes 14.2 42.9 73.8 92.7 104.3 133.9

Net Income to Common 24.5 73.8 127.0 159.6 179.6 230.5

JAIKISHAN PARMAR

Cash flowCash Flow From Financing Activities

07 08 09 10 11Change in Revolver (5.0) 0.0 0.0 0.0 0.0

Change in Senior Debt (64.7) (165.6) (253.4) (340.1) (390.4)

Change in Subordinated Debt 6.7 6.7 6.8 6.9 6.9

Existing Preferred Stock 0.0 0.0 0.0 0.0 0.0

Plus: Non-cash Dividend 0.0 0.0 0.0 0.0 0.0

Less: Common Dividend Paid 0.0 0.0 0.0 0.0 0.0

Cash Provided / (63.1) (158.9) (246.6) (333.2) (383.4)

(Used) by Investing Activities

Beginning Cash Balance 148.6 155.3 162.0 168.8 175.6

Change in Cash 6.7 6.7 6.8 6.9 6.9

Ending Cash Balance 155.3 162.0 168.8 175.6 182.5

JAIKISHAN PARMAR

Balance sheetLiabilities and Shareholders' Equity

2006 2007 2008 2009 2010 2011

Bank Revolver 5.0 0.0 0.0 0.0 0.0 0.0

Accounts Payable 91.0 96.8 106.7 116.0 126.3 137.7

Other Current Liabilities 218.8 246.1 276.9 307.4 338.1 368.5

Total Current Liabilities 314.8 342.9 383.6 423.4 464.4 506.2

Other Liabilities 201.0 201.0 201.0 201.0 201.0 201.0

Senior Debt 2,205.8 2,141.1 1,975.5 1,722.1 1,382. 991.7

Subordinated Debt 661.8 668.4 675.1 681.9 688.8 695.7

Total Liabilities 3,383 3,353 3,235 3,028 2,736 2,394

Existing Preferred Stock 0.0 0.0 0.0 0.0 0.0 0.0

Acquisition PIK Preferred 0.0 0.0 0.0 0.0 0.0 0.0

Common Equity (512.5) (438.6) (311.6) (152.0) 27.6 258.0

Total Liabilities and Equity 2,871 2,914 2,923 2,876 2,763 2,652

JAIKISHAN PARMAR

Objectives of LBO• Investors takeover a company when they see it undervalued or its assets are not being used properly

• Investors takeover the company, improve it causing its value to increase then sell it back to the market at a higher price share

• Sometimes they sell parts of it which could give back a big amounts of money

RITESH MACHHI

Objectives of LBO• Generally, the acquiring group plans to run the acquired company for a number of years, boost its sales and profits, and then take it public again as a stronger company

• In other instances, the LBO firm plans to sell off divisions to other firms that can gain synergies, but the inherent risks are great due to the heavy use of financial leverage

• Saving a lot of taxes because they are borrowing a lot of money

RITESH MACHHI

Pros & Cons Of Using Leverage

PROS

• Large interest and principal payments can force

management to improve performance and

operating efficiency

• As the debt ratio increases, the equity portion

of the acquisition financing shrinks to a level at

which a private equity firm can acquire a

company by putting up anywhere from 20-40% of

the total purchase price

• Interest payments on debt are tax deductible

thus tax shields are created and they have

significant value

RITESH MACHHI

Pros & Cons Of Using Leverage

CONS

• Events such as recession, litigation, or changes in the regulatory environment can lead to financial distress

• Weak management at the target company or misalignment of incentives between management and shareholders can also pose threats

• Increase in fixed costs from higher interest payments can reduce a leveraged firm’s ability to weather downturns

• In troubled situations, management teams of highly levered firms can be distracted by dealing with lenders concerned about the company’s ability to service debt

RITESH MACHHI

CASES

RJR Nabisco CaseA good example of an LBO is KKR’s buyout of RJR Nabisco

• On October 28,1988 Ross Johnson, the company’s CEO, had formed a group of investors that was prepared tobuy all RJR’s stock for $75 per share in cash and take the company private

• RJR’s share price immediately moved to about $75,handling

shareholders a 36 percent gain over the previous day’s price

of $56

• At same time RJR’s bonds fell, since it was clear that

existing bondholders would soon have a lot more company

• Johnson’s offer lifted RJR onto the auction block.

VAIBHAV ATRI

RJR Nabisco Case• Four days later KKR bid $90 per share,$79 in cash plus PIK preferred valued at $11

• The resulting bidding contest had many surprises, but in the end it was Johnson group against KKR

• KKR offered $109 per share, after adding $1 per share in the last hour

• The KKR bid was $81 in cash, convertible subordinated debentures valued at about $10,and PIK preferred shares valued at $18.Johnson group bid $112 in cash and securities

• RJR board chose KKR although Johnson’s group had offered $3 per share more, its security valuations were viewed as “softer” and perhaps overstatedVAIBHAV ATRI

Tata – Corus Deal• Tata Steel's $8.23 billion leveraged buyout

of UK steel producer Corus is multi-faceted

• The Deal Comprises:

- $3.88 billion equity contribution from Tata

Steel

- Fully underwritten non-recourse debt

package of $5.63Bn

- Revolving credit facility of $669 million

VAIBHAV ATRI

Tata – Corus Deal• £3.3 billion is being raised at the SPV level

- Credit Suisse will provide 45% and

- ABN AMRO and Deutsche will pick up 27.5% each

• $1.8 billion bridge debt is being raised at the Tata Steel level in India is being shared between Standard Chartered and ABN AMRO

• In addition, Standard Chartered is providing

subordinated debt of £196 million to Tata Steel

VAIBHAV ATRI

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