Lecture 11

Question 1

What is the role of the buyout funds ?

Answer 1

• Raise capital from wealthy individuals, pension funds, institutional investors
• Acquire troubled firms or divisions of theirs
• Restructure activities of acquired firms
• Exit successful investments through IP, MBO, sellout to corporate bidders
• Exit unsuccessful investments through liquidation

Question 2

What are the sources of value of buyout funds ?

Answer 2

• Restructuring of operating activities

* Redesign financial policy

Question 3

What is the structure of a buyout fund ?

Answer 3

Classical limited partnership

Question 4

What is the difference from VC’s ?

Answer 4

Finance public firms

Question 5

With what do buyout funds finance large fraction of bid ?

Answer 5

Variety of debt securities

Question 6

What is the difference between LBO and ordinary acquistion ?

Answer 6

• Large fraction of purchase price = debt financed

* LBO goes private = no shares traded on open market

Question 7

What are the main characteristics of LBOs ?

Answer 7

• High debt
o Not permanent, supposed to be paid down

• Incentives
o Greater stake business given to managers via stock options or shares
o Generate cash for debt service, managers, employees work harder
o Private ownership

• LBO goes private
o Owned by partnership of private investors who directly monitor performance
o Most successful LBOs go public again as soon as debt = paid down sufficiently and improvements in performance achieved

Question 8

What are the implications of buyout activity for target shareholders ?

Answer 8

Receive offers with premium of 37% vs pre-bid stock price

Question 9

What are the likely targets of an LBO ?

Answer 9

Firms with high levels of FCF, low market to book ratios, conglomerates

Question 10

What are the operational changes induced by LBOs ?

Answer 10

• Lower CAPEX
• Higher operating income
• Better utilization of employment and capital
• No slashing of R&D
• Focus of research in core activities

Question 11

What are the Governance changes in LBOs ?

Answer 11

• Old management ousted with p = 50%
• New management higher incentives
• BoD is smaller
• Independent directors chosen by LBO sponsors

Question 12

What happens when an LBO is announced ?

Answer 12

Buyout fund informs target shareholders about plan of reorganization

Question 13

What does the reorganization plan involve ?

Answer 13

High usage of leverage comprising many different types of debt securities

Question 14

What does one need to take into account when assessing NPV associated with LBO deal ?

Answer 14

Change of leverage over time

Question 15

What does the change of leverage goign to imply ?

Answer 15

Time varying cost of capital

Question 16

What is the idea behind the fact that some of the activity of buyout funds is concentrated on conglomerates ?

Answer 16

Inefficiently run division would be worth more as a stand alone company with its own specialized management

Question 17

How to find out the cost of capital used for the valuation of the divested segment of the firm ?

Answer 17

Need to combine time varying leverage with beta of unlevered assets