LBO_Econ46_AS-0 - The Determinants of Leveraged Buy Out...

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The Determinants of Leveraged Buy Out Transactions: Evidence from the United States Markets Albert Satija _______________________________________________________________________ _ ABSTRACT This study utilizes a dataset of 205 American companies purchased by private equity funds between 1995 and 2005 to create a predictive framework for Leveraged Buyout targets. The following 8 hypothesis are tested: LBO targets exhibit higher cash flow, LBO targets exhibit lower leverage, LBO targets exhibit lower growth, LBO targets exhibit higher levels of liquidity, LBO targets exhibit lower return on capital employed, LBO targets exhibit higher book to market ratios, LBO targets exhibit higher tax expenditures and LBO targets exhibit lower R&D expenditures. The evidence from the multivariate Probit regression supports a majority of the hypothesis. Surprisingly, however, higher existing debt and lower liquidity seem to positively predict LBO activity. In addition, Industry binary variables representing the five most active 2 digit SIC industry group were found to be economically and statistically significant determinants. Finally, the evidence implies that the current framework for predicting LBO activity is more suited to the period between 1995-2000 then 2001-2005. Additional research is necessary to determine to what extent this is true.
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In the past two years, Leveraged buyouts (“LBO”) have generated a level of media exposure unseen since the merger mania of the 1980’s. Aided by low interest rates, high real estate values, greater public expenses and a flood of capital from pension funds and endowments, financial sponsor firms have been snapping up companies at an impressive rate. 1 According to Dealogic, private equity activity totaled $135.7 billion in 2005, the largest total in the last decade with several high profile companies being caught up in the mix. March in 2005 for instance witnessed Toys R Us being purchased for a total of $6.6 billion and Sungard Data Systems for a near record $11.3 billion. 2 In addition to domestic mega-deals, the private equity industry has agitated corporate Europe with a succession of rapid restructurings (usually involving heavy job losses) and unsolicited take over proposals, causing members of the German cabinet to liken the funds to a “horde of locusts.” At the heart of the controversy and, at times, notoriety, is a simple usage of debt to magnify returns on companies. The traditional LBO transaction involves identifying an under-levered company with strong cash flow characteristics and utilizing low grade debt instruments to fund a purchase of the publicly traded shares. By increasing the debt load of the target firm, the financial sponsor’s are presumably optimizing the capital structure and maximizing the tax efficiency of the target. Most LBO transactions last between 3 and 7 years with exit strategies ranging from IPO’s to secondary buyouts by another private equity fund. 1
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LBO_Econ46_AS-0 - The Determinants of Leveraged Buy Out...

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