sLBOJunk(62p) - LBOs and Junk Bonds Leveraged buyouts Also...

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LBOs and Junk Bonds
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Leveraged buyouts Also called going private transaction Shareholders of publicly-traded corporation are bought out usually at high premium Average is around 42% Bidder takes a concentrated ownership position in reconstituted privately-held firms Typical deal is structured such that capital structure of firm consists of 40% publicly traded debt, 40% bank debt and 20% equity Management and/or buyout specialist may be involved
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LBO market going strong in terms of number of deals 0 50 100 150 200 250 300 350 400 450 Number of LBOs 1985 1987 1989 1991 1993 1995 1997
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But both total value of deals falling . .... 0 20000 40000 60000 80000 100000 120000 140000 160000 180000 200000 Size of LBO market in millions 1985 1987 1989 1991 1993 1995 1997
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And average size of deals declining 0 50 100 150 200 250 300 350 400 450 Average size of LBO in millions 1985 1987 1989 1991 1993 1995 1997
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Benefits and costs to LBOs What are the benefits to LBOs? What are the costs?
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Reasons for gains in LBOs Unlike mergers in which two companies are combined, going private transactions do not result in synergy Therefore, why do stockholders reap such high premiums, from 21 to 56%, in these transactions? What are the sources of gains?
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Sources of gains Tax savings Due to increase in debt Step-up in assets Although research indicates that tax savings are important, they are not of very high magnitude Redistribution from bondholders Examined under bondholder/shareholder conflict Still not large enough to explain gains Asymmetric information Managers have inside information about value of firm Mitigation of agency problems
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LBOs and free cash flow Why can’t managers solve the free cash flow problem by simply paying dividends? How can debt be used as a motivating factor for management? What is the role of bankruptcy in bonding the manager’s promise?
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Agency problems in LBOs Pre-LBO Conflicts of interest between old shareholders and management Wealth transfers from bondholders to shareholders Post-LBO Conflicts between new bondholders and managers Conflicts between buyout specialist and managers
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Conflicts between old shareholders and management On positive side, free cash flow problem is solved Old shareholders bought out at premium But in LBO, managers face conflict of interest between their own desire to purchase firm at low price and maximizing wealth of shareholders Shareholders may be suspicious of management's desire to take company private particularly if they believe that management has inside information about future profitability of the company
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Ways to solve conflict: litigation Resolve conflict of interest through courts To enjoin transaction on the grounds that it lacked a proper business purpose or that is was unfair Shareholders can dissent to acquisition and pursue their rights to have the court set the value of transaction through independent valuation
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Regulation SEC regulates conflicts of interest Rule 13e-3 requires management to state whether or not
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sLBOJunk(62p) - LBOs and Junk Bonds Leveraged buyouts Also...

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