The story took a significant u-turn as the Hilton re-listed in , transforming doomed-to-spectacularly-fail into one of the most profitable private equity deals ever. Even though the Blackstone Group managed to triple its initial investment, the very same period brought losses to others. In , the investors were betting on rising natural gas prices giving its coal-fired plants a significant advantage. What happened soon after the acquisition, was the exact opposite — U.
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In fact, the value truly created by LBOs is due neither to tax nor accounting issues i. Many academic studies have shown that bought out companies do much better than their sector peers.
Heavy debt acts as a strong incentive for managers, who are part owners of the company and have hopes of striking it truly rich. It also means that they have to put their noses to the grindstones for three to five years!
This is why LBO funds can pay as much as trade buyers who unlock synergies. If the tax advantage of debt was what drove LBOs, the constant decline in this advantage over the past 10 years, with lower tax rates and interest rates, would have meant the end of LBOs. This has obviously not been the case and shows that debt is actually of quite minor importance. There are now large funds that are only partly invested.
Fund managers are under heavy pressure to invest these sums rapidly, or to "empty" the funds although that is illegal.
Special training of LBO-dedicated teams, attorneys, banks and investors has made the LBO market more liquid and innovative, for example in securitisation buy-out techniques. This is a virtuous circle. Meanwhile, funds are taking on more and more staff and opening offices across Europe.
At the risk of sounding cynical, we believe that fund managers must find a way to justify their often high compensation packages, the size of their staffs, and even their European branch offices. So they make deals. This is the beginning of a vicious circle. This is a danger even though funds are completely autonomous and guarantee investors only a long-term return and obviously not a precise pace of investment and divestment, and even though they are given the freedom to make the right choices the first of which is to do nothing if the timing is not right.
Many sectors are now so concentrated, and competition authorities so vigilant, that in some cases only financial investors can acquire whole companies. In some cases, trade buyers may enter the fray, but under such strict terms from competition authorities that they are unable to offer a competitive price, despite the potential synergies which, in any case, are often harder to generate than expected. They tend to feel even greater reluctance to sell to a trade buyer when their company bears the family name, a name that the trade buyer would be more likely to eliminate.
Moreover, the development of share ownership plans for employees, managers in particular, ultimately makes a management-supported LSO more "normal". Last but not least, managers' hope to strike it rich in the medium term is a clear incentive for preferring an LBO to a trade buyer, which could endanger their jobs. Constant refocusing. Non-core subsidiaries of major groups have always been favoured targets for buyout funds. The current crisis is causing them to sell off subsidiaries phone directory businesses, pipelines, etc.
Entire divisions may not be "ready" for other types of disposals, as their activities may be too diverse to be sold off in one block to a trade buyer or are too small to be floated. Current weakness and volatility in equity markets make a floatation much more complicated.
P-to-P Public to Private , meanwhile, has emerged as a way to use leverage to buy out a listed company. P-to-P is attractive to some because of disappointing showings of listed companies, in particular the small and medium-sized companies that investors have snubbed.
Falling market valuations are a clear boost to LBOs, even though the level of debt that is acceptable to the market has also fallen instead of times EBITDA, it is now generally times , purchasing power of financial investors has often become comparable to that of trade buyers. With equities markets closed off as a source of financing, and with recurrent cash crunches and, in some sectors, the recession, taking their toll, trade buyers no longer have the will or the means for external growth.
When the barn's on fire, you have better things to do than buy up the neighbour's land! This has given buyout funds have a free hand. This is tantamount to sucking capital back out of the company, whose results since its first LBO had make it possible to rebalance its financial structure. In light of current market conditions, this is one of the most reassuring formulas for participants, offering guaranties on the quality of the target's accounts and the buyer's standards in terms of valuation, as all like-minded funds will come to similar valuations.
However, this is only a stopgap for funds, which must "sell" both the sale and the purchase to their shareholders, who are often the same from one fund to another Moreover, the potential for operating improvements is often limited after an LBO. So where is the value creation? Is the future so bright for all buyout funds? No, as some have done very poorly, when considering the risk they have incurred. Some of them will be driven out of the market, as they will be unable to raise new funds.
Consolidation is likely, even though the market is likely to continue growing in the coming years. Why so many LBOs? This trend should conclusively dispel two false notions on LBOs: LBOs create value, since they use leverage and as debt interest is tax deductible; Private equity funds cannot pay more than trade buyers, who are able to count on industrial synergies. So why have LBOs taken off? Growing sophistication by investors and in techniques Special training of LBO-dedicated teams, attorneys, banks and investors has made the LBO market more liquid and innovative, for example in securitisation buy-out techniques.
Intense consolidation in some sectors Many sectors are now so concentrated, and competition authorities so vigilant, that in some cases only financial investors can acquire whole companies. Constant refocusing Non-core subsidiaries of major groups have always been favoured targets for buyout funds. The equities market has been closed off Current weakness and volatility in equity markets make a floatation much more complicated.
Leveraged Buy-Outs: Why do some of them fail?
A leveraged buyout is a transaction whereby the purchase of a company is financed primarily with borrowed funds. A holding company contracts the debt and purchases the target company. The company's cash flow is regularly funnelled upstream to the holding company via dividends to enable the latter to pay interest and reimburse the loans. An LBO is often a solution in a family succession situation or when a large group wants to sell off a division.
Why so many LBOs?