A leveraged buyout (LBO) is the acquisition of another company using a significant amount of borrowed money—via bonds or loans—to meet the cost of acquisition. The assets of the company being acquired, along with those of the acquiring company, are often used as collateral for the loans.
Key Takeaways
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Extensive Debt: A leveraged buyout (LBO) is characterized by the use of borrowed funds, often more than 90% of the total purchase price.
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LBO Resurgence: After declining post the 2008 financial crisis, LBOs are regaining popularity, often seen in large-scale acquisitions.
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Equity Ratio: Typically, an LBO features a financial structure of about 90% debt and 10% equity.
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Business Perception: LBOs can appear ruthless, as assets from the target company can be leveraged against it.
The Dynamics of Leveraged Buyouts
In an LBO, there is commonly a 90% debt to 10% equity ratio. Because of this high debt/equity ratio, the bonds issued are often referred to as junk bonds due to their lower investment grade.
LBOs are notorious as aggressive business strategies since the acquisition does not usually require sanction from the target company. Irony rests in the scenario where the target company’s own successful assets are used as collateral against it by the acquiring firm. The primary aim of leveraged buyouts is to facilitate large acquisitions without a significant capital investment from the acquiring company.
Conducting LBOs can serve several purposes:
- Transition a public company to private ownership.
- Sell off parts of an existing business through a spinoff.
- Transfer ownership privately, often seen in small business transitions.
Successful LBOs typically necessitate profitable and growth-oriented companies.
Historic and Recent LBO Examples
One of the most notable historic LBOs was the acquisition of Hospital Corp. of America (HCA) by Kohlberg Kravis Roberts & Co. (KKR), Bain & Co., and Merrill Lynch in 2006, valued at approximately $33 billion.
Post the 2008 financial crisis, LBO activity saw a decline but experienced resurgence during the COVID-19 pandemic. For instance, in 2021, Blackstone Group led a leveraged buyout of Medline, valuing the medical equipment manufacturer at $34 billion.
How LBOs Operate
An LBO is executed when one company acquires another by borrowing substantially to finance the acquisition. Bonds issued for this purpose lean on the combined assets of both companies as collateral, marking a significant understanding of leveraging the assets effectively.
Motivations Behind LBOs
The motivations for conducting an LBO are varied but often stem from seeking to take a public company private, divesting parts of an existing business, or affecting ownership transitions. The primary draw is allowing the acquiring company to make substantial purchases with minimal equity involvement.
Ideal Candidates for LBOs
Equity firms tend to focus on established industries with robust earnings for LBOs. Optimal candidates feature reliable operating cash flows, established product lines, strong management, and clear exit strategies that promise tangible gains for the acquirer.
The Bottom Line
A leveraged buyout (LBO) involves acquiring a company primarily through borrowed funds. Companies use LBOs to take public ventures private or to spin off parts of their business. This methodology typically fashions a 90% debt to 10% equity ratio, influencing credit ratings of the issued bonds. While perceived as predatory due to the lack of control by the target company, LBOs, albeit risky, present lucrative opportunities in business strategy. Though LBO engagements dwindled post-2008, current times hint a revived interest.
Related Terms: debt/equity ratio, collateral, private equity, junk bond, hostile takeover.
References
- Accounting Tools. “Leveraged Buyout Definition”.
- Leonard N. Stern School of Business, New York University. “Corporate Restructuring”, Page 34.
- Hurduzeu, Gheorghe and Popescu, Maria-Floriana. “The History of Junk Bonds and Leveraged Buyouts”. Procedia Economics and Finance, vol. 32, 2015, pp. 1269-1270. Download PDF.
- HCA Healthcare, Investor Relations. “HCA Completes Merger with Private Investor Group”.
- Blackstone. “Blackstone, Carlyle and Hellman & Friedman to Invest in Medline”.
- Financial Times. “Private Equity Group Reaches Deal to Buy Medline for $34bn”.
- S&P Global Market Intelligence. “As LBOs Surged in Q4'20, US Purchase Price Multiples Hit New Heights”.
- Business Insider. “How Private Equity Firms Screen for LBO Candidates”.
