What is buyout?
A buyout is the acquisition of a controlling interest in a business and is used as a synonym for the term acquisition. If the stake is purchased by company management, it is known as management buyout and if high levels of debt are used to finance the buyout, this is called leveraged buyout. Redemptions often take place when a business becomes private.
Understanding the buyout
Redemptions take place when a buyer acquires more than 50% of the business, which results in a change of control. Companies that specialize in financing and facilitating buyouts, act alone or together on transactions and are generally financed by institutional investors, wealthy individuals or loans.
In private equity, funds and investors look for underperforming or undervalued companies that they can privatize and transform, before going public years later. The buyout companies participate in management buyouts (MBOs), in which the management of the acquired company takes a share. They often play a key role in leveraged buyouts, which are buyouts financed with borrowed money.
Sometimes a buyout company believes that it can bring more value to the shareholders of a company than current management.
Management buyouts and leveraged buyouts
Management buyouts, or MBOs, provide an exit strategy for large companies that want to sell divisions that are not part of their core business, or for private companies whose owners want to retire. The financing required for an MBO is often quite large and usually consists of a combination of debt and equity from buyers, financiers and sometimes from the seller.
Leverage purchases (LBOs) use large amounts of borrowed money, with business assets often used as collateral for loans. The company carrying out the LBO can only provide 10% of the capital, the rest being financed by debt. It is a high-risk, high-return strategy, where the acquisition must generate high returns and cash flow in order to pay interest on the debt.
The assets of the target company are generally provided as security for the debt, and the buyout companies sometimes sell parts of the target company to repay the debt.
Examples of redemptions
In 1986, the Safeway board of directors avoided the hostile takeovers of Herbert and Robert Haft of Dart Drug by letting Kohlberg Kravis Roberts complete a friendly LBO of Safeway for $ 5.5 billion. Safeway sold part of its assets and closed unprofitable stores. After improving revenues and profitability, Safeway went public in 1990. Roberts earned nearly $ 7.2 billion on his initial investment of $ 129 million.
In 2007, the Blackstone Group purchased Hilton Hotels for $ 26 billion via an LBO. Blackstone paid $ 5.5 billion in cash and financed $ 20.5 billion in debt. Before the 2009 financial crisis, Hilton had problems with declining cash flow and revenues. Hilton subsequently refinanced at lower interest rates and improved its operations. Blackstone sold Hilton for nearly $ 10 billion in profit.
Key points to remember
- A buyout is the acquisition of a controlling interest in a business and is used as a synonym for the term acquisition.
- If the stake is purchased by company management, it is known as the management buyout, while if high debt levels are used to finance the buyout, this is called a buyback the sink.
- Redemptions often take place when a business becomes private.