What is a leveraged buyout?
A leveraged buyout (LBO) is the acquisition of another company using a large amount of loan to cover the cost of acquisition. The assets of the acquired company are often used as collateral for loans, as well as the assets of the acquiring company.
Key points to remember
- A leveraged buyout is the acquisition of another company using a large amount of borrowing (bonds or loans) to cover the cost of acquisition.
- One of the largest LBOs ever recorded was the acquisition of Hospital Corporation of America (HCA) by Kohlberg Kravis Roberts & Co. (KKR), Bain & Co. and Merrill Lynch in 2006.
- In a leveraged buyout (LBO), there is generally a ratio of 90% debt to 10% equity.
The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital.
Understanding leveraged buyout (LBO)
In a leveraged buyout (LBO), there is generally a ratio of 90% debt to 10% equity. Due to this high debt to equity ratio, bonds issued on redemption are generally not investment grade and are called unwanted bonds. In addition, many people view LBOs as a particularly unforgiving predatory tactic. Indeed, it is generally not sanctioned by the target company. It is also considered ironic that the success of a business, in terms of balance sheet assets, can be used against it as collateral by a hostile business.
LBOs are conducted for three main reasons. The first is to take a private public enterprise; the second is to create part of an existing business by selling it; and the third is to transfer private ownership, as is the case with a change of small business owner. However, it is generally necessary that the acquired company or entity, in each scenario, be profitable and growing.
An example of leveraged buyout (LBO)
Leveraged buyouts have a notorious history, particularly in the 1980s, when several large takeovers led to the bankruptcy of acquired companies. This is mainly due to the fact that the leverage ratio was close to 100% and that the interest payments were so large that the company’s operating cash flows were unable to meet the obligation.
One of the largest LBOs ever recorded was the acquisition of Hospital Corporation of America (HCA) by Kohlberg Kravis Roberts & Co. (KKR), Bain & Co. and Merrill Lynch in 2006. The three companies paid approximately 33 billion dollars for the acquisition. of HCA.
LBOs are often complicated and take time to complete. For example, JAB Holding Company, a private company that invests in luxury goods, coffee, and healthcare companies, launched an LBO from Krispy Kreme Donuts, Inc. in May 2020. JAB was to buy the company for 1 , $ 5 billion, including $ 350 in a leveraged loan of millions of euros and a revolving credit facility of $ 150 million provided by the investment bank Barclays.
However, Krispy Kreme had debt on his balance sheet that needed to be sold, and Barclays had to add an additional interest rate of 0.5% to make it more attractive. This made the LBO more complicated and almost didn’t close. However, as of July 12, 2020, the agreement was concluded.