Question

Timbuktu Technologies is an​ all-equity firm that is currently trading at​ $22 per​ share, with 50 million shares outstanding. You believe that by replacing​ management, you can increase the value of the firm by​ 50%. What is the maximum amount of value you can extract in a leveraged buyout for​ 50% of the outstanding​ shares?

Answer 1

Currently the value of company is $22 * 50 million = $1,100 million and you estimate you can add an additional 50% or $550 million. If you borrow $550 million and tender offer succeeds, you will take control over the company and install new management. The total value of the company will increase its value by 50% to $1,650 million. You will also attach the debt to the company, so the company will now have $550 million in debt.

The value of equity once the deal is done = Total value - Debt outstanding = $1,650 million - $550 million = $1,100 million

The value of the equity is the same as the pre merger value. You own half the shares which is worth $550 million and you paid nothing for them, so you captured the value you anticipated adding to FAT.

Assume you were able to borrow $600 million,

Value of equity after merger will be = $1,650 million - $600 million = $1,050 million

This is lower than the premerger value. However, in the United States existing shareholders must be offered at least the premerger price of their shares. Because existing shareholders anticipate that share price will be lower once the deal is complete, all shareholders will tender their shares. This implies that you will have to pay $1,100 million for these shares and so to complete the deal you will have to pay $1,100 - $600 = $500 million out of your own pocket. In the end, you will own all the equity which is $1,050 million. Ultimately, the profit will be $550 million ($1,050 million - $500 million)

In each case, the most you earn is $550 million in value you add by taking over FAT. Thus, you cannot extract more value than the value you add to the company.