In: Finance
What made a good LBO candidate? Please provide a detailed answer in essay form (No bullet points) and please don't copy paste material from other sites, minimum 250 words and cite any sources. Thank you.
LBO involves buying a company with a very proportion of borrowed fund (compared to acquirer's own equity). Though this leverage is taken by the company making the acquisition, it is expected to be paid from the target company balance sheet - the key idea being to scout for target companies with inherent assets/value/cash flows which, have not been discovered by others, can be unlocked in a short period of time by the acquirer which will result in a very return on (acquirer's equity) due to the leverage effect.
Given the high levels of leverage involved, the target companies invariably will have mature and predictable cash flow streams with low leverage on their own. This is important since once the LBO has been executed, the debt servicing commitment of the LBO will have to be serviced by the target company. Another consideration is that the market value or the perceived value of the target company should be significantly lower than the acquirer expected value because the acquirer is looking to profit from this unlocking of value and gain from the same. Additionally the target company should not have its own huge fund requirements plus even the unlocking of value should not entail significant upfront investments. The acquirer will also scan the target for possible divesture opportunities of non - core assets which can immediately bring in cash flown and help reduce debt, hence this can also be a criterion for target selection. Lastly, the acquirer would be very sensitive to likely feasible (& quick) exit option opportunities and target companies which meet all these requirements will be considered for LBO