Question

Do you agree with this statement ? why or why not ? write at least 200-250 words and gives examples of current stuituion. Leveraged Buyout (LBO) operations, or leveraged acquisitions, refer to the acquisition of part or all of an asset, such as a company, using third party capital (debt) as a significant part of the transaction value. Leveraged acquisitions began to be used in the USA by private equity funds and gained prominence in the 1980s, a period in which the cost of capital was low and allowed them to take high risks to make some acquisitions feasible.
The purpose of leveraged acquisitions is to allow the investor to make major acquisitions in the market, without the need to compromise or contribute the total value of the business. The investor who chooses to acquire a company via LBO only needs to commit a small portion of the total capital allocated to the purchase of the new business. In contrast, the largest portion is due to the use of debt, which will be issued by the acquired company itself. An LBO operation is very similar to a mortgage loan, where the financing is guaranteed by the property to be purchased, whereas, in the LBO, the debt contracted is secured by the assets of the acquired company.

The most iconic LBO operation that has ever occurred was that of RJR Nabisco, an American group formed by the merger of the companies R. J. Reynolds (manufacturer of cigarettes) and Nabisco (of food products). RJR Nabisco was acquired in an LBO transaction carried out by the PE Kohlberg Kravis Roberts & Co. fund in 1988 for $ 25 billion. RJR Nabisco's Unlevered beta at the time was 0.69, which meant that the group was relatively insensitive to market fluctuations, in addition to low levels of indebtedness, made RJR Nabisco a good attractive business for an LBO operation.
The expectation with leveraged acquisitions is that the return generated on the acquisition offsets the interest paid on the debt, thus making it attractive to experience high returns while the company that runs the LBO only risks a small amount of equity.

Answer 1

Yes I agree with the statement regarding LBOs and its limited equity risk for the company.

Leverage Buyouts or LBO can be defined as the process of acquiring a target firm by another company by borrowing huge amount of capital from the Banks. The company will get the approval of such huge capital by showing the assets of the target company as collateral to these financial institutions. Some of the LBOs structure provide the range as high as 9:1

LBO approach of acquiring is generally followed by Private Equity firms. Now some of the established companies are also following this approach to acquire distressed companies.

Some of the uses are:

• Large company acquisition can be made possible without risking too much in equity
• Can be used to convert Public company to Private

Benfit to the acquirer(Quantitative):

	No Debt acqusition	LBO acquisition
IEquity (millions)	10	1
Debt (millions)	0	9
Total Assets(millions)	10	10
EBIT (millions)	1.5	1.5
Interest rate	0%	10%
Pretax income (milions)	1.5	0.6
Tax rate	33.33%	33.33%
Net Income (millions)	1.00	0.40
ROE (Net Income/Equity)	10.00%	40.00%

From the table it can be seen high ROE for the acquirer is obtained for LBOs. Hence using only a small portion of the investor money we will get higher returns by following the Leverage Buyout. ie: The return generated on the acquisition offsets the interest paid on the debt, thus making LBO attractive with only a small risk in amount of equity.

Disadvantages:

• Some of the LBOs has had negative effect in the performance of the company
• unk Bonds which are non investment grade are issued during buyouts which are high risk.
• Cash flows has to match the interest requirements to Banks
• Used for Predatory acquisition