Finals

• Leveraged buyout (LBO)


  An acquisition technique involving the use of a large amount of debt to purchase a firm
• LBOs


  • A good example of a financial merger undertaken to create a high debt private corporation with improved cash flow and value
  • In a typical LBO 90% or more of the purchase price is financed with debt where much of the debt is secured by the acquired firm's assets, and because of the high risk, lenders take a portion of the firm's equity
• Attractive candidate for acquisition through an LBO

  • It must have a good position in its industry with a solid profit history and reasonable expectations of growth
  • It should have a relatively low level of debt and a high level of "bankable" assets that can be used as loan collateral
  • It must have stable and predictable cash flows that are adequate to meet interest and principal payments on the debt and provide adequate working capital
• LBO Example

  • Company A wants to buy Company B for $20 million. It uses $5 million of its own cash and takes out a $10 million business loan. It then gets a mezzanine loan from Bank C for an additional $5 million. Company A uses the $20 million to acquire Company B.
• Divestiture


  The partial or full disposal of a business unit through sale, exchange, closure, or bankruptcy
• Reasons for divestiture


  • A management decision to cease operating a business unit because it is not part of a company's core competency
  • If a business unit is deemed to be redundant after a merger or acquisition
  • If the disposal of a unit increases the sale value of the firm
  • If a court requires the sale of a business unit to improve market competition
• Business failure


  A company ceasing operations following its inability to make a profit or to bring in enough revenue to cover its expenses
• A profitable business can fail if it does not generate adequate cash flow to meet expenses
• Business failure


  When a company is unable to meet its financial obligations and is forced to shut down or suspend operations
• Leveraged Buyouts (LBOs)


  • A strategy used by private equity firms to acquire a company with the intention of increasing its value and eventually selling it for a profit
  • The acquisition is heavily financed through debt, which is why it's called "leveraged"
  • The buyer only puts up a small amount of equity, typically around 10%, and the rest is funded through loans
• Valuing the Target Company

  The valuation process involves detailed financial modeling to forecast the company's future cash flows, which are used to service the debt incurred during the acquisition. The valuation often includes a Discounted Cash Flow (DCF) analysis, which calculates the present value of the expected future cash flows
• How LBOs Work


  1. Acquisition: In an LBO, though the common scenario is directly acquiring entity, there are also instances where a private equity firm, creates a new company specifically for the acquisition. This new entity then purchases the target company with a combination of debt and equity.

  2. Management of Debt: Once the acquisition is complete, the target company's cash flows are utilized to pay off the debt incurred during the buyout. This includes both the principal and the interest.

  3. Exit Strategy: The ultimate goal of an LBO is to sell the target company at a higher price than it was bought for, thereby realizing a profit. This can be done by improving the company's operations and financial performance, and then either taking it public through an Initial Public Offering (IPO) or selling it to another company or investor.
• Factors for LBO success

  • The target company must have stable and predictable cash flows to service the debt
  • Interest rates on the debt should be manageable within the company's cash flow
  • The economic environment should be favorable to support business growth and eventual exit
• Advantages of LBO


  • Bigger return on equity (ROE) with using seller's assets
  • Lowering taxable income and realizing tax benefits
• Disadvantages of LBO


  • If the company's cash flow is not as expected or if interest rates rise, it can lead to difficulties in servicing the debt
  • If the economic conditions deteriorate, it may reduce the company's value and hinder the exit strategy, potentially leading to losses
• Reasons for LBO


  • To take a public company private
  • To spin off a portion of an existing business by selling it
  • To improve a company that is underperforming
• Purpose of LBO


  • Allow a company to make a major acquisition without committing a lot of capital
  • LBOs typically have strong, potential gain
• LBO


  Leveraged buyout - a transaction that requires careful planning and consideration of financial and market conditions to be successful
• Why LBOs happen


  • To take a public company private
  • To spin off a portion of an existing business by selling it
  • To improve a company that is underperforming
• Reason for LBO


  Company does not want to exert much capital in buying a significant purchase so they resort to debt
• LBO funding


  Funded with debt, assets and cash flows of the target company used as collateral and to pay for the financing cost
• Purposes of LBO

  • Allow a company to make a major acquisition without committing a lot of capital
  • Realize gains from strong, dependable operating cash flows, well-established product lines, or strong management teams
  • Lower probability of sacrificing the company's asset (from buyer's perspective)
  • Increased credit worthiness for the buyer in the future
• How LBO creates value

  1. Operational enhancements (organic growth, cost cutting, synergies from add-on acquisitions)

  2. Multiple expansion (buy low, sell high)
• If none of the expected value creation methods occur, the equity returns can be significantly impaired. Moreover, if one or more of the expected value creation drivers goes the opposite way, the effects can be disastrous
• Divestment


  The process of selling subsidiary assets, investments, or divisions of a company in order to maximize the value of the parent company
• Types of divestiture strategies

  • Sell-off
  • Spin-off
  • Split-up
  • Carve-out
  • Liquidation
• Types of business failures

  • Unavoidable (caused by unpredictable changes)
  • Predictable (can be predicted and prepared for)
  • Intellectual (from experimenting with new products or strategies)
• Causes of business failure

  • Poor planning
  • Unprepared expansion
  • Cash flow crunch
  • Flawed business strategies
  • Shrinking clientele
• Multinational company (MNC)


  Company that has business operations in at least one country other than its home country
• Multinational company


  • Has offices, factories, or other facilities in different countries around the world as well as a centralized headquarters which coordinates global management
  • Can have budgets that exceed those of small countries
• Types of multinational corporations

  • Decentralized Corporation
  • Centralized Global Corporation
  • International Division Within a Corporation
  • Transnational Corporation
• Standardization


  Offering the same products and services with little variation in order to save costs and achieve economies of scale
• Adaptation


  Adapting product offerings to match the tastes and preferences of the local customers
• Financial goals


  Targets related to profitability, growth, liquidity, and shareholder value maximization
• Financial goals


  • Achieving a certain level of profitability
  • Increasing revenue
  • Improving liquidity
  • Enhancing shareholder value
  • Managing costs
• Corporate governance


  System of rules, practices, and processes by which a company is directed and controlled, ensuring accountability, fairness, and transparency
• Corporate governance practices


  • Board of Directors
  • Transparency and Disclosure
  • Executive Compensation
  • Risk Management
  • Stakeholder Engagement
  • Ethical Standards and Corporate Social Responsibility (CSR)
• Domestic financial statements


  Prepared for companies operating within the borders of a single country
• Foreign financial statements


  Prepared for companies operating in multiple countries or jurisdictions
• Domestic financial statements


  Typically prepared in the local currency of the country where the company operates