MBA 643 Managerial Finance A Primer on LBO and MBO

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MBA 643Managerial FinanceA Primer on LBO and
MBO

• Spring 2006
• Jim Hsieh

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What is a Leveraged Buyout (LBO)?

• LBO is a general form of corporate restructuring.
  It entails the purchase of a company by a small
  group of investors, financed largely by debt.
• The buying group may be associated with buyout
  specialists (e.g., Kohlberg Kravis Roberts
  Co.), investment bankers, or commercial bankers.

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What is a Management Buyout (MBO)?

• MBO is a going-private process led by the
  incumbent managers of the formerly public firm.
• MBO is a special form of LBO. When incumbent
  management is included in the buying group and
  key executives perform an important role in LBO
  transactions, then these going private
  transactions are called MBOs.
• A Critical Issue for MBO
• The buying group needs to be fair to
  minority/outside shareholders to avoid
  accusations of security fraud against controlling
  shareholders.

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Stages of a Typical LBO Operation

• (1). Raise the cash required for the buyout and
  design a new management incentive system.
• (2). The organizing sponsor group buys all the
  outstanding shares of the company and takes it
  private.
• To reduce the debt by paying off a part of the
  bank loan, the new owners sell off some parts of
  the acquiring firm.
• (3). The management strives to increase profits
  and cash flows by cutting operating costs and
  changing marketing strategies.

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Stages of a Typical LBO Operation (contd)

• (4). It will consolidate or reorganize production
  facilities, improve inventory control and
  accounts receivables management, improve product
  quality and customer service, try to extract
  better terms from suppliers, and any other ways
  to increase firm value and most importantly, meet
  payments on the swollen debt.
• (5). The investor group may take the company
  public again if the leaner and meaner company
  emerges stronger and the goals of the group are
  achieved.
• Reverse LBOs

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Deal Size and Premium in LBOs MBOs

• Relative Size of LBOs and MBOs (in MM)
• Weston, Chung, Siu, 1998
• Relative Premiums Offered