CRG L6 - 2019

Corporate Restructuring
& Governance
BUSI 3101
Lecture 6
Dr. Young Un Kim
2016 CRRC International Talent Development Programme

Announcements
• Seminars start next week

• Attend your designated seminar time
You are required to:

– Read the article of Denis 1994 with various cases of
restructuring that is provided on Moodle under seminar 1.
– Prepare answers to the questions asked in the document
seminar 1 assignment on Moodle under seminar 1.
Copyright 2019 © Nottingham University Business School China. All Rights Reserved 2
Lecture 6: Private Equity and Buy-outs
• Introduction to Private Equity and Leveraged

Buyouts
• The role of Private Equity firms in corporate
restructuring and corporate governance
• Types of LBOs
• Why do LBOs happen?
• The Private Equity and Buy-Out Controversy
– Jensen & Rappaport
Copyright 2019 © Nottingham University Business School China. All Rights Reserved
What is Private Equity?
• private equity is an asset class consisting of equity securities and
debt in operating companies that are not publicly traded on a stock
exchange
• A private equity investment will generally be made by a private equity
firm, a venture capital firm or an angel investor. Each of these
categories of investor has its own set of goals, preferences and
investment strategies;
• Investors with risk-bearing capital for private companies (not publicly
listed on stock market) used to finance: - growth of private company
– start-up company – divested division new company – public to
private of entire public corporation
• Private equity vs. public equity
• Reasons for private equity investment: inefficiency &
underperformance / undervaluation / lack of public capital for growth
/ constraints for business units (blocking innovation).
What is an LBO?
• LBOs including MBOs are types of corporate restructuring

transactions (CRTs) and is the acquisition of another company or
division/subsidiary using a significant amount of borrowed money to
meet the cost of acquisition
• involves simultaneous changes in the ownership, financial structure
and incentive systems of firms
• The purchase is facilitated by the use of debt secured against the
target’s assets and/or future cash flows – hence, they are leveraged
transactions
• Private Equity (PE) firms are active investors in PE backed deals
– LBOs are the principal investment vehicle for private equity firms
LBO Trend
Value of LBO market
Country Comparison
Key Facts of 2017
LBO Association
Who are the top 10 private equity firms in the
world?
• The Blackstone Group, $82.9 billion (capital raised in
last 5 years)
• The Carlyle Group, $63.8 billion
• Kohlberg Kravis Roberts (KKR), $47.9 billion
• CVC Capital Partners, $47.4 billion
• Warburg Pincus, $36.5 billion
• Bain Capital, $35.5 billion
• EQT Partners, $30.05 billion
• Thoma Bravo, $29.8 billion
• Apollo Global Management, $29 billion
• Neuberger Berman, $28.8 billion
Top 5 PE firms in China
• Hony Capital, $ 3.9 billion (capital raised in last

10 years)
• SAIF Partners, $ 3.9 billion
• IDGVC Partners, $ 3.3 billion
• Hopu Investment Management, $ 2.5 billion
• GP Capital, $ 1.6 billion
Types of Leveraged Buy-outs
• Institutional Buyouts (IBO) – Outside LBO

Association main owners; high debt
• Management Buyouts (MBOs) – incumbent
management initiate the deal e.g. Harley Davidson
• Management Buy-In (MBI) – outside management
team initiate the deal
• Buy-In Management Buyout (BIMBO) – a MBO and
MBI hybrid
• Secondary Buyout – when a Private Equity firm buys
a firm from another Private Equity firm
Buy-Outs / Buy-ins: Three Core
Structural Characteristics
• A new company is established (using
existing organisational assets)
• High leverage
• Unique ownership structure comprising
management and active investors
having equity
Why Private Equity and Buy-outs?
Pre-Buyout Agency Problem
Separation Excessive Excess FCF Attractive

of managerial waste & restructuring
ownership discretion inefficiency target
& control
Monitoring Takeover
by board activity & /
or threat
Anti-t/over Friendly Hostile LBO /

devices merger takeover MBO
Source: Fox and Marcus, 1992, AMR

The Nature of PE backed Leveraged
Buy-Outs
• PE firms can acquire private firms and public firms
• Referred to as public to private transaction (PTP)
when public firm is brought private.
• Can be agreed, usually, or hostile.
• Principal subscribers of equity have significant
ownership but 60-90% of deal price met by borrowing.
• The resulting private company (de-listed) controlled by
small BoD representing the private equity firm and
CEO.
Why LBOS
• Company or entity is undervalued

• Company or entity is underinvested and
therefore can not realise its full potential
• Business unit/entity is constrained by parent
company
• Company or entity is not fully realizing its
potential due to inefficiencies, poor strategy
• Company is performing below industry average
and needs to be turned around
How do PE firms gain value from LBOs
• By creating incentives and structures for better

performance of the LBO
• By a close advisory and monitoring role
• Through exit of the LBO after some period
through:
– Flotation, IPO (company gets listed on stock market)
– Trade sale (sale to corporate acquirer)
– Secondary buyout (sale to other PE firm)
The Nature of Management Buy-Outs
• Acquisition of a divested division or subsidiary
[or a family owned firm] by a new company
(former parent may take a stake)
• Typically lower leverage than PE backed LBO
• Management (If incumbent MBO, if outside
management team MBI) takes substantial
proportion of equity
High profile Buyout
• LBO of RJR Nabisco (1989; 25 billion
US$)
RJR Nabisco, food and tobacco giant, led by
CEO Ross Johnson is taken over by private
equity firm KKR (Kohlberg, Kravis, Roberts)
after a fierce takeover battle.
Harper Business, publisher.
Published 1990;
New editions 2003 & 2008
“One of the greatest business

books ever written .. NY Times
Barbarians at the Gate
• A scene in Barbarians at the Gate frames the
question of accountability of corporate management
perfectly. Ross Johnson, CEO of RJR Nabisco
and the man who initiated the leveraged buyout of
RJR-Nabisco, met with Henry Kravis and George
Roberts of KKR to discuss it. There was a brief
discussion of the business before Johnson's
central question came up. "Now Henry, if you guys
get this, you're not going to get into chickenshit stuff
about planes and golf courses are you?" (Johnson's
perquisites included corporate jets, having two
domestic staff at his home on the company pay-roll
and membership fees at 24 country clubs.)
Barbarians at the Gate
• Roberts was candid. "Well, we don't want you to live a
Spartan life. But we like to have things justified. We don't
mind people using private airplanes to get places, if there's
no ordinary way. It is important that a CEO set the tone in
any deal we do.“
• Johnson, as it turned out, wanted to keep significant control
of the company. Roberts responded even more directly:
"We're not going to do any deal where management
controls it. We'll work with you. But we have no interest in
losing control." Johnson asked why.
• "We've got the money," Roberts said, "We've got the
investors, that's why we have to control the deal." From the
look in Johnson's eyes, Roberts could tell it wasn't the
message he wanted to hear. "Well, that's interesting,"
Johnson said. "But frankly, I've got more freedom doing
what I do right now."
Controversy
• Destroying jobs
• Short term profit making asset-strippers
• Casino Capitalists enjoying huge personal
windfalls while gambling other people’s futures
VS.
• Rescuing of distressed firms
• Increased competitiveness of firms
The ‘Jensen - Rappaport’ Debate
Jensen (1989) Rappaport (1990)

• “Eclipse of the public corporation” • “The staying power of the public
– [N.B. Title Imposed by HBR ed.!] corporation”
• Public corporation not suitable in • LBOs - limited to certain firms:
industries where long term growth is stable, strong cash flow.
slow and cash flows outstrip • LBOs reduce financial flexibility -
opportunities to invest - LBOs as necessary in fierce global
alternative competition
• Leverage - forces managers to • Removes daily stock price - an
disgorge FCF not waste it + can objective source of information
make bankruptcy less likely as • LBOs transitory - issue of exit by
problems identified earlier investors
• Strong pay - performance link
Entrepreneurship perspective
(Wright et al., 2009)
• Agency perspective criticised for focusing on cost
cutting and ignoring opportunities for upside gains
• Divisional structure truncates divisional managerial
incentives and rewards
• Small firms may need financial resources to
develop new products and markets
• PE firms provide complementary skills to help the
LBO management grow their business
Concluding Comments
• Private Equity and Buy-outs a form of
corporate restructuring transaction
– often involve financial, portfolio and organizational
restructuring
– Simultaneous changes
– reduction in agency problem
– Stimulates entrepreneurship
• Controversial because of alleged problems
• Buyouts can also create space for
entrepreneurship
Next Lecture
• Focus on evidence of effects and longevity of
buyouts
Key articles:
• Wright et al (2009) Private equity and corporate
governance
• Nikoskelainen & Wright (2007) Value creation ..
• Wright et al (2005) Corporate Governance: The Role of
Venture Capitalists and Buy-Outs, chapter 10 in book
Keasey et al , Corporate Governance
THANK YOU

CRG L6 - 2019

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Corporate Restructuring

Dr. Young Un Kim

2016 CRRC International Talent Development Programme

• Seminars start next week

You are required to:

• Introduction to Private Equity and Leveraged

• LBOs including MBOs are types of corporate restructuring

• Hony Capital, $ 3.9 billion (capital raised in last

• Institutional Buyouts (IBO) – Outside LBO

Separation Excessive Excess FCF Attractive

Anti-t/over Friendly Hostile LBO /

Source: Fox and Marcus, 1992, AMR

• Company or entity is undervalued

• By creating incentives and structures for better

“One of the greatest business

Jensen (1989) Rappaport (1990)

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