The Impact of LBO on Firms Performance

By
Sneha.LS Soujanya.N

Sowmya.N.R

What is Leverage buyout.???!!!

The acquisition of another company using a significant amount of

borrowed money (bonds or loans) to meet the cost of acquisition.

Often, the assets of the company being acquired are used as collateral

for the loans in addition to the assets of the acquiring company. The
purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital.

Transaction structure
Issues to be considered in LBO transaction

Industry characteristics

Company-specific characteristics
Market conditions

Characteristics of a Good LBO Candidate

Certain features of potential target firms, that attracts LBO

High growth, high market share firms

High profit potential firms Viable exit strategy Low operating risk firms Low existing debt loads. A multi year history of stable and recurring cashflows. Strong management team Divestible assets.

Capital structure of Leverage buyout

9%
13%

15%

Subordinate debt Long term senior debt Short or Intermediate debt Common stock Preferred stock

Tranches in the LBO Structure

1. Revolving Credit Facility
2. Bank Debt

27%

36%

3. High-Yield Debt 4. Mezzanine Debt 5. Seller Notes 6. Securitization 7. Common Equity

Source: Mergers and Acquisitions corporate restructuring 4th edition By: Gaughan, Patrick A., New York, NY

From Firms Point Of View

ADVANTAGES
1.

DISADVANTAGES
1.

Corporate Restructuring Small Amount Of Capital Requirement

The Restructuring leads a Company to downsize.

2.

2. 3.

Restructuring results in Hostile Takeovers. Corporations Bankruptcy.

3.

Management Buy-out

4.

Economy

4.

Management buyouts can produce conflict of

interest and possible mismanagement by Buyout Owners.

The Effect of LBO.

1. 2. 3.

Stock Price Corporate Efficiency Original Bond Holders

4.

New Management

List of well known LBOs so far...

Harley Davidson Bharati Airtel And Zain The Blackstone Group Tata and Tetley

Tata and JLR

Tata and Corus Hindalco and Novelis Suzlon and Re-power systems Ub group and Whyte&mackey

CASE: Tata tea and Tetley

Tata Tea acquired the UK heavyweight brand Tetley for a staggering 271 million pounds. The biggest ever cross-border acquisition.

Pushing for aggressive growth and worldwide expansion.

Tetley's price tag of 271mn pounds (US $450 m) was more than four times the net worth of Tata tea which stood at US $ 114 m.

Sources of financing the purchase:

1.

Equity-subscribed by Tata tea,

2.

Junior loan stock subscribed by institutional investors (including the vendor institutions Mezzanine Finance, arranged by Intermediate Capital Group Plc.)
Senior debt facilities arranged and underwritten by Rabobank International.

3.

CASE: Tata and JLR

On June 02, 2008, India-based Tata Motors completed the acquisition of the Jaguar and Land Rover (JLR) units from the US-based auto manufacturer Ford Motor Company (Ford) for US$ 2.3 billion. Tata motors raised a bridge loan of Us $3bn through syndicate of banks .The amount was repaid in following manner

Rs 1.92 billion Underwriting agreement with JM financial consultants

Rs.1.75 billion was raised through a deposit scheme from the public Additional subscriptions by promoter companies Tata Sons , Tat capital and Tata Investment Ltd

Share price of Tata Motors from Jan 2006 to Jan 2012

Year 2006 2007 Open 121.51 168.42 High 186.30 182.23 Low 114.08 115.19 Close 168.3 138.73

2008
2009 2010 2011

138.81
31.60 158.20 264.20

152.55
159.96 276.28 266.86

24.40
25.20 129.02 137.65

31.81
158.52 261.26 178.10

2012

182.00

221.45

178.65

218.55

Effects of Acquisition

Over the next 10 months, TATA incurred a loss of $468mn seemed the loss spree would continue like it had been with ford. After Acquisition, TAMO posted a loss of $67mn for the quarter, which was $147mn profit, for the same quarter last year Tata has sunk almost $2billion for operations, R and D of Jaguar and Land Rover Tata has already an existing debt of $6bn in tthi books of accounts.

TATA Auto Component

TATA Steel Corus

JLR

TCS

TATA Technologies

Cost Synergies

Statistics
Net profit
10000 8000

EPS
150 100 standalone consolidated Rs 50 0 2011 2010 2009 2008 Consolidates Standalone

Rs in Crores

6000 4000 2000 0 -2000 -4000 2011 2010 2009 2008

-50
-100

Year

Year

The graph above shows the net profit of Tata motors

Mar11
Reported EPS[Rs] Standalone Reported EPS [Rs] Consolidate 28.55 145.30

EPS of TATA Motor share

Mar 09
19.48 54.80

Mar 10
39.26 44.11

Mar 08
52.63 57.97

Mar 07
49.65 57.21

Market Mix FY 11 24% 16% 5% 22% 11%

Row
Russia Europe Excl. Russia China North America UK

22%

Market Mix FY 12
19% 19% 23% 16% 18% 5%

Row Russia Europe Excl. Russia China North America UK

Source: www.jaguarlandrover.com

Current Scenario

Criticisms

The M-Cap of Tata Motors at the time of acquisition was Rs.24000crore but as the deal was sealed within few months it plunged to Rs.6500crore. The current M-Cap of Tata Motors is around Rs.70000 crore, more than ten fold rise in M-cap post acquisition. The Company surpassed the Reliance Industries Indias Largest Pvt sector company as Indias Most valuable brand in 2010 with a valuation of $8.45billion. According to the Most Valuable Brands report pegs, the value of the Tata Motors-JLR brand soared 172%in one year to $8.45 billion from only $3.1 billion in 2008-09

Critics of leveraged buyouts argue that these transactions harm the long-term competitiveness of firms involved. LBO transactions have a negative impact on the stakeholders of the firm. The major risk of the leveraged buyout is bankruptcy of the acquired company.

A large chunk of Tata Motors's incremental brand value of $5.35 billion has been generated because the JLR brands are now demonstrating an ability to drive cash flows.

Conclusion

LBOs make the most sense for firms having stable cash flows, significant amounts of unencumbered tangible assets, and strong management teams

Successful LBOs rely heavily on management incentives to improve operating performance and a streamlined decision-making process resulting from taking the firm private.

Tax savings from interest expense and depreciation from writing up assets enable LBO investors to offer

targets substantial premiums over current market value.

Excessive leverage and the resultant higher level of fixed expenses makes LBOs vulnerable to business cycle fluctuations and aggressive competitor actions.

For an LBO to make sense, the PV of cash flows to equity holders must equal or exceed the value of the initial equity investment in the transaction, Including transaction-related costs.