21: Mergers, Acquisitions and Corporate Controlprivate equity company^24 – such as Kohlberg, Kravis and Roberts (KKR), which specialises in such deals.
Other public-to-private transactions can be driven by the current managers of the corporation (known
as a management buyout,or MBO); or even the employees of the corporation itself through an employee stock
ownership plan (ESOP). An LBO that sells shares to the public again in a second initial public offering is
known as a reverse LBO. An interesting Australian example of this type of deal occurred with the Myer
Group. It was listed on the ASX as Myer Emporium Ltd, but subsequently merged with another listed
entity, GJ Coles & Coy Ltd, in the mid-1980s to become Coles Myer Limited. In 2006, Myer was
acquired from Coles Myer and taken private by private equity group Texas Pacific Group. It was then
restructured, transformed and re-listed on the ASX in 2009.
Leveraged buyouts are interesting because of the high premiums often paid and the extensive use of
debt financing. Of course, increased risk accompanies high debt levels, resulting in high costs of debt
and equity (as discussed in Chapter 13, Equation 13.2 can be used to lever up the cost of equity to
reflect greater financial risk). Typically, high debt levels are maintained for several years in an LBO, then
are gradually reduced to more normal, long-term levels. Therefore, when valuing an LBO, the discount
rate is typically high in early years but gradually declines. Terminal values are very important in LBO
valuation and represent the value at which an LBO investor may cash out by selling its stake in the
buyout, perhaps by issuing ordinary shares and taking the company public again.
A dual-class recapitalisation may also concentrate control. Under this form of organisational restructuring,
the parties wishing to concentrate control (usually management) buy all the shares of a newly issued
Class B shares, which carries super voting rights (100 votes per share, for example). Traditional Class
A shareholders generally receive some form of compensation, such as higher dividends, for the dilution
of their voting power. Dual-class companies are rare in the United States, but are common in other
countries.^25 The higher share price typically assigned to the share class with superior voting rights, often
called the voting premium, has been used as a measure for the private benefits of control in a publicly
traded company.^26
A leveraged recapitalisation occurs when a company issues substantial debt to repurchase equity. The
company essentially performs a leveraged buyout on itself, except that not all of the outstanding equity
is retired. The remaining shareholders, known as the stub equity, own a much more highly levered (and
riskier) stake in the company.
Just how much debt can a company manage, whether it becomes highly levered via an LBO or
a leveraged recap? The typical metric considered on the street by finance professionals is based on
the debt/EBITDA ratio. By considering earnings before interest, taxes, depreciation and amortisation,
analysts argue that this captures the full cash flow available to the company to make debt interest
payments. Consequently, LBO pricing and valuation is often expressed in terms of EBITDA multiples
(such as ‘five times EBITDA’). One word of caution: the debt/EBITDA ratio does not explicitly capture
the capital needs of the company. This may not be a major concern if the capital expenditure and
other working capital needs of the company do not outstrip cash inflows. If working capital needs are
significant, however, overall liquidity and working capital implications should be carefully considered
when determining a company’s debt capacity. More generally, we recommend that analysts and managers
consider the capital structure issues presented in Chapter 13 when determining debt capacity.
24 When a private equity firm such as KKR buys a company, it is referred to as a financial buyer. In contrast, when one company buys another
company, the acquirer is often called a strategic buyer. The key difference between each buyer’s acquisition strategy is that strategic buyers
seek opportunities that will synergistically create short- and long-term value for the acquiring firm, while financial buyers often seek to buy a
company, operate it for a short period, and then resell it often within five years.
25 See Tatiana Nenova, ‘The Value of Corporate Voting Rights and Control: A Cross-Country Analysis’, Journal of Financial Economics, 68, 2003,
26 pp. 325–51.
management buyout
(MBO)
The transformation of a public
corporation into a private
company by the current
managers of the corporation
purchasing the voting shares,
often with the assistance of a
private equity company
employee stock
ownership plan (ESOP)
The transformation of a public
corporation into a private
company by the employees of
the corporation itself
reverse LBO
A formerly public company
that has previously gone
private through a leveraged
buyout and then goes public
again
dual-class
recapitalisation
Issuance of a new class of
ordinary shares with the intent
of concentrating control of
voting rights in one group of
investorsleveraged recapitalisation
When a company greatly
increases the portion of debt
in its capital structure, often
retiring equity in the process