LBO: LEVERAGED BUYOUT OPERATIONS

The operations of Leveraged Buyout (LBO), or, leveraged acquisitions, refer to the acquisition of part or all of an asset, such as a company, using third-party capital (debt) as a significant part of the transaction amount. Leveraged acquisitions began to be used in the USA by funds from Private Equity (PE) and gained attention in the 80s, a period in which the cost of capital was low and allowed them to assume high risks to enable certain acquisitions. The purpose of leveraged acquisitions is to allow investors to make large purchases in the market, without the need to commit or contribute the total value of the business. The investor who chooses to acquire a company via LBO only needs to commit a small portion of the total capital allocated to the purchase of the new business, while the largest portion derives from the use of debt (“leveraged”), which will be issued by the acquired company itself. An LBO transaction is very similar to a mortgage loan, where the financing is guaranteed by the value of the property to be purchased, and in the LBO the debt contracted is guaranteed by the assets of the acquired company. During the 80s and 90s, debts could comprise up to 90% of the purchase of a business. However, investors and PE funds are currently more risk-averse and, therefore, generally opt for operations in which the debt reaches up to 50% of financing. The most iconic LBO transaction that ever took place was that of RJR Nabisco, an American group formed by the merger of the companies R. J. Reynolds (cigarette manufacturer) and Nabisco (food products). RJR Nabisco was acquired in a LBO operation carried out by the PE fund Kohlberg Kravis Roberts & Co. (KKR) in 1988 for US$ 25 billion (US$ 109 per share). RJR Nabisco's Deleveraged beta at the time was 0.69, which meant that the group was relatively insensitive to market fluctuations, in addition to the low levels of indebtedness, they made RJR Nabisco a good attractive deal for an LBO operation. The expectation with the leveraged acquisitions is that the return generated in the acquisition will offset the interest paid on the debt, thus making it attractive to experience high returns while the company that executes the LBO only risks a small amount of equity. Considering that the executor of the LBO will capture One large amount of debt, it is essential that the acquired company be able to pay its future debts. Thus, it is crucial that the cash flow analysis, present and especially future, is able to accurately state what the next few years of operation of the acquired will be like. There are, therefore, some characteristics of the acquired one that are extremely important to be analyzed with caution, namely:

As highlighted in the article THE IMPORTANCE OF CASH FLOW MANAGEMENT, after an LBO operation, changes are likely to occur by the acquired management team seeking to improve the operation and predict future cash flow. The competence of the management team in these processes is often the key to success for Turnaround desired. Other changes may also occur, such as the sale of non-operating assets, the purchase of additional assets to make the core business more efficient, among a variety of different options. All of these changes have a single objective, to increase the profitability of the business.

After a few years of managing the acquired company, and if the fund is successful in management, it is likely that it will be able to generate value and amortize a large part of the debt taken to carry out the acquisition. Not only by reducing the degree of indebtedness, but also creating business value, the fund is able to obtain excellent returns on the capital initially invested. In Brazil, LBO operations were not as successful as in the USA. Although Brazil is currently listed as the largest market for Private Equity in Latin America, not only the high cost of Brazilian capital, but also the economic-political instability made operations like these unfeasible.

In times of the Selic Rate at 6.50% per year, the lowest level in the last 10 years, and the good expectations of economic improvement, Companies, Investors, as well as the sector of Private Equity Brazilians can finally opt for LBO solutions. ARTICLE WRITTEN BY HENRIQUE PORTO — PARTNER OF FC PARTNERSGo to our site: http://www.fcpartners.com.br