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To explore the benefit of LBO to the managersin taking up their vital decision regardingmerger as a distinct source of value creation
and to conceptually investigate the goingprivate transactions via LBO as a response todeficient governance structures as well as thepost buyout board restructuring.
Maximization of EPS
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Discussion with Project Guide
Selection of topic and collection of data
Data was collected from Internet, Newspapers,
Journals and books.
Analysis of Data.
Observations based on study
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Buyout The Purchase of a company orcontrolling the interest of a companys shares.
Leverage Buyout - The acquisition of a company
using debt and equity finance. As the wordleverage implies, more debt than equity is used tofinance the purchase, e.g. 90% to 10% equity.Normally, the assets of the company being
acquired are put up as collateral to secure thedebt.
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Mortgaging a Home
Buying a car/taxi, financed by bank
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In an LBO, the private equity firm acquiring thetarget company will finance the acquisition with acombination of debt and equity, much like anindividual buying a rental house with a mortgage .
Just as a mortgage is secured by the value of thehouse being purchased, some portion of the debtincurred in an LBO is secured by the assets of theacquired business. The bought-out business
generates cash flows that are used to service the debtincurred in its buyout, just as the rental income fromthe house is used to pay down the mortgage. Inessence, an asset acquired using leverage helps payfor itself.
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In a successful LBO, equity holders often receivevery high returns because the debt holders are
predominantly locked into a fixed return, whilethe equity holders receive all the benefits from anycapital gains. Thus, financial buyers invest inhighly leveraged companies seeking to generate
large equity returns. An LBO fund will typicallytry to realize a return on an LBO within three tofive years. Typical exit strategies include anoutright sale of the company, a public offering or a
recapitalization.
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Leveraged buyout is a strategic way throughwhich control of a corporation is acquired bybuying up a majority of their stock usingborrowed money. A leveraged buyout may alsobe referred to as a hostile takeover, a highly-leveraged transaction.
Acquire control
(through buying majoritystocks)Pay off
Borrowed Money
(Loans/Debentures) 8
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In an LBO, there is usually a ratio of 90% debtto 10% equity. Because of this high debt/equityratio, the bonds usually are not investmentgrade and are referred to as junk bonds.
Corporate
Finance
CompanyAcquistion
LBO
Method
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Efficient and experienced management team
Assurance of sufficient and stable cash flow
Lower degree of operating risk
Limited amount of Debt
Other factors
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Large positive abnormal returns Tax benefits
Companys credit rating
High levels of debt In case of loss assets
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Senior Debt
Subordinated Debt
Cash-pay Bonds
Step-coup on Bonds
Preference Shares
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Special Purpose Vehicle
Mezzanine Financing
Trading on Equity
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Low capital & cash Requirement
Synergy gains
Efficiency gains
Leveraging
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Tata Steel Corus 2007
Tata Tea Tetley 2000
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Acquisition of Corus by Tata steel Limited is also a caseof Leveraged buyout. In case of Tetley, Tata used onlyone SPV, i.e. Tata Tea (GB) Limited. In case of Corusthey used a chain of SPVs-Tata Steel Asia Pt was set up
as a wholly owned Singapore based subsidiary of TataSteel limited and Tata Steel UK Limited was set up aswholly owned subsidiary of TATA steel Asia Pt.
Debt mobilization was also done by both the SPVs.
$5.6bn through a LBO ($3.05bn through senior termloan, $2.6bn through high yield loan).
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The first major LBO by an Indian company wasacquisition of Tetley by Tata in early 2000.In this case,Tata Tea set up a SPV in the UK in the form of Tata Tea(GB) Limited. This SPV had equity capital of GBP 71million contributed by Tata Tea Limited. The SPV in turn
mobilized GBP 235 million by way of long-term debt onthe security of the assets and cash flows of Tetley andacquired 100 percent of Tetley at the cost of GBP 271million, taking it private.
The Tata-Tetley deal was rather unusual, in that it hadno precedence in India. Traditionally, Indian market hadpreferred cash deals, be it the Rs.10.08 billion takeover ofIndal by Hindalco or the Rs. 4.99 billion acquisition of
India world by Satyam. 17
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LBOs lead to downsizing of operations
Research and development expenditures have
also been controlled.
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Further it has been suggested that managementtakes advantage of superior information abouta firms intrinsic value. The evidence, however,indicates that the premiums paid in leveraged
buyouts compare favourably with those ininter-firm mergers that are characterized byarms-length negotiations between the buyerand seller.
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Merger involves a combination of two firmssuch that only one firm survives.
The leveraged buyout preserves the integrity ofthe firm as legal entity but consolidates
ownership in the hands of a small groups
LBO is different from Sell off/
Spin-off Contraction including equity carve outs,
abandonment of assets, and liquidation;
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If private company will takeover the publiccompany it will come under the LBO
The guidelines for LBO is given by RBI
The objective of business financial investor is to
exit the investment after 3-7 years. Internal Rate of Return (IRR) of in excess of 20%
on its investment
The target company goes private after a LBO.
The ratio of the debt owed by the company is notmore than twice the capital and free reserves aftersuch buy-back
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Tetley United Kingdom Tata Tea 271 million LBO
Whyte & Mackay United Kingdom UB Group 550 million LBO
Corus United Kingdom Tata Steel $11.3 billion LBO
Hansen Netherlands Suzlon Energy 465 million LBOTransmissions
American Axle United States Tata Motors $2 billion LBO
Lombardini Italy Zoom Auto $225 million LBOAncillaries
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COMPANY ACQUIRER VALUE TYPECOUNTRY
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We understand why the L in the LBO is soimportant. It should be clear that by adding aleverage component to our investment ROIsignificantly improves.
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