On LBO or IPO, i understand the question is why go for LBO when you can go for IPO? two things:
1. IPO is a very lengthy process and often takes months to complete...by this time the merger may have fallen through.
2. Secondly, LBO makes more sense to the acquirer as he himself does not need to pledge anything of his own. In a sense, he uses the target to finance the acquisition. Also, the Debt Equity ratio of the Acquirer may be low, in which case it can afford to take on some loan in its balance sheet.
Would like to add in here a point or two
1. LBO uses debt financing, which is comparitatively cheaper than equity financing
2. LBO takes the assets of the acquired company to be used by the acquiree, to raise loans for takeover/buyouts.. Its like "Bheeshma" telling Arjun the way to defeat him.
Disagree over one point in here.
In LBO's, you have a huge debt. if at that time, the profits dip, and that happens consistently, the company cannot pull out of debt and goes bankrupt. Happened for a series of Buyouts in the 1980's and 1990's coz of which LO's became infamous!
So its not a SAFE way to take over a company. High risks, high gains proposition.
PS: Ppl can read over KKR in Wikipedia. He was the pioneer for LBO's!
No offense, but some of whats stated is not entirely accurate. My understanding is so :
LBO does use debt financing. But it does not use the assets of the company being acquired for raising money. The assets of the company are owned by the company's shareholders and they will not agree to give it as collateral for a third party to acquire the company.
The money is raised by issuing high risk bonds. These bonds ("Junk bonds") do not guarantee payments but offer attractive interest rates. Without junk bonds, there are few options to raise money for an LBO. Few, if not none, banks and other conventional lines of credit will be willing to lend money to a PE/LBO firm to take over a company at a hefty premium to its current market valuation.
The premise of an LBO is to acquire an inefficiently run company or a company with diversified lines of business, by issuing cheap bonds, which appeal to certain institutional investors (who have allocated some capital in their investment portfolio to high yield debt), who then buy the bonds.
The proceeds of the bond sale are used to buy the company and remove the current management. In the normal scenario, the company's management itself advises the LBO firm on the company's business model, strengths and weaknesses. The acquirer handsomely rewards the old management team with large bonus payments/retirement packages.
Using the information and experience shared by the old management team and its own knowledge on the industry & financial management, the LBO firms appoints a new management from its own ranks, who are experts in restructuring businesses. The new team identifies business lines which are being inefficiently run and either improves performance with new measures or spins off the business line into another entity, which is sold later. In many cases, it does both : improves performance to an extent that makes the line profitable and then sells it to a company which is a player in that industry for a large profit.
An LBO is meant to clean large, diversified business into smaller, lean mean profitable companies. The US business landscape, was at the time littered with many such firms, which were inefficiently run with less than committed management. The LBO industry began in the late 1970s and ended around 1989, with the biggest LBO deal made till then - the RJR Nabisco-KKR deal of 25 billion USD. It also turned out to be KKR's most spectacular failure, earning negative returns and saddling them with massive debt. The could not improve RJR Nabisco's tobacco division and found no buyers. The deal hemmoraged their financials for a long time.
KKR created and brought to life the LBO concept. But without Michael Milkin's junk bonds, it is unlikely that LBOs would have taken off the way they did. MM had as much a role as Henry Kravis.
LBOs are an example where, a set of market conditions, goverment regulations (or lack of the same), ambitious, risk taking and intelligent entreprenuers create a new industry/new wealth. And just as the conditions that saw the LBO phenomenon wore away, so did the phenomenon. Which is to say that since 1988, we have not seen the frantic pace and large quantity and value of deals as that of 1980 to 1988.
LBOs were abused in the later half of their golden age. Since 1985, deals were made between managements keen on selling off the company in return for large compensation (at the expense of shareholder & employee interests), bond buyers eager for high interest debt and LBO firms focusing on simply stripping off the company to its nuts and bolts, selling it off for profits, rather than genuinely attempt to improve corporate performance, reduce waste and sell at a premium.
IPOs are not necessarily lengthy. Timing the market is the challenge. The IPO should ideally be when the market is most bullish and appetite for new securities is high. The motivations for an IPO and LBO are totally different. An IPO is to raise money for the issuing company's capital expenditures or for retirement of large debt. The LBO case has been discussed above.
In an LBO, the LBO firm is taking a lot of risk. But a good part of the risk is transferred to the bond holders as the bond agreements do not guarantee payments. Aside from the DE ratio, a company that generates large FCF is also fair game for LBO. (FCF - free cash flow). This number is more important than the debt equity ratio.