Leveraged buyouts 101

A leveraged buyout (LBO) is a financial strategy in which a company or a group of investors use borrowed funds, typically in the form of loans or bonds, to acquire a controlling interest in a company. The acquired company’s assets are often used as collateral for the debt. The purpose of the leveraged buyout is to increase the potential return on investment, as the company’s future profits are expected to exceed the cost of the debt used to acquire it.

The mechanics of a leveraged buyout involve several steps:

1. Identification of the target company: The investors or private equity firms identify a company with potential for significant future growth and a solid cash flow.
2. Structuring the transaction: The investors decide on the amount of debt they will use to finance the acquisition, the terms of the loans or bonds, and the equity that they will contribute.
3. Execution of the transaction: The investors purchase a controlling stake in the target company using the funds obtained through the debt financing.
4. Post-acquisition restructuring: The investors typically implement changes to improve the company’s profitability and reduce costs. This may include changes to the management team, operations, or strategic direction.
5. Exit strategy: The investors aim to exit the investment and realize a profit, either through a sale of the company or an initial public offering (IPO).

Examples of prominent leveraged buyouts include:

1. RJR Nabisco: In 1988, private equity firm Kohlberg Kravis Roberts (KKR) acquired RJR Nabisco, a tobacco and food company, for $25 billion. The acquisition was the largest LBO in history at the time.
2. TXU: In 2007, KKR and other private equity firms acquired TXU, a Texas-based energy company, for $45 billion. The acquisition was one of the largest LBOs ever.
3. Hilton Hotels: In 2007, Blackstone Group acquired Hilton Hotels for $26 billion, making it the largest LBO in the hospitality industry.
4. Toys “R” Us: In 2005, a group of private equity firms acquired Toys “R” Us for $6.6 billion. The company struggled with the high levels of debt, eventually leading to its bankruptcy and liquidation in 2018.
5. Chrysler: In 2007, private equity firm Cerberus Capital Management acquired a controlling stake in Chrysler for $7.4 billion. The acquisition failed to improve the company’s financial performance, and Chrysler filed for bankruptcy in 2009.