100% Leveraged LBO?
Hi guys,
Say there is a company that is Cash-Rich. This company has over one billion in cash and cash equivalents and long term US Treasury bonds. Making this company highly liquid. Even with the early redemption of the long term bonds, the company is still in excess of $1B. Moreover, this company is producing solid earnings results, but the bottom-line could be drastically improved. (This company is not in the financial services industry).
The market cap of this company is trading somewhere around 150-200mm. The price has flat-lined and has absolutely no pulse. This company also does not share a dividend. Therefore, there is no value creation for shareholders happening.
My question is that is this company a potential LBO candidate? Would a bank find this kind of loan attractive? The company is cash-rich and could easily pay back the loan immediately seeing how liquid it is. Not only could it be paid back instantly, but the acquiring firm could afford a large premium of the current trading price.
I am aware that these companies are rarer than unicorns, some do exist. I wanted to get an opinion on if this type of LBO is feasible. Please let me know if I am crazy or does this seem like a low/no-risk LBO? (Providing the company doesn’t white knight or poison pill).
LBOs are typically cash-free, debt-free. Meaning the seller keeps the cash and satisfies the debt.
A bank is more concerned with the future cash flows of the business. Nonetheless, banks are rather hesitant if there is no "new equity" coming into the deal.
To really get a deal done, the company would need enough future cash flow to maintain covenants (total debt / EBITDA and fixed charge coverage) and have hard equity invested in the transaction (buyer cash to the seller).
Why would a company with $1bn net cash have a market cap of 200m? That would mean EV is actually MINUS $800m. Perfect LBO candidate: liquidate all activities ASAP and cash in 800m!
Only way this would happen is if it had debt/very serious negative cash flow problem. Otherwise its just 800k undervalued yes?
And OP: A dividend is not the only way companies create value for shareholders. The idea is to create future cash flows either reinvested for later distributionsor distributed (as buybacks or dividends).
This is physically impossible. To put it into perspective, let's assume you took $1B of cash and put it into a box. You then offered to sell the box to somebody. What would it's market value be? The answer is $1B. Because it's cash. It has no liquidity discount, no idiosyncratic risks, nothing. At the minimum, unless the company does something with the cash, it will always be worth at least $1B, since you can just buy the entire company and liquidate it at no risk.
Now the real issue is the fact that you say the company does not issue dividends. Let's assume it never issues any dividends ever, and that you can never buy over the company. This means there are no cash flows to any investor, and consequently the shares of this company are worth nothing. Then it's market cap is $0.
Not issuing dividends is fine. Amazon, Google, and Berkshire Hathaway are 3 of the largest companies in existence today and shareholder value has been created for years without dividends.
Berkshire equity is not worth $0. Your cash flows in this case are through the retained earnings account.
Not issuing dividends is fine in the short run, never ever issuing dividends and never liquidating is a zero coupon perpetuity bond with no value. It's a DCF with no cash flows.
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