Examples of LBO-Restructure-IPO

Emma-Muhleman:

Now why would you be TRYING to purposely create a model that suggests 1) we start with a distressed company, 2) it is bought by private equity and levered to the nines, 3) the PE investors make no actual operational improvements (basically, all they do is execute a recapitalization) and instead throw masses of debt onto the company's balance sheet which would, naturally, make the company less attractive to the public equity markets (thereby making the stock more risky to prospective equity investors in public markets), and, finally, 4) you want to assume the dummies trading equities won't be smart enough to notice that this is the same sh** company being offered to them, the only difference now is that it is under-capitalized due to a huge debt overhang and hefty interest payments ... ?? Those assumptions do not make sense. For instance, if you want to assume you are modeling a take-private LBO deal in which the PE firm ultimately exits through an IPO, you will need to assume operations were restructured in some way such that the company now has a better business model, has lower debt, a better product or a new strategy, new management, etc. As an example, it would be silly to assume the equity markets would value company XYZ at $20/share today but would suddenly re-value the same company at $50/share in 2 years, but only if KKR takes it private in the meantime and throws 4x debt onto the balance sheet .... Hope this helps.

It can make sense to run a slightly modified scenario in the context of investing in a mezzanine acquisition instrument that may end up becoming the fulcrum security in a future restructuring. If you play the restructuring correctly as the mezz and end up with a large enough piece of the equity post restructuring, the returns can be higher than the original projections on the mezz. Of course, you wouldn't underwrite that instrument if you expected the company to go into restructuring, but if you saw this in the market and had the opportunity to buy a piece at a discount, then things get more interesting... look at all the U.S. manufacturing / energy / etc PE deals that have gone bust recently, many hedge funds bought debt on pennies on the dollar hoping to sell the post restructuring equity at a higher price after emergence

As for the original scenario, it can make sense if the company has a profitable project it can't execute on due to capital constraints. The new capital could "unlock" extra value and turn the company around.

Example: mining company X has one mine with $30mm EBITDA and $20mm interest expense. A new $100mm debt facility at 10% would crush EBITDA to negative territory, but it could PIK for 3 years while mine #2 is under construction. Once mine #2 comes on, EBITDA could now be $50mm with ~$33mm interest. You're still doing stuff on the operational side, but it was enabled by a different capital structure.