Leveraged Buyout (LBO) - Where to learn more
I recently had an interview with a MM bank and was asked about LBO's. I had read Rosenbaum and Pearl, WSO and the vault guide but i was still asked specific questions that were not answered in what i had read before. Does anybody have any advice on where to find advanced materials to brush up on LBO's or even DCF's for that matter.
I think that book is very well done and it includes a lot of useful information.. what did they ask you?
Leveraged Buyouts by Paul Pignatano (I think that is the author)
I don't understand LBOs - Help! (Originally Posted: 01/05/2013)
This is probably really stupid, but I don't understand who is paying the cash/issuing the debt in an LBO.
When a PE firm buys a company, I know they fund the transaction with a combination of equity and debt, but is it the PE firm taking the debt or is it the company they buy taking the debt? I assume it is the company they purchase since you adjust their financial statements for new debt issued, but if it is the company - that doesn't really make sense either since the PE firm is using the debt to buy the company. Wouldn't the PE firm have to essentially purchase the company before they can raise debt on behalf of the company?
Secondly, I don't get the concept of issuing both bank debt and high yield debt. I thought a company's debt was considered either corporate debt or high yield depending on their overall rating. How is it possible for one company to issue both?
Sorry in advance if this is overly dumb, I've just never grasped this concept and as a result don't feel I understand LBOs.
1) Shell company takes out debt 2) Don't forget debt is separated into tranches
The PE firm is buying an income-generating asset (the company). The income from this asset (cash flow) is used to pay off the debt.
The debt that is "investment grade" or HY depends on the actual rating of the debt not the overall rating of the company (even though the company rating is really the sr unsecured debt rating but just go with me here)...the further the debt moves away from the company (i.e. access to the CF or assets; in terms of structual subordination or jr debt or unsecured or no sinking fund/no guarantor) the worse the rating gets. Eventually it will become HY
As couchy said it is separated into tranches, so your first 3 or so tranches may be IG but then you are too far away from the cash and the next tranche of debt will be HY because it is more risky in the event of default all the other tranches are above you and get first dibs.
The PE firm is putting up cash to fund part of the purchase (equity), and the lender is providing debt to fund the remaining part of the purchase and potentially refinance existing debt (debt).
When the PE firm looks at a deal, the lender or lenders also looks at the company financials to assess the cash flow of the business. The total cash from the lenders and the PE firm is used to acquire full ownership of the target. The actual mechanics of the transaction is, as couchy said, that a shell company is created and the target is merged into the shell. Although the shell company takes out the debt, the cash flow of the target is assessed by the lenders. If the deal doesn't happen for some reason, the lenders don't provide the debt.
The different types of debt depends on how much leverage is used and how consistent the target's cash flows are. Most lenders will have a limit (usually as a multiple of EBITDA or FCF) on how much debt they are willing to provide. For example, maybe the senior debt is capped at 3x EBITDA. Although you can't raise anymore senior, you can find mezzanine or subordinated lenders who will come in "under" the senior debt but at a higher cost.
The hope is that by the time you exit, all or most of the debt has been paid off, thus increasing the equity holder's (the PE firm's) position in the company.
Why are you guys complicating this so much?
1) The company being bought takes on the debt, not the PE firm. The company's internal cash flow is used to pay it back.
2) "Corporate debt" and "high-yield debt" are blanket terms and really not descriptive. Any debt issued by a company can be called "corporate debt", and if the debt's ratings are below investment grade, "high yield debt." Generally, "bank debt" refers to loans from a bank and "high yield debt" refers to bonds sold to investors.
Thanks this makes a lot more sense. So when adjusting the company's balance sheet, you adjust for the amount of debt they have taken on, and then do you also adjust for cash? I know the PE firm pays the cash but they are in a sense acquiring the company's cash as well, right?
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