I am just wondering why corporates don't try to boost their return on equity if they can lever up and buy strategic companies in their space? Is there any logic behind it or is it just conservatism?
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They do use debt. Just not as much as PE. The reasoning for this lies in that fact that for strategic M&A, the acquirer has to take on all the debt used onto their own balance sheet, If they over lever themselves for the acquisition, it could send them to chapter 11. If a private equity firm over levers an LBO acquisition, only the acquired company goes bankrupt; not their entire fund.
The recent Bayer-Monsanto deal is a good example of this. Even though the deal was all cash by Bayer, Monsanto had a lot of debt (and subsequent lawsuits) that is dragging on their stock price.
On the other hand I assume lenders aren’t stupid: PE funds pay for limited liability in the form of higher interest rates, no? Otherwise plenty of non-PE firms would probably try to do acquisitions via bankruptcy remote LLCs.
I think the simple answer to op’s question is that cash on the balance sheet is a cheaper and faster source of capital than either debt or equity
also consider the intent of the acquisition. do strategic buyers acquire with the intent to flip and earn outsized returns, or for strategic rationale? agree with above about debt being on the strategic acquirer's balance sheet as a reason.
Public strategic acquirers also care about the transaction being accretive to EPS for the sake of their shareholders and stock price. It’s usually more likely a cash acquisition will be accretive since the interest earned on keeping that cash is less than the cost of debt involved in a transaction.
sorry to open up an old trend. am interviewing for an opening in strategic and acquisition finance.
had look at associates' profile and they deal with merger models. can someone please explain why? i get the part on lbo and stuff but was wondering why would they need to build merger models? are they financing the merger with some debt? thank you
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