Buyout is the process of acquiring a controlling interest in a company, either via out-and-out purchase or through the purchase of controlling equity interest. The underlying principle is that the acquirer believes that the target company’s assets are undervalued.
Usually, buyout takes place when a purchaser acquires more than 50% stake in the target company resulting in a change of management control. In case the stake is acquired by the company’s own management, then it is known as a management buyoutManagement BuyoutA management buyout (MBO) is a type of acquisition where the management of the company acquires the ownership of the business by increasing their equity stake or by purchasing assets and liabilities with the objective of leveraging their expertise to grow the company and drive it forward using own resources. (MBO). On the other hand, if the acquisition is funded through a significant level of debt, then it is known as a leveraged buyoutLeveraged BuyoutLBO (Leveraged Buyout) analysis helps in determining the maximum value that a financial buyer could pay for the target company and the amount of debt that needs to be raised along with financial considerations like the present and future free cash flows of the target company, equity investors required hurdle rates and interest rates, financing structure and banking agreements that lenders require. (LBO). Usually, companies opting to be private go for buyouts.
The process is initiated by the interested acquirer who makes a formal buyout offer to the management of the target company. It is then followed by rounds of negotiations between the acquirer and the management of the target company, after which the management share their insights with the shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares. and advise them on whether or not to sell their shares.
In some cases, the management of the target company are not very willing to go ahead with the acquisitionAcquisitionAn acquisition is defined as the act of taking over or gaining control of all or most of another entity's stocks by purchasing at least fifty percent of the target company's stock and other corporate assets. , and such buyouts are considered to be hostile takeovers, while, the rest is seen to be friendly takeoversFriendly TakeoversA friendly takeover occurs when the target company peacefully accepts the acquisition offer. The takeover is subject to the approval of the target company's shareholders as well as regulatory approval to ensure that the acquisition complies with antitrust laws.. The funding used in transactions is usually provided by private wealthy individuals, private equity investors, companies, pension fundsPension FundsA pension fund refers to any plan or scheme set up by an employer which generates regular income for employees after their retirement. This pooled contribution from the pension plan is invested conservatively in government securities, blue-chip stocks, and investment-grade bonds to ensure that it generates sufficient returns. and other financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. .
Types of Buyout
There are two major types – Management and Leveraged buyout.
- Management: Here, the existing management of the company gains control of the company from its owners through the purchase of management control. Basically, the management finds the potential of the company to be attractive and hence intend to earn higher returns by becoming owners instead of employees of the company.
- Leveraged: In this type, a significant portion of the acquisition is backed by debt. As the acquirer gains control of the target company, its assets are often used as collateral for the debt. In this way, the purchasers can acquire companies that are quite large as compared to their funding ability.
Examples of Buyout
In the year 2013, Michael Dell got involved in one of the nastiest Tech buyouts. The founder of Dell joined hands with a private equity firm, Silver Lake Partners, and paid $25 billion to buy out the company that he had originally founded. In this way, Michael Dell took it private so that he had better control over the company operations. This is a classic example of a management buyout.
In the year 2007, Blackstone Group acquired Hilton Hotels in a $26 billion LBO deal. The deal meant that each shareholder got a 40% premium over the prevailing share price. The acquisition was largely backed by debt funding of $20.5 billion while the remaining was in the form of equity by Blackstone. Some of the banks in the consortium lending included Bank of America, Lehman Brothers, Goldman Sachs and Morgan Stanley.
- These buyouts help in getting rid of product or service duplication that can significantly reduce the operating expensesOperating ExpensesOperating expense (OPEX) is the cost incurred in the normal course of business and does not include expenses directly related to product manufacturing or service delivery. Therefore, they are readily available in the income statement and help to determine the net profit. and in turn, increase the profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance..
- The purchaser can enjoy the benefits of economies of scaleEconomies Of ScaleEconomies of scale are the cost advantage a business achieves due to large-scale production and higher efficiency. by acquiring the competitors.
- The companies can increase their profits by buying their competitors as it tends to eliminate the need for competitive pricing.
- In some cases, both the acquirer and the target company mutually benefit through sharing each other’s resources.
- In most cases, the buyouts are backed by a large amount of debt that affects the capital structureCapital StructureCapital Structure is the composition of company’s sources of funds, which is a mix of owner’s capital (equity) and loan (debt) from outsiders and is used to finance its overall operations and investment activities. of the acquiring company. This results in higher leverage and increased obligation in the acquirer’s books.
- In some cases, the management of the target company is not in favour of the buyout, and hence they quit. So, it is no surprise that many of these acquisitions are followed by the resignation of some of the key personnel of the target company. At times, it becomes a great challenge for the acquirer to find a replacement.
- Although both acquirer and target company may belong to similar businesses, still the corporate cultures and the operating methods can be significantly different. This may lead to resistance to change within the target company, which in turn may result in costly problems.
This has been a guide to buyout and its meaning. Here we discuss process, examples and top 2 types along with advantages and disadvantages. You may learn more about financing from the following articles –