Return of the Leveraged Buyout Deal, The

Weekly Corporate Growth Report, Aug 23, 2004 by Dolbeck, Andrew

Leveraged buyouts, or LBOs, are acquisitions in which the buyers use a significant amount of borrowed capital to takeover companies. Because they rely on debt financing, LBOs are risky propositions, but they have the potential to pay off well in the long run. Buyout firm Leonard Green and Partners has recently agreed to sell most of its shares of VCA Antech Inc., a veterinary hospital concern, which it acquired in a leveraged buyout in September 2000. Leonard Green will reap more than 325 percent profit from its investment.

LBOs can also provide faster returns. Buyout firm GTCR Golder Rauner will likely recover a portion of its $860 million leveraged buyout of Prestige Brands Holdings Inc. as the company makes an initial public offering of income deposit securities. Prestige, which makes Comet cleanser, Spic and Span cleaner, Murine eye drops, Prell shampoo, and other household products, indicated that it would use proceeds from the IPO to pay off debt and to redeem preferred stock held by GTCR. Golder Rauner acquired Prestige in a leveraged buyout last April.

LBOs were popular in the 1980s but went out of fashion when the technology and telecommunications bubbles burst. In today's market, the LBO is making a comeback. Leveraged buyout activity has reached its highest pace since the late 1990s. US-based LBO firms completed more than $165 billion in deals over the past two years, according to Private Equity Analyst. The first six months of 2004 have been the busiest for LBO deals since the first half of 1998, according to Standard and Poor's LCD group. The second quarter of 2004 saw $34 billion in completed LBO deals, the highest single quarter total in over ten years.

The return of the LBO deal is part of a return to stronger overall US M&A activity, which is at its highest level since 2000, but there are also certain factors driving the increase in LBO activity. Money is becoming more readily available for LBOs. Improved lending conditions have been attributed to the strengthening economy and to increasing competition in the lending market.

Banks and investors have shown a renewed willingness to take risks, thus making financing for buyouts more readily available. "The financing market is as strong as we've seen it for the past five years or so," says Craig Bundy, Vice President of GTCR Golder Rauner. "Lenders seem to be getting more aggressive and appear much more eager to put capital to work."

Investment banks profit from LBO activity by charging fees for advising on deals as well as by providing financing for the actual acquisitions. Leveraged loans, the low-rated high-yield debt used for LBO deals, reached $26 billion in the first two quarters of 2004, compared with $24 billion for the whole of 2003, according to a report from investment bank Piper Jaffray & Co.

One sign of the increasing strength of the private equity financing market is the rising debt-to-equity ratios of the deals completed in 2004. According to Standard & Poor's LCD group, the average debt multiple of highly-leveraged loans for the first two quarters of the year was 4.SxEBITDA, while bank debt for the period was at BxEBITDA.

Another factor driving LBO activity is strong investor interest in leveraged loans, the non-investment grade bank debt used to finance LBOs. Demand for these loans allows the sponsors of LBOs to sell off the debt portions of their deals relatively inexpensively, which allows them to arrange deals with smaller portions of equity.

With financing available, LBO buyers are able to pay more for acquisitions. As a result, purchase price multiples are also on the rise. Kohlberg Kravis Roberts & Co.'s recent acquisition of Sealy Corp. is a good example. The buyout firm paid 9.SxEBITDA, backing the deal with $1.075 billion in total debt - over 70 percent of the purchase price.

The increase in leveraged buyouts may prove to be a temporary phenomenon, however. As interest rates rise, leveraged loans with their low-rated high-yield debt may become less attractive to investors. As the economy recovers, it is possible that the stock market may improve, drawing investment capital to stock acquisitions. Increasing stock values would also raise the price of corporate acquisition targets, making buyouts more costly.

The recent rise of leveraged buyout acquisitions, driven by the increased ability to both finance and sell leveraged loans, clearly contributes to the rise in overall US mergers and acquisitions activity. The current LBO activity not only impacts the amount of deals in the M&A marketplace, but also their value, raising purchase prices and purchase price multiples. Whether the current level of LBO activity is a temporary trend or a lasting part of the deal landscape remains to be seen.

Sources: Buyouts, The Deal, InvestorWords.com, New York Times, Wall Street Journal

By Andrew Dolbeck

Editor