Leveraged buyout

A leveraged buyout (LBO) is the takeover of a company using borrowed funds. In an LBO, the ASSETS of the company being acquired are used as collateral to secure LOANS needed to finance the company’s purchase. The takeover company or group then repays the loans using the PROFITs from the company being acquired or by selling off part or all of the assets of the targeted company. In the United States, leveraged buyouts were quite popular during the 1980s. Kohlberg, Kravis, Roberts (KKR), the leading LBO group, analyzed companies, looking for situations where a company’s assets were greater than the current capitalization (price of the company’s stock times the number of shares outstanding). By 1990 KKR had acquired 36 firms using $58 billion of borrowed funds. Their pinnacle acquisition was RJR-Nabisco for a record $25 billion. Critics contended KKR contributed nothing to the economy and were undermining American CAPITALISM. Supporters suggested KKR and other LBO specialists increased efficiency and improved MANAGEMENT by replacing overpaid executives closely tied to their BOARD OF DIRECTORS with new LEADERSHIP. In some instances, the companies’ management initiated leveraged buyouts themselves, taking their companies “private,” using borrowed funds to pay stockholders a premium over the current price to repurchase shares in order to gain control and avoid layouts by firms such as KKR. BONDS rated below investment grade by MOODY’S RATINGS and STANDARD & POOR’S were often used in leveraged buyouts. The two firms rate bonds, both public and private sector, according to their DEFAULT risk, and both use two broad classifications of RISK. Those bonds with ratings of BBB or Baa and higher are termed investment-grade or investment-quality bonds and have minimal default risk. Bonds with ratings less than BBB or Baa are termed speculations because of their considerable risk of default. The more common name for these speculative bonds is junk bonds. Because the acquiring company used loans to take over the targeted company, the company’s debt rating usually fell below investment grade. Often leveraged buyouts are “hostile takeovers” in which the company being targeted does not want to be acquired. With the proliferation of LBOs in the 1980s, the board of directors of many U.S. companies instituted POISON PILL STRATEGIES—also called shareholder rights plans— to make their company unattractive to a hostile acquisition. “Poison pills” create rights (or options) for shareholders to purchase stock at a discount when certain events are triggered by the bidder (the individual or company initiating the takeover), such as purchasing a certain percentage of stock. They thus make the target company prohibitively expensive for the bidder to buy. By the 1990s the use of LBOs declined as the number of attractive companies for takeover disappeared and companies developed strategies to avoid being acquired.