| A leveraged buyout (LBO) occurs when a financial | | | | the transaction would justify the debt levels based |
| sponsor gains a controlling interest in a firm’s | | | | on the cash flows of the acquisition target and their |
| equity and where a major % (percentage) of the | | | | ability to make interest and principal payments. Senior |
| buying value is financed through borrowing. The | | | | more secured ‘mezzanine debt’ might be |
| possessions of the obtained firm are often used as | | | | offered to investors at LIBOR (London Interbank |
| collateral for the borrowed money, sometimes with | | | | Offer Rate) + 700 basis points while the longer term |
| assets of the acquiring company. The bonds issued | | | | unsecured tranches (the junk) might be sold at |
| for leveraged buyouts normally have several | | | | LIBOR + 1200 basis points. |
| trenches ranging from barely investment grade to | | | | In the halcyon days of yore (circa 2006), the LBO |
| high coupon ‘junk’ because of the major | | | | funds would often quickly take operating profits of |
| risks involved. In today’s financing markets, even | | | | the company and pay themselves a dividend covering |
| the most prestigious LBO firms have had difficulty | | | | their investment, effectively leaving them with a free |
| financing transactions leading to a dearth of deals and | | | | call option and all the risk transferred to the |
| some say the death of the LBO industry as we | | | | bondholders – and the employees and taxpayers. |
| know it. | | | | Like most examples of excess in the capital markets, |
| Historically, LBO funds made huge acquisitions of | | | | the pendulum has dramatically swung the other way. |
| global behemoths valued at tens of billions of dollars | | | | Gone are the days of inebriated, covenant-light debt. |
| borrowing as much as 90% of the value from banks. | | | | In fact, the banks aren’t lending at all. The best |
| The banks would syndicate the loans and sell them | | | | of the breed have gone out of business forever |
| to other sophisticated financial institutions such as | | | | altering the LBO landscape. |
| pension funds and endowments. The bank financing | | | | |