What’s a Leveraged Buyout?

A leveraged buyout (LBO) is a method for acquiring a company when the buying company uses little relative cash to complete the purchase. When a company is sold to private investors, it is considered hostile since the target company must be profitable and have a strong history of performing well. This may seem a little strange, but it is perfectly legal for the assets of a targeted company, such as Toys ‘R’ Us, to be used as collateral for the debt created that privatizes it. Investment bankers issue and sell “junk” bonds when they finance the deal. As bonds work, coupon and monthly interest payments must be made to service the debt.

Bain Capital, KKR, and Vornado are in the news and under the scope of lawmakers as to why America’s favorite toy store went bankrupt in February. They bought the company in 2005. In fact, eighteen Democratic members of Congress and Senator Sanders (I., Vt.) signed a letter requesting an explanation as to why Toys ‘R’ Us failed, leaving tens of thousands without jobs or severance packages.  Philadelphia Business Journal They believe this “strongarm” tactic is leaving local communities reeling from the burdens it causes municipal governments, and because it results in thousands of unemployed workers at one time. Former managers have stated that they were promised severance payments and received nothing. Displaced employees are organizing to bring attention to the issue by voicing how they’ve been affected.

LBOs are unlike mergers and acquisitions or even hostile takeovers by competing brands. Ideally, the buyers intend to increase the profitability or efficiency of the target company in some way. Private equity firms do this constantly. But, there is apparently no guarantee that the business operations or even shareholder equity of a privatized firm will produce fantastic results. Other notable privatizations are StanCorp Financial Group, Inc. by Meiji Yasuda Life in 2015. JAB Holding Company bought out Krispy Creme doughnuts in July of 2016 for $1.5 billion with a $350 million leveraged loan and a $150 million revolving credit facility. Investopedia As more retail giants face competition from Amazon, declining sales, and a fading consumer affinity for shopping malls, it will be interesting to see what will become of Kmart, Sears, and Macy’s. Are they still attractive targets for takeover though revenues are not what they used to be? Amazon bought Whole Foods though it arguably sells many more household goods. I think that we may only be witnessing the beginning of major changes in big box retail markets.

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