Deck 13: Financing the Deal

Question 1

you believe that Heinz is a good candidate for a leveraged buyout? Explain your answer.

Answer 1

Yes. In the food manufacturing business for 120 years with a widely recognizable brand, the firm has a substantial and defensible market share in the United States. Moreover, given the nature of its basic food product, its sales tend not to be cyclical. Moreover, industry growth tends to be modest in the mature segments in which the firm competes. The need for substantial future capital expenditures is likely to be limited or at least discretionary if the firm chooses to expand internationally. Overall, the firm's operating cash flow can be expected to remain relatively predictable, increasing its ability to pay off its outstanding debt.

Question 2

5 In a move reminiscent of the blockbuster buyouts of the late 1980s, seven private investment firms acquired
100 percent of the outstanding stock of SunGard Data Systems Inc. (SunGard) in late 2005. SunGard is a financial software firm known for providing application and transaction software services and creating backup data systems in the event of disaster. The company's software manages 70 percent of the transactions made on the Nasdaq stock exchange, but its biggest business is creating backup data systems in case a client's main systems are disabled by a natural disaster, blackout, or terrorist attack. Its large client base for disaster recovery and back-up systems provides a substantial and predictable cash flow. Furthermore, the firm had substantial amounts of largely unencumbered current assets. The deal left SunGard with a nearly 5 to 1 debt to equity ratio. Why do you believe lenders might have been willing to finance such a highly leveraged transaction?

Answer 2

The firm had substantial market share in a stable industry, disaster recovery and back-up systems, that provides a substantial and predictable cash flow. The firm also had substantial unencumbered current assets which could be used for collateral for short-term financing.

Question 3

do you believe was the purpose of the $1.5 billion senior secured revolving loan facility, and the $2.1 billion second lien bridge loan facility as part of the deal financing package?

Answer 3

The revolving loan facility is commonly a part of financing such transactions as it provides a source of financing of short-term working capital requirements and is especially important in meeting unanticipated cash needs. The bridge loan facility was intended to provide funds to pay cash to Heinz shareholders at closing and to give the firm time to raise so-called permanent or long-term financing.

Question 4

7 Following Cox Enterprises' announcement on August 3, 2004 of its intent to buy the remaining 38% of Cox Communications' shares that they did not currently own, the Cox Communications Board of Directors formed a special committee of independent directors to consider the proposal. Why?

Question 5

do you believe Berkshire Hathaway wanted to receive preferred rather than common stock in exchange
for its investing $8 billion? Be specific.

Question 6

was ownership transferred in this deal? Speculate as to why this structure may have been used?

Question 7

Accounts receivable represent an undesirable form of collateral from the lender's point of view because they are often illiquid.

Question 8

8 Qwest Communications agreed to sell its slow but steadily growing yellow pages business, QwestDex, to a consortium led by the Carlyle Group and Welsh, Carson, Anderson and Stowe for $7.1 billion in late 2002. Why do you believe the private equity groups found the yellow pages business attractive? Explain the following statement: "A business with high growth potential may not be a good candidate for an LBO."

Question 9

1 What are the primary ways in which a leveraged buyuot is financed?

Question 10

Describe the motivation for Berkshire and 3G to buy Heinz.

Question 11

Leveraged buyout firms use the unencumbered assets and operating cash flow of the target firm to finance the transaction.

Question 12

Because of their high liquidity, lenders often lend up to 100% of the book value of accounts receivable pledged as collateral in leveraged buyouts.

Question 13

do loan and security covenants affect the way in which a leveraged buyout is managed? Note the
differences between positive and negative covenants.

Question 14

Describe common strategies LBO firms use to exit their investment. Discuss the circumstances under which
some methods are preferred to others.

Question 15

9 Describe the potential benefits and costs of LBOs to stakeholders including shareholders, employers, lenders, customers, and communities in which the firm undergoing the buyout may have operations. Do you believe that on average LBOs provide a net benefit or cost to society? Explain your answer.

Question 16

will the investors be able to recover the 20% purchase price premium?

Question 17

Identify the form of payment, form of acquisition, acquisition vehicle, and post-closing organization? Speculate why each may have been used.

Question 18

4 While most LBOs are predicated on improving operating performance through a combination of aggressive
cost cutting and revenue growth, hospital chain HCA laid out an unconventional approach which relied heavily on revenue growth in its effort to take the firm private. On July 24, 2006, management again announced that it would "go private" in a deal valued at $33 billion including the assumption of $11.7 billion in existing debt. Would you consider a hospital chain a good or bad candidate for an LBO? Be specific.

Question 19

10 Sony's long-term vision has been to create synergy between its consumer electronics products business and its music, movies, and games. On September 14, 2004, a consortium, consisting of Sony Corp of America, Providence Equity Partners, Texas Pacific Group, and DLJ Merchant Banking Partners, agreed to acquire MGM for $4.8 billion, consisting of $2.85 billion in cash and the assumption of $2 billion in debt. The cash portion of the purchase price consisted of about $1.8 billion in debt and $1 billion in equity capital. Of the equity capital, Providence contributed $450 million, Sony and Texas Pacific Group $300 million, and DLJ Merchant Banking $250 million. In what way do you believe that Sony's objectives might differ from those of the private equity investors making up the remainder of the consortium? How might such differences affect the management of MGM? Identify possible short-term and long-term effects.

Question 20

6 In an effort to take the firm private, Cox Enterprises announced on August 3, 2004 a proposal to buy the remaining 38% of Cox Communications' shares that they did not currently own for $32 per share. Cox Enterprises stated that the increasingly competitive cable industry environment makes investment in the cable industry best done through a private company structure. Why would the firm believe that increasing future levels of investment would be best done as a private company?

Question 21

negative loan covenant is a portion of a loan agreement that specifies the actions the borrowing firm agrees to take during the term of the loan.

Question 22

According to fraudulent conveyance laws, if a new company is found by the court to have been inadequately capitalized to remain viable, the lender could be stripped of its secured position in the assets of the company or its claims on the assets could be made subordinate to those of the general creditors.

Question 23

LBO investors seldom sell assets to repay debt used to acquire the firm.

Question 24

A leveraged buyout initiated by a firm's management is called a management buyout.

Question 25

LBO investors often use public offerings of the firm's stock or sell the firm to a strategic buyer in order to exit the business.

Question 26

growth firms with high reinvestment requirements often make attractive LBO targets.

Question 27

Financial buyers usually hold onto their investments for at least 15-20 years.

Question 28

Premiums paid to LBO target firm shareholders often exceed 40%.

Question 29

LBO investors will often use the target firm's cash in excess of normal working capital requirements to finance the transaction.

Question 30

A single asset is often used to collateralize loans from different lenders in LBO transactions.

Question 31

Typical LBO targets are in mature industries such as manufacturing, retailing, textiles, food processing, apparel, and soft drinks.

Question 32

LBO capital structures are often very complex, consisting of bank debt, subordinated unsecured debt, preferred stock, and common equity.

Question 33

The high premiums paid to LBO target shareholders reflect the tax benefits associated with the high leverage of such transactions and the improved operating efficiency following the completion of the buyout resulting from management incentive plans and the discipline imposed by the need to repay debt.

Question 34

Investors in highly leveraged transactions who are primarily focused on relatively short-to-intermediate term financial returns are often called financial buyers.

Question 35

When a public company is subject to a leveraged buyout, it is said to be "going private."

Question 36

agreements commonly have cross-default provisions allowing a lender to collect its loan immediately if the borrower is in default on a loan to another lender.

Question 37

Asset based lending does not require the borrower to pledge assets as collateral underlying the loans.

Question 38

The loan agreement stipulates the terms and conditions under which the lender will loan the borrower funds.

Question 39

Investors in LBOs are frequently referred to as financial buyers, because they are primarily focused on relatively short-to-intermediate-term financial returns.

Question 40

bonds are high-yield bonds either rated by the credit-rating agencies as below investment grade or not rated at all.

Question 41

Borrowers often seek revolving lines of credit that they can draw upon on a daily basis to run their business.

Question 42

Fraudulent conveyance laws are intended to prevent shareholders, secured creditors, and others from benefiting at the expense of unsecured creditors.

Question 43

When a public company is subject to an LBO, it is said to be going private, because more than 50% of the equity of the firm has been purchased by a small group of investors and is no longer publicly traded.

Question 44

Borrowers often prefer term loans because they do not have to be concerned that these loans will have to be renewed.

Question 45

Financial buyers usually plan to hold onto acquired firms longer than strategic buyers.

Question 46

Junk bonds have invariably proved to be a reliable source of low-cost financing in LBO transactions during the last 30 years.

Question 47

Firms with redundant assets and predictable cash flow are often good candidates for leveraged buyouts.

Question 48

A term loan usually has a maturity of less than one year.

Question 49

The LBO that is initiated by the target firm's incumbent management is called a management buyout.

Question 50

To avoid being subject to fraudulent conveyance laws, a properly structured LBO should have a balance sheet that clearly indicates solvency at the time of closing.

Question 51

Divisions of larger companies are generally poor candidates for successful leveraged buyouts.

Question 52

Under-performing operating units of large companies are often excellent candidates for LBOs.

Question 53

Common exit strategies for LBOs include sale to a strategic buyer, an IPO, a leveraged recapitalization, or a sale to another buyout firm.

Question 54

An affirmative covenant is a portion of a loan agreement that specifies the actions the borrowing firm cannot take during the term of the loan.

Question 55

LBOs can be of an entire company or divisions of a company.

Question 56

Cash flow lenders view the borrower's future cash flow generation capability as the primary means of recovering a loan, while largely ignoring the assets of the LBO target.

Question 57

Asset based lenders will usually lend up to 100% if the book value of the LBO target's receivables.

Question 58

The loan agreement stipulates the terms and conditions under which the lender will loan the firm funds.

Question 59

The risk associated with overpaying is magnified for leveraged buyout transactions.

Question 60

Junk bonds are always high risk.

Question 61

Secured debt often is referred to as mezzanine financing.

Question 62

The growth in LBO activity is not simply a U.S. phenomenon. Western Europe has seen a veritable explosion in private equity investors taking companies private, reflecting ongoing liberalization in the European Union as well as cheap financing and industry consolidation.

Question 63

Limitations the lender imposes on the borrower on the amount of dividends that can be paid, the level of salaries and bonuses that may be given to the borrower's employees, the total amount of indebtedness that can be assumed by the borrower, and investments in plant and equipment and acquisitions are called affirmative covenants.

Question 64

Because term loans are negotiated privately between the borrower and the lender, they are much more expensive than the costs associated with floating a public debt or stock issue.

Question 65

Bridge financing is usually expected to be replaced within two years after the closing date of the LBO transaction.

Question 66

If the LBO is structured as a direct merger in which the seller receives cash for stock, the lender will make the loan to the buyer once the appropriate security agreements are in place and the target's stock has been pledged against the loan. The target then is merged into the acquiring company, which is the surviving corporation.

Question 67

Management buyouts without a financial equity contributor are relatively rare.

Question 68

Preferred stock often is issued in LBO transactions, because it provides investors a fixed income security, which has a claim that is junior to common stock in the event of liquidation.

Question 69

LBOs may be consummated by establishing a new subsidiary that merges with the target. This may be done to avoid any negative impact that the new company might have on existing customer or creditor relationships.

Question 70

There is some evidence that the Sarbanes-Oxley Act of 2002 has also been a factor in some firms going private as a result of the onerous reporting requirements of the bill.

Question 71

LBO investors have become much more actively involved in managing target firms in recent years than they have in the past.

Question 72

An indenture is a contract between the firm that issues the long-term debt securities and the lenders.

Question 73

LBOs normally involve public companies going private.

Question 74

The acquirer often is asked for a commitment letter from a lender, which commits the lender to providing financing for the transaction.

Question 75

Debt issues not secured by specific assets are called debentures.

Question 76

LBO exit strategies involving selling to a strategic buyer usually result in the best price as the buyer may be able to generate significant synergies by combining the firm with its existing business.

Question 77

If the borrower defaults on the loan or otherwise fails to honor the terms of the agreement, the lender can seize and sell the collateral to recover the value of the loan only if the borrower agrees that it is unlikely that the loan will be repaid.

Question 78

LBO firms seldom purchase a firm to use as a platform to undertake other leveraged buyouts in the same industry.

Question 79

A common technique used during the 1990s was to wait for favorable periods in the stock market to sell a portion of the LBO's equity to the public. The proceeds of the issue would be used to repay debt, thereby reducing the LBO's financial risk.

Question 80

The promissory note commits the borrower to repay the loan, only if the assets when liquidated fully cover the unpaid balance.