Horizon Information Portal

MSOE Library Home

MSOE Library Home

Home

Analysis of the leveraged buyouts and the case study of RJR Nabisco / by Renus Suntareja.

by Suntareja, Renus

Leveraged buyouts -- United States -- Case studies.

Consolidation and merger of corporations

RJR Nabisco (Firm)

x, 172 leaves : ill. ; 29 cm.

Advisor: Dr. William Gleason.

Committee members: Gene Wright, Dr. Bruce Thompson.

Introduction -- Analysis of a leveraged buyout -- The case study of RJR Nabisco buyout -- Conclusion -- Appendices A) ESOP Leveraged Buyouts B) RJR Nabisco's Operation.

The Leveraged Buyout (LBO) became one of the most popular corporate restructuring techniques of the 1980's. Many entrepreneurs and corporate managers want to own their own corporation and control their own destiny. However, most do not have the personal resources to achieve this goal in a short period of time. The LBO became a vehicle ideally suited to then current circumstances to enable many to achieve their desire for corporate ownership or control as well as personal wealth beyond conventional dreams.

The LBO also came into existence because the timing was right. A dissatisfaction with ordinary returns on investment, a desire for personal ownership by short-cut methods, a tax structure that allowed assets to be written off against current earnings, interest payments that could also be written off against current earnings and the existence of a small group of investment brokers who saw an opportunity to take advantage of all these circumstances to make large sums of money for themselves and for their clients. Thus, the LBO was created.

An LBO is a highly leveraged buy-out of an existing company by an investment group. Because of the high degree of leverage it is also an investment with a much higher degree of risk than commercially acceptable. The investment group consists of an investment banking institution, an array of different types of investors with different tolerances for risk and an ownership group consisting of the existing management of the corporation, an outside management team, public investors or the employees of the company or some mix of all these different groups. The two essential players are the group that can raise the usually very large sums of capital needed to buy the corporation and the management team that can run the acquired corporation more effectively than it has been run in the past.

The premise of the LBO is that the price paid today will be paid for within a relatively short period of time -- five to ten years -- by the subsequent sale of the corporation at a much higher price, after allowing for inflation. This will enable the original borrowing to be repaid and the owners left with a substantial capital appreciation. A further premise is that the performance of the target corporation will be improved after acquisition by new management, better motivation of management and by the introduction of productivity techniques. The new performance levels will generate, it is assumed, significantly higher profits than before which will service the higher debt load of the acquired corporation.

The requirements of the ideal target corporation are a multi-million dollar return potential, a market leader or similar sized company in a stable rather than a cyclical industry and with low requirements for expensive R & D efforts or advertising. The ideal target should have unpledged assets or a low debt structure. Excess assets not needed for operations are also useful since they can be sold to raise immediate cash. Lastly, there should be a good management team available either internally or from outside.

Theories that have been used to explain the LBO process include Asymmetric Information and Underpricing, Agency Cost and Free Cash Flow, Tax Code Incentives, Inefficient Management and Increased Efficiency and Performance. Also important in explaining the reason for the success of the LBO are greater motivation of management, the economies of operating as a private company and the common interests of stockholders and management.

Because an LBO usually involves a public corporation and typically a larger rather than a smaller one, they are highly visible. The economic impact of an LBO is therefore, more public and frequently involves plant closings and employee layoffs. All of this generates much publicity which more often than not – especially in the early days -- is negative because the benefits only come at the end of the buy-out process, the liabilities occur at the start. For all of these reasons LBOs have attracted much attention. This has related as much to their social impact as to their commercial impact.

The beneficial effects of the LBO are greater productivity from the capital investment, a higher return on the capital employed and an increase in market value of the corporation concerned. It is not always a case of universal profit. There are also losses. Some employment may be permanently lost, communities may lose a local employer, bondholders often lose much of their investment while other classes of investors are gaining. The biggest problem may be that not every LBO has been successfully executed. The failures are an economic cost to the economy. They also represent a shifting of capital and earnings from one investor to another under conditions of excessive risk.

The research as to the effects of an LBO on the corporation are summarized. R&D does not in practice appear to be cut as is often predicted by critics of LBOs. Taxes collected are often reduced during the period when higher amounts of interest are being paid although taxes will typically be higher after the LBO borrowing has been repaid. So in the long run taxes returns might be higher.

An analysis of the RJR Nabisco case is given as an illustration of how this type of financial deal is structured. This was the most highly publicized LBO of the decade and possibly the most controversial. The problems met, the mistakes made and the results are set out towards the end of the Thesis.

In conclusion, the thesis summarizes that the controversy surrounding the LBO technique is not always founded on facts. The LBO often produces gains for investors and that these are not always just transfers of wealth from either other types of investors or taxpayers in general. It shows that LBOs create wealth through improvement in operating performance and utilization of assets. The role of management is significant as a key instrument in the process though financial involvement leading to high motivation.

The RJR Nabisco case indicates the LBO process. It shows that the LBO would have been much more successful had it not been for mistakes made during the bargaining process by the competitive bidding teams and the shareholders interests. Lack of experience in negotiating a deal of this complexity was instrumental to the lack of total success.

Horizon Information Portal 3.25_9885

Powered by SirsiDynix

© 2001-2013 SirsiDynix All rights reserved.

Horizon Information Portal