why are the HY bonds of a target company forced to refi in the event of a LBO? Why arent the bonds for investment grade issuers forced to refi?
Shooting from the hip here. I think you’d ask “why do such-and-such bondholders GET to tender” since an LBO will generally devalue existing debt. Such screw-the-bondholders tactics, made famous in the 1980s buyout binge, were subsequently spiked by change-of-control covenants in indentures. Your question is contrasting “HY bonds of a company” with “bonds of an IG issuer”. What are you really trying to ask?
bmwhype Wrote: ------------------------------------------------------- > why are the HY bonds of a target company forced to > refi in the event of a LBO? Why arent the bonds > for investment grade issuers forced to refi? what do you mean high yield bonds forced to refinance? does that make sense? how is a financial instrument forced to “refi” themselves? your question, as it is written, does not really make sense. anyway, the question that i think you’re asking is, why do buyout shops refinance the existing debt on the company? well, in a buyout situation, they almost always refinance the debt and load on new debt with terms and covenants that are favorable to the investor for the purposes of the buyout transaction. it makes much more sense for the PE investor to have debt with terms that are aligned with the goal of their transaction. generally, the existing debt is generally replaced via exchange or knockout provision. however, paying down or replacing the existing debt is not a necessary condition of an LBO – in some cases, if there are very favorable terms and rates on the existing debt, the investor will opt to leave that debt on the books. does this answer your question?
also, as an aside, these kinds of questions are good for everyone to know so no need to preface it in the subject line as an “i-banking” question. it is as much a question for private equity investors and financial sponsors as it is for “i-banking”
numi, Maybe you can straighten something out for me, why is it I hear to be an attractive buy-out target companies must have low leverage? To me this makes no sense, because, as you just explained you can refinance if whats in place doesn’t work for you and the valuation reflects the leverage. What am I missing?
Sims Wrote: ------------------------------------------------------- > numi, > why > is it I hear to be an attractive buy-out target > companies must have low leverage? Maybe you’re listening to the wrong people? Targets are attractive for financial purchasers if they have strong, reliable cash flows. The situation is more complicated for strategic buyers.
Sims Wrote: ------------------------------------------------------- > numi, > Maybe you can straighten something out for me, why > is it I hear to be an attractive buy-out target > companies must have low leverage? To me this makes > no sense, because, as you just explained you can > refinance if whats in place doesn’t work for you > and the valuation reflects the leverage. What am I > missing? this is a very good question. generally, companies with low leverage can receive better terms and covenants on their debt as well as better credit ratings, so to that end, an argument can be made that companies with low debt levels are more apt to receive favorable lending terms. but what REALLY matters is the pro forma leverage levels and the sustainability and predictability of future free cash flows the target company can generate, because it is these cash flows that will be used to service and pay down the debt that the sponsor layers onto the company. also, as another point, you have to remember that companies that have a ton of debt loaded onto them also have higher enterprise value than those that don’t, and as an investor looking to purchase the company, you essentially have to consider the firm’s enterprise value in a buyout situation. and what does the enterprise value tell you? well, it tells you the theoretical/implied takeout price for the company, i.e. assumption of equity and paydown of debt netted against the target’s cash on the books. btw, i’m really starting to like this level III forum. more interesting and thoughtful discussions here. not too shabby for someone like me who’s only passed level I, right?
(duplicate post deleted)
numi you an ib analyst or associate?
numi Wrote: ------------------------------------------------------- > btw, i’m really starting to like this level III > forum. more interesting and thoughtful discussions > here. not too shabby for someone like me who’s > only passed level I, right? Pride goeth before destruction, and an haughty spirit before a fall. Or, the AF credo: Whom CFAI would bring low, first they elevate.
haha, sorry, that wasn’t my implication. all i’m saying is that i find the discussion here a lot more interesting than on the other boards. people who know me also know that i don’t plan to pursue the CFA designation so the concept of “levels” makes little difference to me, but i still can appreciate the knowledge that charterholders/level III candidates have. strikershank, i’m actually in research but have been interested in buyouts for a while and also work closely with ex-bankers, so i learn a lot from them as well as through my own initiative
ah numi, interesting (as i jack this thread). Ex research myself. now learning in PE. anywaz. You have my attention.
thanks strikershank, likewise to you…i think you definitely had the right idea on that other thread where we were discussing how to compare the two business opportunities, and you have an effective way of explaining things in a fundamental way that can be easily understood. how long have you been in PE for? what type of shop? just curious how you made the transition from research to PE? would be interested in knowing if you feel compared to share…either here or privately if you prefer (i am at porcupines AT gmaiI DOT com). always interested in sharing ideas
numi Wrote: > > also, as another point, you have to remember that > companies that have a ton of debt loaded onto them > also have higher enterprise value than those that > don’t, All else equal, EV doesn’t rise with debt. (If you took a firm and threw debt on it, the most common use of proceeds would be to buy down equity.) E.g. RJR wasn’t worth more after the MBO/LBO that added a lot of debt to them. If you just left the proceeds as cash, then net debt won’t change anyway. Microsoft is a good counterexample of EV being delinked from debt. (An underlevered firm might reduce WACC and thus increase EV by doing a levered recap, but at some point they’ll venture into pre-distress area and quickly reduce EV.)
Darien’s bang on. There is an optimal capital structure and, sans buyout, EV hits an optimal point when WACC is minimized (that is, the pv of the sum of the tax shields on the debt is greater than the probability of bankruptcy that is reflected in the cost of debt and equity). EV rises to a point, then falls of. however, 9 times out of 10 (cuz there are always exceptions), you can lever up a firm and increase its EV. Provided you don’t thrust the firm into solvency worries (with cost of capital increases).
strikershank Wrote: ------------------------------------------------------- > > however, 9 times out of 10 (cuz there are always > exceptions), you can lever up a firm and increase > its EV. Provided you don’t thrust the firm into > solvency worries (with cost of capital increases). that’s what i was getting at, just didn’t explain it well. my pt was that debt is considered as part of enterprise value and as such is a key consideration for buyout and exit valuation purposes because it becomes part of the theoretical takeover price. good pt on WACC too.
numi Wrote: > my pt was that debt is considered as part > of enterprise value and as such is a key > consideration for buyout and exit valuation > purposes because it becomes part of the > theoretical takeover price. good pt on WACC too. Don’t let the tail wag the dog here. EV is calculated by e.g. PV’ing FCFE. You don’t calculate EV by looking at debt, because you would then have to value equity, which can only be done if you’re given EV to start with. Circular. Given EV, the value of D is useful because it tells you what you think MV of E is. Put differently, EV should be thought of as the value of assets. Decide that first. Then go sniffing around the capital structure if you only want to take out part of it.
DarienHacker Wrote: ------------------------------------------------------- > numi Wrote: > > my pt was that debt is considered as part > > of enterprise value and as such is a key > > consideration for buyout and exit valuation > > purposes because it becomes part of the > > theoretical takeover price. good pt on WACC > too. > > Don’t let the tail wag the dog here. EV is > calculated by e.g. PV’ing FCFE. no – it’s the PV of FCFF, not FCFE. >You don’t > calculate EV by looking at debt, because you would > then have to value equity, which can only be done > if you’re given EV to start with. Circular. no. at entry, you have to determine purchase price for the company. if you look at *any* LBO model for a public or private company, what comprises the potential price of the firm includes the value of the equity, debt on the books, and transaction costs associated with the buyout. and you know these things by looking at the OM or their most recent filing. > Given EV, the value of D is useful because it > tells you what you think MV of E is. yes, and this is how you calculate equity valuation at EXIT. at ENTRY, you already know what the purchase price is (assuming you are running your LBO model for confirmatory analysis) and in so doing it is up to the sponsor to test how much leverage to put on the transaction. so actually, entry works the other way around.
numi Wrote: ------------------------------------------------------- > no – it’s the PV of FCFF, not FCFE. sorry, typo > no. at entry, you have to determine purchase price > for the company. if you look at *any* LBO model > for a public or private company, what comprises > the potential price of the firm includes the value > of the equity, debt on the books So how do you value equity? You somehow have to value the assets. (You can’t look at e.g. market cap because that’s someone else’s valuation, and shouldn’t influence what you’re willing to pay for the firm.)
Enterprise value is the current MARKET value of equity + debt less excess cash. You value a firm based on the market prices. You value the takeout price (what you are willing to pay) based on your own models. These models will include transaction costs, changes in capital structure and so forth. BUT for EV, it remains the market prices.