I believe that JoeyDVivre understands what I meant. I have no desire to argue here with “numi”.
TSG knows just enough big words to be dangerous.
HoldSideAnalyst Wrote: ------------------------------------------------------- > This presents a much more interesting question - > what is a “high enough” premium to take a company > private? There are certain companies in our > portfolio that I would be pissed if they tried to > take private for less than a 100% premium to > today’s price. One one hand, the shares are > trading freely in the market at today’s price, so > the consensus is that’s the fair price for a > non-control stake in the company. On the other > hand, everyone who owns the stock thinks it’s > undervalued, by definition, so they might not be > so anxious to let it go for a 15% premium. ‘Control premium’ is a bit of a canard. Two rational investors can price the same stock differently based simply on differing (reasonable) assumptions about cost of equity, growth prospects, technology impact, competition, and so on. You might calculate $50 value, I could calculate $60. For whatever reason today’s inside book is 45-45.10. If someone wants to tender, they have to price it where they capture enough holder’s price points. For boring stable companies investors will show a much tighter range of valuations, so the “control premium” is lower. I’d guess that your firms that want a 100% premium are in highly volatile industries, and exhibit a wide analysts’ valuation range. This has nothing to do with hypothetical inefficiencies or unlocked value or changes that a new controlling entity would make to the firm, which is why I think “control premium” is misnamed.
in an lbo, what si the difference between the liquidation and replacement value?
Well in valuation liquidation is what you’d get if you sold the assets on ebay. Replacement is what you’d pay to buy them. Don’t know of any particular tweak for lbo tho.
Are there any LBO’s listed on eBay? I never checked that out. Usually, I buy art deco crap from Grandma’s basement…
A few posts have come in the interim, but I think “gradient optimization” basically means “incremental optimization” in the sense of only making incremental changes that improve whatever you are trying to optimize. Therefore if public markets only allow this, and some large transformation involving periods of low or negative EPS, then a PE/LBO firm would be better suited to doing this (though GM seemed to make it through). I do think that LBO firms either need access to cheap capital that the company couldn’t otherwise get or a strategic vision that really works (as opposed to just saying “I have a vision”). If I were in a fund of funds and had to invest in a PE firm, I would certainly ask them how they come up with their strategy (unless it’s just that they get cheap debt) and see if I agree with it.
I’m sure that’s what TSG meant with the additional condition that optimizing on the gradient is also taking the steepest path locally. I’m sure someone here is going to agree with that assessment of LBO’s (that a global trasnformation cannot be done in publicly-held companies) and that strategic vision can be implemented better in a private company. That’s no doubt been true sometimes. In fact, I think my buddy at Bain was telling me that was the motivation for forming the company - that Bain consultants were earning chump change by giving away their strategic vision for consulting fees when they should be buying companies and transforming them for themselves. As a justification for LBO’s I think it doesn’t work very often because: a) That global transformation needs to take place amidst a pile of debt and cash flow needs. b) Why should we think outsiders have better strategic vision than insiders? c) I just don’t see the evidence that it’s happened much.
Orderly liquidation value is the amount realized from a liquidation sale or auction on an as-is basis, where-is basis. Replacement cost new is the amount realized from a “like-kind”, substitute asset that can replace, or perform the same function for your subject assets in the fixed asset account. The RCN may have to be trended using an inflation cost index if the numbers used aren’t current, and is further adjusted for “appraisal” depreciation (physical, functional, economic, not accounting deprn. that nullifies the asset at the end of it’s useful life) using an acceptable depreciation curve (M&S, market, OLV, etc) typcially by asset class. Such asset valuation techniques aren’t employed until after closing during the purchase price allocation process during which the entire balance sheet of the portfolio company is fully restructured. This is typically the case in section 338 elections where target assets are stepped up to FMV, as is the case with most sponsor-backed stock purchases. Prudent investors understand that effective purchase price allocation and lifing for acquired assets is key to maximizing cash flows for debt pay down post-LBO, so careful thought and planning goes into this, and can certainly be the deciding factor between chapt. 11 and meeting IRR targets.
JoeyDVivre Wrote: ------------------------------------------------------- > I’m sure that’s what TSG meant with the additional > condition that optimizing on the gradient is also > taking the steepest path locally. > Hmm… that doesn’t sound like “the path of least resistance” that I’m used to thinking of in bureaucratic organizations. > I’m sure someone here is going to agree with that > assessment of LBO’s (that a global trasnformation > cannot be done in publicly-held companies) and > that strategic vision can be implemented better in > a private company. That’s no doubt been true > sometimes. In fact, I think my buddy at Bain was > telling me that was the motivation for forming the > company - that Bain consultants were earning chump > change by giving away their strategic vision for > consulting fees when they should be buying > companies and transforming them for themselves. Yeah, that’s similar to the reasons I decided to shift from international development consulting to investment related work… I still get torn between the hands-on approach of private equity and the more “sit back and track the big picture” of quantitative and global macro trading. So far I’ve targetted the later. > As a justification for LBO’s I think it doesn’t > work very often because: > a) That global transformation needs to take place > amidst a pile of debt and cash flow needs. > b) Why should we think outsiders have better > strategic vision than insiders? > c) I just don’t see the evidence that it’s > happened much. OK, now I’m understanding where the extra risk comes in. If the assumption is that a public company can’t weather low EPS statements, but private owners can, then it only works if the private owners have accurate estimates of “how low can earnings go” in the meantime. If they are too optimistic on this, they fail to meet their debt payments during the transition period and then … bankruptcy? reorganization? It also makes me wonder about how systemic risk affects public firms vs. private firms. Private firms don’t really have a market that their equity can be marked to, so it would be difficult to figure out if the beta of a private company is the same as it’s beta would be as a public company. In theory, beta is the link between an asset (a company) and the market for all risky assets, so there should be a beta for private companies… is there any way to observe beta for a private company? Or possibly, being private would be its own separate risk factor, possibly co-mingled with liquidity risk, but probably also an independent risk in some way.
It’s not just cheap capital. It’s a huge driver - and one major reason why sponsor volume was up so much until july, but from a historical perspective deals still get done with great returns in periods of high spreads. just run a shell with L+200 and 8% on subs and then run it again at L+400 and 12% on subs - it affects returns (maybe 200 bps) and may kill a deal on the margin but is not the key driver - its not the rates - its the overall leverage bchadwick Wrote: ------------------------------------------------------- > A few posts have come in the interim, but I think > “gradient optimization” basically means > “incremental optimization” in the sense of only > making incremental changes that improve whatever > you are trying to optimize. Therefore if public > markets only allow this, and some large > transformation involving periods of low or > negative EPS, then a PE/LBO firm would be better > suited to doing this (though GM seemed to make it > through). > > I do think that LBO firms either need access to > cheap capital that the company couldn’t otherwise > get or a strategic vision that really works (as > opposed to just saying “I have a vision”). If I > were in a fund of funds and had to invest in a PE > firm, I would certainly ask them how they come up > with their strategy (unless it’s just that they > get cheap debt) and see if I agree with it.
bchadwick Wrote: ------------------------------------------------------- > > I do think that LBO firms either need access to > cheap capital that the company couldn’t otherwise > get or a strategic vision that really works (as > opposed to just saying “I have a vision”). If I > were in a fund of funds and had to invest in a PE > firm, I would certainly ask them how they come up > with their strategy (unless it’s just that they > get cheap debt) and see if I agree with it. LBO debt is never cheaper than corporate debt… Also on the use of consultants. They’re just an insurance policy! It’s nice to have the M/B/B type people (whom you have employed) batting for you and saying xxx can be achieved which will lead to margin improvement etc etc when you are trying to raise the debt for your LBO. Do we really believe what they say? Maybe a little, but they are used to justify our margin assumptions and for banks to get comfortable with our projections…
What he’s saying is LBO debt is not cheap relative to underlevered company debt. What he’s saying is if a sponsor takes a company private their cost of debt will be cheaper than if a public company does a recap with same credit stats/profile - this is generally true.
“underlevered company debt”? You must be one of those guys who thinks that if your credit card isn’t maxed, youre not having enough fun.
JoeyDVivre Wrote: ------------------------------------------------------- > “underlevered company debt”? You must be one of > those guys who thinks that if your credit card > isn’t maxed, youre not having enough fun. I can assure my cost of cap does not include credit card loans. I’m not sure what ive done to upset you, but you always have a snide remark waiting.
He just loves paying taxes. I don’t understand all these people trying to assert, or prove in some hypothetical theoretical universe, that levered take-private’s can’t add value. I’m sure that there also folks who don’t believe in giving up voting equity stakes in their firms. Two Chicago GSB professors are walking down the quad. One spies something on the far sidewalk. “Is that a $50 bill?” “It couldn’t be or someone would have picked it up already.” Granted the profit lemmings have followed the early buyout firms that made large fortunes in the early days, and it’s getting harder to earn an abnormal return at the business any more. It’s also evident that corporations have levered up considerably in the last two decades, whether defensively or simply because they want to improve enterprise value. There’s no refuting the evidence that a lot of $50 bills have been picked up and will continue to be picked up; they’re lying there in part because of the attitudes displayed on the three pages of this thread.
Nobody said that levered take-privates can’t add value (maybe TSG did). But just because you can make a lot of money doing them doesn’t mean they add value. In fact, as a societal issue companies spend lots of resources, have inappropriate capital structures, poison pill securities, etc. to avoid LBO’s so the loss to society from these things is pretty large. I think I was pretty clear above on my thoughts about LBO’s. Now if an LBO guy says something like “Who cares? I make money doing it and if there’s a $50 bill over there and I have to trample a few people getting it, I’m fine with that”, well, at least that’s honest. This stuff about adding value simply because you take home a big paycheck from doing it couldn’t be more wrong.
bankingbaby Wrote: ------------------------------------------------------- > Alright. To address a few people who don’t > understand the “magic” of how an LBO works to get > the returns it does. > > First off leverage (duh). Leverage drives returns. > Is that simple to understand? To the > academics/CFAs in the crowd, firm value is not > determined by cap structure (MM) - until you bring > in this thing called taxes. And then as interest > expense is tax deductible, you can “create” value > by levering up, until the point in which your > costs of financial distress are too much. The > majority of public companies capital structure are > not optimized. Why - because it is very hard to > do this as a public company (sounds circular > right?). If a typical industrial company that was > publicly traded went and levered themselves up to > 6 or 7x shareholders would freak out. Maybe they’d > appreciate the special dividend they got > initially, but the stock would trade a > ridiculously low multiple going forward. Not only > that, but as many public co’s trade on EPS (which > is total BS), and PF EPS is destroyed with all the > interest expense, you would have a twice as strong > effect (lower multiple and lower EPS is stock > price that is crushed). > > In addition, as mgt of a public co, you are > incentivized by stock options to hit certain EPS > targets to try and improve stock price so your > options vest and you can exercise them. > Unfortunately improving EPS is a totally misguided > way to run a business - and can have very perverse > effects. So now the confused public exec at this > new leveraged company is trying everything he can > to increase EPS so that hopefully his stock price > will increase and his options will be in the > money, while paying just enough attention to his > credit stats/solvency that he can remain a going > concern. Eventually economy goes into a recession > and firm hasn’t paid down enough debt (b/c its > been trying to improve its magical q over q EPS) > to weather the storm and blows up. end of story. > > The simple conondrum is that firm value increases > with leverage. But public companies cannot be > levered as much private companies. So a perpetual > arb opportunity exists - and then add generous > leverage terms, low financing rates and a company > that the public market does not understand or is > improperly valued, or a sub that a cash strapped > company needs to get rid of, or an orphan division > that never received proper mgt attention/capital > resources - and you can opportunities for > ridiculous returns. > > Plus levering up instills what is often desribed > as the “discipline” of debt. The 1000th project > that the idiot in R&D thinks will be fantastic but > everyone knows is worthless, but the company has > extra cash so why not? That is gone now - never to > be funded when the company has to focus on > leverage. > > The mgt team that was held hostage to manage its > EPS to make quarterly earnings targets? They are > now able to focus on creating value over a 5 year > time frame - their sponsor owners dont give a crap > about q-o-q EPS as long as debt is getting paid > down. What do you think creates more value? End > goal - pay down as much debt 5 years out? or End > goal - manipulate EPS long enough so your options > will vest. > > Finally - PE guys are pros. They look at deal > after deal and know very quickly how to improve > margins, operations etc - or bring in people who > do. > > It’s pretty simple - that’s how it works. I think you’ve hit the basic story but this isn’t how significant PE returns are reached. Financial engineering alone rarely generates significant returns. While leverage is certainly what allows PE firms to acquire companies. Leverage alone isn’t going to generate returns. There needs to be an investment thesis beyond that. I agree that EPS alone is an inefficient way to run a business. However, firms hitting EPS targets are usually not targets. So EPS usually play a small part of the story when going private. The discipline of debt also sometimes certainly reduces wasteful R&D projects but they sometimes reduce a company’s competitiveness as R&D and capex are cut to minimum levels. The classic maintenece capex vs. growth capex comparison works in the short run but it doesn’t take long for these companies to lose competitiveness if money used to hit required debt payments is taken away from the running of the business. When management takes a long-term view…servicing 7-8x times leverage isn’t much better than managing Q earnings. I think LBOs work when these factors are available to enhance a strong investment thesis beyond simple financial engineering. I’m not trying to be critical of your response since it wasn’t a great orginal question and you answered explains a large part of the PE boom of the last few years but the best deals I see go beyond the factors you mentoned.
Certainly agree. My point is fundamentally an LBO, and what generates a significant portion of the returns, is the “L” element. But leverage is no longer a differentiating feature (look how many more PE funds there are today versus 5 years ago) - and alot of other things have to be present in order to generate top decile returns. Any investment a good sponsor will make these days will have a differential angle (new mgt, different insight, structuring/divestitures, new market ideas, etc.) and will not purely be a leverage play - the PE market is too efficient for that now
another pro-LBO argument nobody is really mentioning in this thread is the porfolio managment implications. If you own a portfolio of private companies, you can merge/spinoff various parts of portfolio companies and play more of a role in shaping what exactly you’ll take public when you exit. For various informational/agency issues, you can’t typically do that sort of thing with public companies…