By Matthew Bazard, Boston University
LBOs are predicted to experience a resurgence of deals as cash-rich PE firms search for investments. LBO shops make money in three main ways: multiple expansion, debt reduction, and EBITDA growth. If a deal can realize all three, it’s a homerun. With the recent economic recession, M&A slowed with companies conserving cash, and thus not wanting to pay a high multiple for an acquisition. The debt market froze and has experienced a slow recovery so LBO shops could not lever up deals. Debt allows the sponsor to grow the equity value at a multiple of the rate that the enterprise value grows. Finally, organic growth was difficult with the state of the economy. Consequently, many funds which were already raised, but not invested, have large amounts of cash. Investors are pushing for returns and deals to be executed.
Barron’s recently released its top dozen LBO candidates looking at firms with modest debt that trade at reasonable multiples of earnings and pretax cash flow. Some characteristics for a good LBO candidate include a strong cash flow for debt reduction, which is typically supported by a mature business with lower growth. Other factors are a strong market position and sound, tangible assets to provide debt collateral.
Barron’s twelve companies include eBay (EBAY), Dell (DELL), Yahoo (YHOO), Gap (GPS), Fidelity National Information Services (FIS), Safeway (SWY), Computer Sciences Corp (CSC), Western Digital (WDC), Whirlpool, (WHR), Seagate Technology (STX), GameStop (GME), and Aeropostale (ARO).
On the other hand though, Morgan Stanley says, “We note growing concern in investment-grade markets over potential resurgence in large-cap leveraged buyouts, and many key ingredients for a rebound in LBO activity seem to be in place. But we must push back (gently) on the sound and fury regarding mega-cap LBOs by looking at the economic backdrop, the structure of financing markets, and corporate balance sheets.” Some banks may still not be comfortable lending to buyout companies in the current environment.
On of the most recent deals that has been announced is the LBO of Burger King by 3G Capital Management for $4 billion. 3G offered $24 a share for the fast food chain, representing a 46% premium over Burger King’s closing price of $16.45 the day before the announcement. The purchase represents an EV/Revenue multiple of 1.6x and an EV/EBITDA multiple of 9.1x. TPG Capital, GS Capital, and Bain Capital currently own 31% of shares. They took the company private in 2002, but returned it to the public market in 2006. Burger King’s board of directors has already approved the deal and 3G has received debt commitments from JPMorgan Chase and Barclays Bank, with an aggregate amount totaling to $1.9 billion. Morgan Stanley is the lead advisor for Burger King with approximately a $20 million fee. Other recent deals are listed below. Ultimately, LBOs are coming back in size and scale, and seem to be closing at fairly high multiples. How quickly they come back though will be determined by a variety of factors.
