Can anyone explain to me simply what an leverage buyout means?
Why does it become so contraversal?
How do you make money off it?
In an LBO, a small group of shareholders, often the management of a corporation, borrow money secured by the assets of the corporation to have the corporation buy out all the other (public)shareholders of the corporation. Thus, they “leverage” their purchase by borrowing against the assets of the corporation.
The remaining (management) shareholders will make money if the corporation can earn more than the interest cost of the borrowing. This might be the case, in particular, if interest rates are low and/or the stock price is (in their estimation) too low. The transaction may also be attractive as a way of taking the corporation “private,” i.e., getting rid of the “public” shareholders and not having to continue complying with all the reporting and other regulatory requirements imposed on “public” companies by the SEC, stock exchanges, and others.
The transaction is controversial mainly because it results in businesses taking on a lot of debt (which, in some cases, the corporations haven’t been able to repay). The debt itself ( e.g., in the form of “junk bonds”) may also be controversial, particularly when people (the proverbial “widows and orphans”) buy it who shouldn’t take on such a risky investment.
That’s my 2 cents.
The book (and movie) Barbarians At The Gate is about the battle that took place for RJR Nabisco in the 80’s. Probably not what you’re looking for, because it’s a long book. James Garner is in the movie, though I haven’t seen it yet.
I read the book, I didn’t necessarily understand all of it, but it looks like tullius did a good job of explaining it.
In the book (and real life) the management group, headed by Ross Johnson, would have had to cut a lot of the perks (company planes, cars, vacations, etc.) that the executives enjoyed because of all the debt the company would have had to take on.
My memory is failing me right now, and I’m not remembering much else about the book (too young to remember when it happened for real). The major players for the company were the management group with Ross Johnson, RJR’s CEO at the time, and KKR. I can’t remember the right name for what KKR is off the top of my head; I think they’re kind of like a holding company though. I think Michael Milken was involved with the financing (read: junk bonds) for the deal. Ross Johnson kind of fell off the face of the earth as far as I know.