Which industries are suitable for leveraged buyouts

Opportunities and risks of externally financed company takeovers - leveraged buyouts (LBO)

Table of Contents

List of abbreviations

List of figures

1 Objective and methodology of this work

2 basics
2.1 Definitions
2.1.1 Mergers & Acquisitions
2.1.2 Leveraged Buyouts
2.1.3 Leverage Effect
2.1.4 Cash flow
2.2 History of the LBO

3 Implementation and technology of an LBO
3.1 Motives of the groups involved
3.2 Evaluation phase
3.2.1 Properties of the target object
3.2.2 Contract and Purchase
3.3 Investment phase
3.3.1 Increase in value and strategic reorientation
3.3.2 Return flow from the investment
3.4 Exit phase

4 Analysis of the current situation
4.1 Review & actual situation
4.2 Current: Real estate crisis
4.3 Macroeconomic Aspect

5 Opportunities & Risks of LBO
5.1 Opportunities & advantages
5.1.1 For the individual company
5.1.2 Macroeconomic
5.2 Risks & Disadvantages
5.2.1 For the individual company
5.2.2 Macroeconomic

6 Conclusion and Outlook

Appendix 1: Definition of financial investor

Appendix 2: Definition of Lenders

Appendix 3: Defense options of the target object

Appendix 5: Key Figures

Appendix 5 case studies:


List of abbreviations

Figure not included in this excerpt

List of figures

Figure 1 Development of the LBO volume worldwide and in Germany

Figure 2 Simplified acquisition structure and cash flows

Figure 3 Strategic reorientation

Figure 4 Simplified representation of the LBO total return

Figure 5 Exits 2006

Figure 6 Overview of opportunities and risks

Figure 7 Investment structure 2006

Figure 8 The 10 largest takeover funds in 2006

Figure 9 Private Equity Capital in Germany 2006

Figure 10 Lenders of the largest buyouts

Figure 11 Total debt to EBITDA (Europe)

1 Objective and methodology of this work

The term leveraged takeover describes a technology for company acquisition that has been known in the United States since the late 1960s. In Europe, the concept first gained popularity in Great Britain and, since the 1990s, in Germany as well. Due to the economic upswing and cheap loans at good conditions, takeovers financed by outside or also leveraged buyouts (LBO)[1], has become an integral part of the German investment market. Almost 1 million employees and growth rates that are well above the national average , go to the account of financial investors.[2] The efficiency of this industry is also noteworthy, with the largest in the industry such as Blackstone or KKR sometimes showing substantial returns of over 40%. LBOs are the most common form of investment for these private equity firms[3] and thus the image of the LBO inevitably depends on that of the private equity industry and vice versa.

However, there have always been and still are critical voices that emphasize the risk of debt-financed transactions in particular. Furthermore, the image of the "locusts" still exists in public opinion today, who buy up companies, remove the substance and then drop it.[4] However, statistical figures show the opposite. So how are LBOs to be rated? Do they increase the efficiency of the markets or are they capitalist robber barons who take what they can get , without taking any social responsibility into account.

The aim is to clarify whether LBOs represent a risk for sole proprietorships as well as for the national economy or whether they are an opportunity to carry out macro- and micro-economic change.

For this purpose, the basics of the LBO concept are explained in the first part of this thesis, i.e. the central terms are first defined. This is followed by a brief historical review and then details of the implementation and technique of an LBO. In particular, the three phases evaluation, investment and exit are dealt with.

The second part begins with the analysis of the current situation. First of all, a brief review of the last few years is given, as well as the current situation. Building on this, the macroeconomic aspect is shown. The analysis of the current situation also includes a brief excursus about the American real estate crisis and is followed by a detailed discussion of the opportunities and risks of LBO, for the individual companies as well as for the entire economy. The thesis concludes with a summary of the main content and a brief outlook on the buy-out market in the future.

Due to the difficulty of differentiating between individual buy-out types and the fact that in practice most takeovers are in the form of an LBO[5], in the following the term LBO will be used as a synonym for all buy-outs.[6]

The focus of this work is on the German market and, according to the title, concentrates on the opportunities and risks of the LBO. Accordingly, details of the takeover process or the transaction, as well as due diligence and legal details are not deepened.

2 basics

2.1 Definitions

2.1.1 Mergers & Acquisitions

The term Mergers & Acquisitions (M&A) comes from the Anglo-Saxon language area and can be translated into German with mergers and acquisitions.

A generally applicable definition has not yet established itself in the literature, but in a broader sense all processes are described that are associated with the acquisition and sale of companies.[7]

M&A also describes the industry of the service providers involved.

In the context of this work, the focus is particularly on financial investors from the private equity industry and strategic investors.[8]

2.1.2 Leveraged Buyouts

One speaks of leveraged buyouts or German debt-financed takeovers, if the acquisition of a company takes place with the inclusion of a large proportion of debt capital. It is not precisely defined , From what proportion of borrowed capital it is an LBO, a rate of 70 to 100% is generally assumed.[9]

The investor tries to achieve a higher return on his invested capital through the high proportion of borrowed capital. He uses the leverage effect, which works if the cost of debt is lower than the return on total capital. Assets of the acquired company (target) are used as collateral for the borrowed capital.[10] The interest and principal payments are made from the future income of the company taken over and / or through the sale of assets.[11]

In simplified terms, the overall result of the LBO investment results from the capital invested for the purchase, funds withdrawn during the investment and the sales price.[12]

2.1.3 Leverage Effect

The concept of leveraged buyouts is closely related to the leverage effect known from financial theory[13] (leverage) together. The leverage effect of the leverage effect is determined by the level of the borrowing rate and the overall profitability. If the interest rate on borrowed capital is lower than the return on total capital, the return on equity increases with the addition of borrowed capital. This is referred to as a “positive leverage effect”; as the level of debt increases, the return on equity increases.[14] With the LBO, the leverage effect lies in the presentation of a high purchase price with little use of own funds. However, the leverage effect also harbors a high risk, since it can also have a downward effect to the same extent if the cost of borrowing is higher than the overall profitability. The result is then the destruction of equity.

2.1.4 Cash flow

The most important metric for an LBO transaction is the free cash flow[15], since this is essential for the repayment of the debt and its interest.[16]

The cash flow is a consideration of payment flows. This becomes clear when the term is literally translated as “flow of liquid funds”.

The cash flow is used to determine a financial surplus that is independent of the valuation and that eliminates the distortions in the statement of expenses and income when determining profits in the annual financial statements. In this way, you get a more detailed insight into the financial and earnings position and look at the company more from a financial point of view.[17]

Accordingly, cash flow is the most important indicator of debt capacity.

2.2 History of the LBO

So-called “bootstrapping deals” existed in the USA as early as the 1960s, whereby acquisitions were financed with a high proportion of borrowed capital and debt was reduced from the cash flow.

After these first early forms of leveraged takeovers, a comprehensive LBO concept was developed in the USA a few years later.[18]

With the first LBO “mega deals” in the 80s, the concept also gained popularity in Europe, especially in Great Britain.[19] Other countries with strongly increasing LBO activities were France and the Netherlands. In Germany, LBO transactions only gained importance in the mid-1990s. Up to this point in time, the annual volume in Germany was well below EUR 1 billion. By 1997, however, this value quadrupled and rose from peak to peak in the years to come.[20] In 2006 the volume of LBO transactions on the German market already amounted to EUR 2.6 billion.[21]

Figure not included in this excerpt

Figure not included in this excerpt

Figure 1 Development of the LBO volume worldwide and in Germany

Source: Own illustration, see BVK annual statistics 2006 and Oglesby / Popowitz / Bowen (2006).

3 Implementation and technology of an LBO

3.1 Motives of the groups involved

The interests of LBOs are complex. For buyers, sellers and lenders, there are sometimes very different motives for carrying out an LBO:


The buyers are either strategic investors or financial investors in the private equity industry[22]. The strategic investor is primarily interested in the know-how and market share of the target company. This is a competitor or a company that wants to operate in the target company's market.[23]

The interests of individual investors, on the other hand, are primarily the prospect of a high return on investment.

Thus, the large funds and investment companies, i.e. financial investors who manage the money of the individual investors, also pursue this goal with the aim of achieving an above-average return, in particular through the highest possible profit on resale.[24] In the case of high transaction volumes, several buyers usually join forces, such buyer associations are called club deals.[25]


The seller pursues different interests, depending on the reasons for the sale of all or part of the company. Apart from the fact that he usually tries to achieve the maximum sales revenue, his further motives can be varied. Mention should be made here of an unresolved corporate succession, as well as the need for restructuring or reorganization.

For state-owned companies, savings incentives, increased efficiency and debt repayment are often a motive.[26] A sale of state-owned companies is called privatization.


The motives of the lenders[27] are similar to those of financial investors. You hope for a higher return than with alternative transactions. In addition, there is possible cross-selling potential such as consulting services or the asset management of the previous owner.[28]

3.2 Evaluation phase

3.2.1 Properties of the target object

In the literature there are numerous requirement profiles and characteristics that a company should have that is eligible for an LBO. Such requirement profiles outline an “ideal candidate” and can usually never be 100% fulfilled. However, they offer a way of roughly assessing and describing the profile of a company. The following requirements should be met[29]:

- steady, high cash flow
- demonstrably historically above-average profitability
- underutilized debt capacity
- Partial decomposition option
- strong experienced management team
- established market position
- high market share
- Prospect of a successful exit
- Inexpensive production techniques
- growth potential
- To a large extent independence from economic fluctuations
- Products independent of technological change
- Oligopolistic market
- Excellent company from the production sector, no service.

The more these success factors are met, the more attractive the company is for an LBO and the lower the risks for those involved.

The most important key figure for an LBO transaction is in particular the free cash flow[30], since this is essential for the repayment of the debt and its interest.[31]

Also of great importance are the cyclical dependency, profitability, an experienced management team and an established market position.[32] Accordingly, it becomes clear that industries in which high investments in research and development have to be made, such as high-tech industries, are rather unsuitable for an LBO.[33]

3.2.2 Contract and Purchase

After the motives of those involved and the requirements for the company to be bought have been presented, the implementation of the takeover will now be discussed in more detail.

The buying process often takes place in the context of auctions, i.e. the seller sells his company to the best-bidding buyer through a structured process. In the event of a positive result on both sides, the lender and the investors will receive the confidential documents on the basis of which they can then decide whether to participate in the transaction.[34]

It should be noted that the LBO's initial opportunities to increase in value arise when the company is purchased, and indeed when it is bought relatively cheaply, without disclosing possible approaches and potentials for increasing value.[35]

After the financing has been bindingly clarified, lengthy contract negotiations with the “Board of Directors” can follow. The buyers submit an offer to buy and the representatives of the owners try to get the highest possible price for the shareholders. If an agreement can be reached, a merger agreement will be drawn up. The last hurdle is now ultimately only the merger control procedure.

If the target company is, for example, a stock corporation, the acquisition of the shares must be approved by the stock exchange supervisory authority and confirmed in a shareholders' meeting to be convened.[36]

Figure not included in this excerpt

Figure 2 Simplified acquisition structure and cash flows Source: Own illustration

The figure shows the flow of a typical transaction. In the case shown, the purchase price of the company is EUR 20 billion, 80% of which is paid with borrowed capital.[37] As a rule, the buyer sets up an acquisition company specifically for the takeover, this serves as a pure takeover vehicle and does not conduct any operational business. Lenders and equity providers pass their financial resources on to the acquiring company accordingly. This then completes the transaction.

3.3 Investment phase

3.3.1 Increase in value and strategic reorientation

"When the deal is closed, the work begins"[38]

Under the pressure of borrowed capital, restructuring now follows immediately, i.e. intensive measures to reduce costs and increase efficiency are carried out. With the help of increased productivity, the debt component is repaid as quickly as possible and brought to a normal level that is customary in the industry. At the same time, a consolidation is carried out. The financial sector is particularly focused, but other areas such as personnel management, marketing and production are also being consolidated.[39]

After the consolidation, which is heavily influenced by financial issues, such as the introduction of a cash flow oriented reporting system[40], the company will put growth targets in the foreground as soon as possible and drive forward the strategic reorientation.

Investment companies do not see their role as active shareholders in the company, but only in accompanying the management team. The buyout company advises and supports, but only the management can ultimately increase the company's value through successful business.[41] The first strategic phase therefore includes a vision based on corporate philosophy and corporate mandate. This vision becomes a basic strategic attitude with internal and external reviews.

Figure not included in this excerpt

Figure 3 Strategic reorientation

Source: Own illustration, cf. Hax, A./Maglaf, N. (1988), p.69.

In the vision, a picture is drawn of how the company is desired. This picture is then compared with the current situation and the relevant future scenarios of the internal and external environment in order to obtain the basic strategic attitude - a kind of company guide - as a result.Based on this basic attitude, the strategies on the individual levels must then be developed and coordinated with the overall strategy.

For this rough initial analysis and the following structuring and support of a value enhancement program, at least three months of working time must be expected.[42]

3.3.2 Return flow from the investment

An important investment criterion is the possibility of realizing the return on investment after a certain period of time. After the borrowed capital has been repaid and brought to a level customary in the industry, the return on investment is realized, depending on the investment motive of the different investment groups.[43]

Purchase price surplus after loan repayment Selling price return

Figure not included in this excerpt

Figure 4 Simplified representation of the LBO total return

Sources: Own illustration

Figure 3 shows the return on the investment. It results from the sales proceeds and income during the investment phase, minus debt capital and debt repayment. The following example shows this:

Statistically, it should be added that the managers and conservative funds involved are more interested in long-term capital investments, whereas classic buyout companies plan to exit after a maximum of 8-10 years from the start. The typical duration of participation is 3-5 years.[44]

The returns of buyout companies are usually over 20%, the five leading funds even achieve returns of over 40%.[45]

3.4 Exit phase

Buyout companies are temporary investors, often due to the term of the funds. After a period of time that is usually set in advance, the investment leaves the investment, the so-called exit. There are the following options:

a) Sale to management

If the financial strength of the management allows it, there is a possibility that it will take over the divested shares of the investor. In this way, management has the opportunity to become completely independent entrepreneurs. This way is called buy-back.[46]

b) Sale to a financial investor

When selling to an investor, there is a so-called secondary buy-out.[47]

For a financial investor to be interested, it is crucial that the company still has sufficient growth potential.

c) Sale to strategic buyers

Reselling to a strategic buyer, also known as a trade sale, is easier, faster and cheaper than going public.[48] In addition, the equivalent value is often paid in one sum immediately after the contract is concluded, which minimizes the risk. Strategic buyers are often competitors who want to gain market share or know-how.

d) Selling on the stock exchange

When selling on the stock exchange, shares of the previously private company are offered on the capital market.

The advantage of the stock market placement is the freely determinable starting point. The reputation gain that can be achieved through a successful IPO and the possibility of financing via the capital markets are also positive for the company. Selling on the stock exchange can generate the highest profits, but as Figure 5 shows, it still only accounts for the third largest share of the total volume. The reason for this is the higher risk, in particular due to the costs of an IPO and the inevitable diversification of company shares.[49]


[1] The terms leveraged takeover, leveraged buyout (LBO) and buyout are used synonymously in the following.

[2] Further information can be found in Appendix 1

[3] See BVK annual statistics 2006 (2007) p. 2, also Rosarius, S. (2007), p. 36.

[4] The "locust debate" was brought to life through an interview with Franz Müntefering in Bild am Sonntag, April 17, 2005.

[5] See ECB Monthly Bulletin August 2007, (2007) p.89.

[6] Other forms of buyout include management buyouts (MBO), owner buyouts (OBO) and employee buyouts (EBO).

[7] See Lucks / Meckl, (2002) p.24.

[8] See chapter 3.1.

[9] See Loader, D. (2007), p.52.

[10] See Zerey, J.C. (1994), p.32.

[11] See Stahl / Diegelmann / Wiehle, (2005) p.41.

[12] See chapter 3.3.2.

[13] See Modigliani / Miller (1958), pp. 261-297.

[14] See Steifl, J (2003), p.119.

[15] A detailed consideration of the calculation method will not be discussed at this point, however, a simplified calculation is shown in Appendix 4, excluding extraordinary effects.

[16] See Michael / Shaked (1988), p.47.

[17] See von Düsterlho (2003), p.39.

[18] See Graebner A.C.G. (1991), pp. 37-38.

[19] See Crawford, E.K. (1987), p.3.

[20] See chapter 4.1.

[21] See BVK annual statistics 2006 (2007), p.2.

[22] See Appendix 1, definition of financial investor, private equity and buyout company.

[23] See Wolf / Hill / Pfaue (2003), p.131.

[24] See Bruun C.W. (2007), p.1.

[25] See Bruun C.W. (2007), p.32.

[26] See Stadler (2000), p. 129.

[27] See Appendix 2, definition of debt capital providers and Rosarius (2007), p.37.

[28] See Wolf / Hill / Pfaue (2003), p.127.

[29] See Olsen (2003), p.4, as well as Pointl (2003), p.538 and Kohlberg Kravis Roberts & Co (KKR) (1989), p.5-2.

[30] See chapter 2.1.3.

[31] See Michael / Shaked (1988), p.47.

[32] See Graebner, Ulrich A.C. (1991), p.19.

[33] See Regehr, F. (1999), p.129.

[34] See Wolf / Hill / Pfaue (2003), p.142.

[35] See Mehrer (2004), p.13.

[36] See Wirtz (2006), pp. 613-640.

[37] Loans are usually granted in several tranches at different conditions. These different loans (e.g. senior debt, junior debt, mezzanine capital and high yield bonds) are summarized as debt capital (FC).

[38] Raether in Baker / Smith (1998).

[39] See Wright, M. et al. (1987) pp. 86-90.

[40] See Wirtz, B.W. (2006), p. 172.

[41] See Wirtz, B.W. (2006) p.168.

[42] See Baur / Liebler (2001), p.139.

[43] See Bruun (2007), page 24, see also Appendix 5 Key figures.

[44] Cf. EVCA: Six key misconceptions regarding buyouts (2007), pp. 2-3, also ECB: Monthly Bulletin August 2007 (2007), p. 91.

[45] See Olsen J. (2003), p.1, and Roland Berger Strategy Consulants Outlook 2008 (2007), p.1.

[46] See von Daniels, H. (2004), p.52.

[47] See Wolf / Hill / Pflaue (2003), p. 135.

[48] See Mehrer C. (2004), p. 35.

[49] See . EVCA: Six key misconceptions regarding buyouts (2007) p. 4, as well as Mehrer C. (2004), p. 34.

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