This report provides a comprehensive survey of leveraged buyouts (LBOs), examining their motivations, structures, and the wealth creation processes. LBOs are defined as acquisitions financed primarily through debt, usually resulting in the target company being taken private.

Motivations for LBOs

The primary motivations behind LBOs include tax benefits, reduction of agency costs, wealth transfers from stakeholders, and improvement in operational efficiency. The report identifies several hypotheses explaining these factors, including incentive realignment, control benefits, and free cash flow hypotheses.

Wealth creation and agency costs

Agency cost reduction is a significant driver of LBOs. By aligning management and shareholder interests, LBOs reduce the inefficiencies in public corporations. The report presents evidence of performance improvements post-buyout, especially in management buyouts (MBOs). Kaplan (1989) finds that firms undergoing LBOs often increase operating margins and asset turnover, supporting the incentive realignment hypothesis. Moreover, the restructuring efforts post-buyout, such as cost reductions and a renewed focus on core operations, play a pivotal role in wealth creation.

Stakeholder wealth transfers

Wealth transfers, particularly from bondholders, are another key aspect of LBOs. The report discusses empirical studies demonstrating bondholder losses, especially when protective covenants are absent. For example, Warga and Welch (1993) report an average bondholder loss of 1.08% in LBO transactions. However, evidence suggests that shareholder wealth gains are primarily driven by operational improvements rather than wealth expropriation. In some cases, LBOs have also been linked to slower employment growth compared to industry peers, although employment levels generally remain stable or grow post-buyout.

Tax considerations

The tax shield provided by debt financing is a crucial factor in LBOs. The report highlights that while tax benefits contribute to value creation, they are not the primary source of wealth gains in most transactions. Empirical studies suggest that tax benefits account for 10-30% of the total value generated in LBOs, depending on the specific structure and jurisdiction.

Operational improvements

Post-buyout operational improvements are critical to the success of LBOs. Studies show that firms typically improve their cost efficiency, capital allocation, and management practices. For example, Opler (1992) reports that operating cash flows increase by an average of 40% in the first three years following a buyout. Additionally, LBO firms tend to invest more in long-term innovation, especially in private-to-private transactions, contributing to sustained value creation.

LBO Trends

The report discusses the resurgence of LBOs in the early 2000s, driven by increased access to private equity and favourable interest rates. Data from the UK and Europe show a rise in both the number and value of public-to-private transactions during this period. However, recent evidence indicates that the value creation potential of LBOs has diminished due to increased competition and higher acquisition prices. Furthermore, the average duration of private ownership following an LBO is around 3.5 years, with extended durations often leading to decreased returns.

Recommendations

The report recommends further research into the post-buyout phase of LBOs, particularly in private-to-private transactions. Additionally, it suggests that regulators should focus on improving bondholder protection through covenants, as bondholders are often negatively affected in LBO transactions.

Conclusion

Overall, the report provides a detailed analysis of the mechanisms and outcomes of LBOs, combining both theoretical perspectives and empirical evidence. It concludes that LBOs can create substantial value through improved efficiency, although the benefits may be partially offset by stakeholder wealth transfers and market competition. The role of restructuring and innovation post-buyout also emerges as significant contributors to the long-term success of LBOs.