PC manufacturer Dell is ready to go private in a $24.4-billion buyout. The company which is facing slump will pay its stockholders $13.65 per share to leave the company on its own. The company will be sold to a group of investors that includes investment firm Silver Lake. Once this is done, DELL will stop trading on the NASDAQ.
Dell did rapid growth through the 1990s which brought its founder Michael Dell into one of the world’s richest people. Michael Dell, who owns nearly 16% stake in the company, will remain the CEO after the sale closes. Dell’s sale is the highest-priced leveraged buyout of a technology company.
What is a “Leveraged buyout (LBO)”?
- LBO = Acquisition of a company (or a part of a company or it can also be single asset like a real estate) using a substantial amount of borrowed money (bonds or loans / debt) to meet the cost of acquisition.
- The financial buyer (e.g. private equity fund) puts a small amount of equity (relative to the total purchase price) and utilizes leverage (debt or other non-equity sources of financing) to fund the rest of the amount that is paid to the seller.
- LBOs can have many different forms such as Management Buy-out (MBO), Management Buy-in (MBI), secondary buyout, tertiary buyout, etc.
Can LBO be employed in public companies also?
- YES. Though, mostly LBOs occur in private companies, but it can also be employed with public companies.
The +ves of Leveraged buyout::
- In LBO transactions, financial buyers seek to generate high returns on the equity investments and use financial leverage (debt) to increase these potential returns.
- Financial backers of Dell are of the view that it will be easier to engineer a turnaround without having to pander to the stock market’s fixation on whether the company’s earnings are growing from one quarter to the next.
- Taking the company private will leave it without publicly traded shares to attract and reward talented workers or to help buy other companies.
The -ves of Leveraged buyout:
- LBOs need companies to reserve some of their incoming cash to reduce the debt taken on as part of the process of going private.
- The obligations mean Dell will have less money to invest in innovation and expansion of its business.
Equity holders – Risk arises due to significant financial leverage. Interest amount that has to be paid for the debt taken by the company are are "fixed costs" and thus they can in future force the company into default if they not paid.
Debt holders – The debt holders assume the risk of default compared with higher leverage as well, but as they have claims on the assets of the company, they are likely to realize a partial, if not full, return on their investments, even in bankruptcy.
What is “Management Buyout (MBO)”?
MBO is quite similar to a LBO, but the difference is that in an MBO the Management Team of the target company acquires the company instead of a financial sponsor as in case of a LBO.
Example: Mr. Ram is the sole owner of XYZ company. Mr. Ram is now 65 years old and is set to retire in coming months and exit the business. Now, the Higher Management Team at the company believes strongly that the company has good future ahead and so the Management people come together and they buy out the Mr. Ram’s (owner’s) equity in the company and assume control in the XYZ company.