The leveraged buyout (LBO) transaction is the acquisition of a company, division, business or set of assets ("target") using debt to finance a large part of the remainder of the amount is financed using a financial sponsor. The financial sponsor, usually in the form of private equity funds, invests a small percentage of compared to the total value of the acquisition and uses leverage (loans or other sources debt) to finance the remainder of the amount paid to the seller. Oftentimes, the assets of the company to be acquired are used as collateral for the loans, in addition to the acquiring company.
The objective of leveraged acquisitions is to enable financial entities to realize large acquisitions without having to commit a large amount of their equity and equity. Buyers are also looking to maximize the value of the company acquired to its investors by trying to create a new entity stronger and more profitable through the financial and operational synergies planned with the union of the investment fund and the acquired company.
The expectation of leveraged acquisitions is that the acquisition is greater than the interest paid on the debt made for the purchase, therefore, generating compensatory returns for the high degree of indebtedness performed. While the risk of the buyer is minimized due to the use of a small portion of its own capital in the investment, which will result in positive returns with low investment risk. According to McCue and Thompson (2012), the most common way of obtaining debt is the use of the assets of the target company as collateral of your assets will be considered a guarantee if it is not possible for the buyer payment of interest and amortization of the debt. The private equity fund will then use the future cash flow of the acquired company to repay the borrowed loan, but not enough; it will sell parts of this company to pay off the rest of the borrowed amount.
To conduct an LBO, the buyer must make sure that the target assets are as collateral for the loan required for the acquisition. The private fund should also analyze and project the combined entity's financial certify that they will generate enough cash to cover interest and principal payments, at the same time as it should generate a return on the investment made to shareholders. In some cases, maintaining the ideal cash flow can be a challenge if the target management team leaves after the acquisition, making the implementation of the planned synergies much more difficult (McCue, 2012).
Once the buyer has determined that LBO is financially viable, he starts searching for funding sources for your project. In some cases, funding is from one or more commercial or investment banks, in other buyer issues debt securities in the open market. Since the transaction offers an entity combined with a high proportion of debt or equity (which can reach 90% of the debt, 10% of capital stock), securities issued are generally valued at a low investment grade, with low liquidity and high volatility.
Leveraged buyouts are usually conducted by private equity firms, is that this form of acquisition gained notoriety in the 1980s with the leveraged acquisition of RJR Nabisco. Private equity firms often specifically raise money to make leveraged acquisitions, times these funds for LBO operations hold hundreds of millions of dollars equity, and it should be considered that these funds would still lend most of the money they will need to purchase their targets. Many LBO funds are large banks such as JP Morgan or divisions of private equity firms such as Carlyle Partners and Blackstone Capital Partners. Generally, private equity firms or divisions of large banks divestment of the acquired company through its sale or making it public with the opening of its shares in the market, usually in the period of five to ten years after its purchase. Taking as a goal the generation of profits, often expected from 15% to 25% compound annually, and the payment of the debt contracted in this period. However, the sale does not always mean that the debt is fully settled, cases in which the act of offering new actions to the public is necessary as an attempt to obtain money for the payment of the debt, an operation classified by Cohn, Mills, and Towery (2014) as a leveraged reverse buyout.
HCA Discount Above The Current Market Price
HCA Healthcare Inc. is a hospital operator with two large resources in this problematic market. To begin with, it has a large scale with 170 hospitals and a market limit of USD 34 Billion. In addition, second, it is in the recession-proof medical care sector, which sees strong demand regardless of commercial or consumer trends. From a valuation perspective, things look very good with an advanced P / E ratio of less than 11. And that despite a red-hot race in 2018, even when the market has melted; HCA shares have risen almost 12% to date. The reason for the resistance is, in part, the strong gains reported in January. These include a 12% increase in income to the highest estimates, a pace on adjusted earnings and modest growth in both admissions and admissions revenue. The strawberry of the dessert was a better guide than expected and the institution of a quarterly dividend of 35 cents payable in March. When you see this kind of growth and this kind of momentum in a troubled market, it's a great sign. But when you see this together with such a low direct P / E, you must act before the negotiation price disappears.
Of course, the health sector, in general, was undervalued last year for a good reason, as Republicans talked about cutting Medicare and revoking Obamacare. However, given the failed health legislation in 2017 and litigation just around the corner, do not expect major changes to interrupt the sector again in the short term. The market discounted HCA shares last year, and now is the perfect time to buy at bargain prices. From the purchase of the buyer can keep a high perceived level of risk. Accordingly, the seller has the ability to fully or partially take the risk. That is what happened when Baxter, one of the leading manufacturers of medical products, offered Columbian HCA (a major health care institution) to acquire an information management system developed specifically for it. For eight years, the system was supposed to save Columbia several million dollars. However, the company refused, and then Baxter gave a guarantee of achieving an economic efficiency. If Columbia does not save the promised amount, Baxter compensates for the difference (Bos & Boselie, 2018). The contract has been signed! The company could go even further and offer this option: if its information system saves more money than promised, then Baxter will receive a certain percentage of the value of additional savings. To guarantee savings and, possibly, to participate in the profits could many companies, especially suppliers of industrial goods.
Company management must also take into account the response to the pricing of other market participants, including distributors, dealers and sales staff. Marketers are required to know the current national legislation affecting pricing issues. US law, for example, requires sellers to set prices on their own, without any negotiations with competitors. An artificial price hike is illegal. Many federal laws protect consumers from the practice of pricing, misleading.
Bos, A., & Boselie, P. (2018). Private equity in health services. The Routledge Companion to Management Buyouts.
Haadsma, C. (2016). Hospital Corporation of America: An Analysis of the Financial Statements of HCA Holdings, Inc(Doctoral dissertation, University of Mississippi, Patterson School of Accountancy).
McCue, M. J., & Thompson, J. M. (2012). The impact of HCA's 2006 leveraged buyout on hospital performance. Journal of Healthcare Management, 57(5), 342-356.
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