Leveraged Buyout

Leveraged buyout (LBO) is defined as the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. The asset of the company that has been acquired is used as collateral for the loans in addition to the assets of the acquiring company. Leveraged buyout is also known as hostile takeover, a highly-leveraged transaction, or a bootstrap transaction 

The main purpose of this concept of leveraged buyout is to allow companies to make large acquisitions without having to commit a lot of capital. When the new company takes over the control and is acquired, the company is often made private, so that the new owners have more leeway to do what they want with it. The result is that it involves splitting up the corporation and selling the pieces of it for a high profit, or liquidating its assets and dissolving the corporation itself.

The LBO usually involves a ratio of 90% debt to 10% equity. Since the density is so high of the debt/equity ratio, the bonds are not considered of the investment grade and are referred to as junk bonds. The concept of the leveraged buyout in finance had first originated in the late 1960s. In the 1980s it was a situation when several prominent buyouts led to the eventual bankruptcy of the acquired companies. The reason was that the leverage ratio was nearly 100% and the interest payments were so large that the company's operating cash flows were unable to meet the obligation.

An example of one of the largest LBOs on record was the acquisition of HCA Inc. in 2006 by Kohlberg Kravis Roberts & Co. (KKR), Bain & Co., and Merrill Lynch. These three companies had together paid around $33 billion for the acquisition. The main idea is that a company's success (in the form of assets on the balance sheet) can be used against it as collateral by a hostile company that acquires it. Due to this some consider the LBOs as ruthless.

Questions:

• What is a leveraged buyout?
• How do the new company mange the acquired company?