Friday, June 20



Leveraged buy-out is a corporate finance method under which a company is acquired by a person or entity using the value of the company's assets to finance its acquisition; this allows for the acquirer to minimize its outlay of cash in making the purchase.
A leveraged buyout may also be referred to as a hostile takeover, a highly-leveraged transaction, or a bootstrap transaction.

In other words a LBO is a company acquisition method by which a business can seek to takeover another company or at least gain a controlling interest in that company. Special about leveraged buy-outs is that the corporation that is buying the other business borrows a significant amount of money to pay for (the majority of) the purchase price (usually over 70% or more of the total purchase price).
Furthermore, the debt which has been incurred is secured against the assets of the business being purchased along with the acquiring company. Interest payments on the loan will be paid from the future cash-flow of the acquired company or the ‘joint’ company.

Leveraged buy-outs became very popular in the 1980s, as public debt markets grew rapidly and opened up to borrowers that would not previously have been able to raise loans worth millions of dollars to pursue what was often an unwilling target. The persons or company doing such a "takeover" often used very little of its own money and borrowed the rest, often by issuing extremely risky, but high interest, "junk" bonds. These bonds, since they were high-risk, paid a high interest rate, because little or nothing backed them up. No surprise some of these LBO's in the 1980s ended disastrous, with the borrowers going bankrupt.

Typical advantages of the leveraged buy-out method include:
· Low capital or cash requirement for the acquiring entity
· Synergy gains, by expanding operations outside own industry or business,
· Efficiency gains by eliminating the value-destroying effects of excessive diversification,
· Improved Leadership and Management. Sometimes managers run companies in ways that improve their authority (control and compensation) at the expense of the companies’ owners, shareholders, and long-term strength. Takeovers weed out or discipline such managers. Large interest and principal payments can force management to improve performance and operating efficiency. This “discipline of debt” can force management to focus on certain initiatives such as divesting non-core businesses, downsizing, cost cutting or investing in technological upgrades that might otherwise be postponed or rejected outright. In this manner, the use of debt serves not just as a financing technique, but also as a tool to force changes in managerial behavior.
· Leveraging: as the debt ratio increases, the equity portion of the acquisition financing shrinks to a level at which a private equity firm can acquire a company by putting up anywhere from 20-40% of the total purchase price.
· Critics of Leveraged buy-outs indicated that bidding firms successfully squeezed additional cash flow out of the target’s operations by expropriating the wealth from third parties, for example the federal government. Takeover targets pay less taxes because interest payments on debt are tax-deductible while dividend payments to shareholders are not. Furthermore, the obvious risk associated with a leveraged buyout is that of financial distress, and unforeseen events such as recession, litigation, or changes in the regulatory environment can lead to difficulties meeting scheduled interest payments, technical default (the violation of the terms of a debt covenant) or outright liquidation. Weak management at the target company or misalignment of incentives between management and shareholders can also pose threats to the ultimate success of an Leveraged buy-out.

Firms of all sizes and industries may be the targets of a leveraged buyout, but because of the importance of debt and the ability of the acquired firm to make regular loan payments after the completion of a leveraged buyout, some features of potential target firms make for more attractive leverage buyout candidates, including:
· Low existing debt loads
· A multi-year history of consistent and reliable cash flows
· Hard assets (property, equipment, real-estate, inventory) that may be used as collateral for new debt
· The potential for new management to make operational or other improvements to the firm to boost cash flows
· Temporary market conditions that are depressing current valuation or stock price


Case Study –

About Tata Steel

Established in 1907, Tata Steel is Asia’s first and India’s largest integrated private sector steel company with 2005/06 revenues of US$5 billion and crude steel production of 5.3 million tonnes across India and South-East Asia. It is a vertically integrated manufacturer and is one of the world’s most profitable and value creating steel companies. In 2005, Tata Steel acquired 100% equity interest in NatSteelAsia in Singapore and in 2006 acquired majority control of Millennium Steel in Thailand, now Tata Steel Thailand.

About Corus

Corus is Europe’s second largest steel producer with revenues in 2005 of £9.2 billion (US$18 billion and crude steel production of 18.2 milliontonnes, primarily in the UK and the Netherlands. Corus provides innovative solutions to the construction, automotive, packaging, mechanical engineering and other markets worldwide. Corus has 41,100 employees in over 40 countries and sales offices and service centres worldwide. Combining international expertise with local customer service, the Corus brand represents quality and strength.

Acquisition of Corus and its Financing
a) Corus Acquisition Process
On 20th October 2006, the Boards of Tata Steel, Tata Steel UK (100% subsidiary of Tata Steel) and Corus reached an agreement on the terms of a recommended acquisition of the entire issued and to be issued share capital of Corus, at a price of 455p in cash for each Corus share. This was to be implemented by means of a Scheme of Arrangement under Section 425 of the UK Companies Act, 1985, and the relevant scheme document was sent to the Corus shareholders on 10th November, 2006.
Subsequently, a competitive situation emerged when a Brazilian steel company - Companhia Siderurgica Nacional(CSN) subsequently approached Corus with a proposal to make a cash offer. While Tata Steel revised its offer to 500p per share, CSN made a binding offer at 515p per share in December 2006. The Board of Corus recommended CNS’s offer to the shareholders.
As the process got extended, the Panel on Takeovers and Mergers in the UK (the Panel) set a deadline of 30th January, 2007 as the final date by which Tata Steel and CSN could revise their offers for Corus Group plc. The Panel subsequently announced in January 2007 that in order to provide an orderly resolution to this competitive situation, an auction process would be held on 30th January, 2007 to establish final bids from both Tata Steel and CSN. This auction process began in the evening of 30th January (Indian time) and ended in the early hours of 31st January, 2007 (Indian time) when the Panel announced that Tata Steel has won the auction to acquire Corus at a price of 608p per share.
The Board of Corus subsequently recommended the Tata Steel offer to its shareholders who voted to approve Tata Steel’s Scheme of Arrangement, at an Extra-Ordinary General Meeting held on 7th March, 2007. Corus’ shares were subsequently suspended from trading on each of the London, New York and Amsterdam Stock Exchanges and the Scheme became effective on 2nd April, 2007.

b) Corus Financing Structure
The financing structure of the Corus transaction as on date is given below:
The above financing structure is being re-organised to achieve fiscal unity in Netherlands and consequent tax efficiencies.

c) Corus Financing
On 2nd April, 2007, Tata Steel completed its acquisition of Corus Group plc (Corus) at a price of 608p per ordinary share in cash. The net funding requirement for the acquisition of Corus was Rs. 56,150 crores (USD 12.90 billion). The acquisition was initially funded by a cash contribution by Tata Steel of Rs. 11,750 crores (USD 2.7 billion) (funded by a mixture of its own cash resources and syndicate loans) to Tata Steel Asia Holdings Pte. Ltd. (TSAH). TSAH raised bridge loans of Rs. 10,900 crores (USD 2.5 billion) and Tulip UK Holdings raised a mezzanine loan of Rs. 2,600 crores (USD 0.6 billion) which was invested by way of equity in Tata Steel UK Ltd. To finance the balance ofthe consideration due under the acquisition, Tata Steel UK Ltd. (through its wholly owned subsidiary, Tulip Finance Netherlands BV) raised senior debts of Rs. 17,400 crores (USD 4.0 billion) and Mezzanine bridge of Rs. 13,500 cores (USD 3.1 billion). These loans were raised without recourse to Tata Steel.
At the Board Meeting held on 17th April, 2007, Tata Steel’s Board approved the long term funding arrangement for the acquisition of Corus as per details given below:

Equity Capital from Tata Steel Ltd. Rs. 17,850 Crore (US$ 4.10 bn)
Quasi - Equity / long term funding Rs. 11,570 Crore (US$ 2.66 bn)
Total Equity and Quasi-Equity contribution (a) Rs. 29,420 Crore (US$ 6.76 bn)
Non-recourse long-term debt at Corus (b) Rs. 26,730 Crore (US$ 6.14 bn)
Total (a+b) Rs. 56,150 Crore (US$ 12.90 bn)

The Company proposes to infuse USD 4.1 billion as equity to part finance the transaction. The equity will comprise of USD 700 million from internal generation, USD 500 million of external commercial borrowings, USD 640 million from the preferential issues of equity shares to Tata Sons Ltd. in 2006- 07 and 2007-08, USD 862 million from a rights issue of equity shares to the shareholders, USD 1000 million from a rights issue of convertible preference shares and about USD 500 million from a foreign issue of equity-related instrument.


Valuation of Corus Group plc
The Enterprise Value (EV) of the Corus acquisition was around Rs. 59,850 crores (USD 13.75 billion), which includes its continuing debt of Rs. 3,700 crores (USD 0.85 billion). The Enterprise Value/tonne of the Corus acquisition works out to around Rs. 32,700/tonne (USD 751/tonne) based on Corus’ actual crude steel production of 18.3 million tonnes in 2006 and Rs. 28,250/ tonne (USD 649/tonne) based on its crude steel capacity.
Source: Tata steel 0607 Annual Report

Tata Steel Growth Strategy

In 2005, the Company made long term plans of becoming a 50 million tonne steel producer by 2015 having multi-locational manufacturing facilities with strong regional presence focusing mainly on auto, packaging and construction sectors across the global markets. The long term growth plans of Tata Steel are focused on the following levers:

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