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Chapter 13: FINANCING THE DEAL
Private Equity, Hedge Funds, and Other Sources of Financing
Examination Questions and Answers
1. Leveraged buyout firms use the unencumbered assets and operating cash flow of the target firm to finance the
transaction. True or False
2. Accounts receivable represent an undesirable form of collateral from the lender’s point of view because they
are often illiquid. True or False
3. Because of their high liquidity, lenders often lend up to 100% of the book value of accounts receivable
pledged as collateral in leveraged buyouts. True or False
4. A negative loan covenant is a portion of a loan agreement that specifies the actions the borrowing firm agrees
to take during the term of the loan. True or False
5. Loan agreements commonly have cross-default provisions allowing a lender to collect its loan immediately if
the borrower is in default on a loan to another lender. True or False
6. Junk bonds are high-yield bonds either rated by the credit-rating agencies as below investment grade or not
rated at all. True or False
7. According to fraudulent conveyance laws, if a new company is found by the court to have been inadequately
capitalized to remain viable, the lender could be stripped of its secured position in the assets of the company or
its claims on the assets could be made subordinate to those of the general creditors. True or False
8. Typical LBO targets are in mature industries such as manufacturing, retailing, textiles, food processing,
apparel, and soft drinks. True or False
9. High growth firms with high reinvestment requirements often make attractive LBO targets. True or False
10. Premiums paid to LBO target firm shareholders often exceed 40%. True or False
11. The high premiums paid to LBO target shareholders reflect the tax benefits associated with the high leverage
of such transactions and the improved operating efficiency following the completion of the buyout resulting
from management incentive plans and the discipline imposed by the need to repay debt. True or False
12. Investors in highly leveraged transactions who are primarily focused on relatively short-to-intermediate term
financial returns are often called financial buyers. True or False
13. When a public company is subject to a leveraged buyout, it is said to be “going private.” True or False
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14. A leveraged buyout initiated by a firm’s management is called a management buyout. True or False
15. Financial buyers usually hold onto their investments for at least 15-20 years. True or False
16. Investors in LBOs are frequently referred to as financial buyers, because they are primarily focused on
relatively short-to-intermediate-term financial returns. True or False
17. LBO capital structures are often very complex, consisting of bank debt, subordinated unsecured debt,
preferred stock, and common equity. True or False
18. LBO investors seldom sell assets to repay debt used to acquire the firm. True or False
19. LBO investors often use public offerings of the firm’s stock or sell the firm to a strategic buyer in order to exit
the business. True or False
20. LBO investors will often use the target firm’s cash in excess of normal working capital requirements to
finance the transaction. True or False
21. Asset based lending does not require the borrower to pledge assets as collateral underlying the loans. True or
False
22. The loan agreement stipulates the terms and conditions under which the lender will loan the borrower funds.
True or False
23. A single asset is often used to collateralize loans from different lenders in LBO transactions. True or False
24. Asset based lenders will usually lend up to 100% if the book value of the LBO target’s receivables. True or
False
25. Cash flow lenders view the borrower’s future cash flow generation capability as the primary means of
recovering a loan, while largely ignoring the assets of the LBO target. True or False
26. Junk bonds have invariably proved to be a reliable source of low-cost financing in LBO transactions during
the last 30 years. True or False
27. Fraudulent conveyance laws are intended to prevent shareholders, secured creditors, and others from
benefiting at the expense of unsecured creditors. True or False
28. To avoid being subject to fraudulent conveyance laws, a properly structured LBO should have a balance sheet
that clearly indicates solvency at the time of closing. True or False
29. The risk associated with overpaying is magnified for leveraged buyout transactions. True or False
30. Under-performing operating units of large companies are often excellent candidates for LBOs. True or False
31. Junk bonds are always high risk. True or False
32. Firms with redundant assets and predictable cash flow are often good candidates for leveraged buyouts. True
or False
33. Common exit strategies for LBOs include sale to a strategic buyer, an IPO, a leveraged recapitalization, or a
sale to another buyout firm. True or False
34. Divisions of larger companies are generally poor candidates for successful leveraged buyouts. True or False
35. Financial buyers usually plan to hold onto acquired firms longer than strategic buyers. True or False
36. Borrowers often seek revolving lines of credit that they can draw upon on a daily basis to run their business.
True or False
37. A term loan usually has a maturity of less than one year. True or False
38. The loan agreement stipulates the terms and conditions under which the lender will loan the firm funds. True
or False
39. An affirmative covenant is a portion of a loan agreement that specifies the actions the borrowing firm cannot
take during the term of the loan. True or False
40. Borrowers often prefer term loans because they do not have to be concerned that these loans will have to be
renewed. True or False
41. LBOs can be of an entire company or divisions of a company. True or False
42. When a public company is subject to an LBO, it is said to be going private, because more than 50% of the
equity of the firm has been purchased by a small group of investors and is no longer publicly traded. True or
False
43. The LBO that is initiated by the target firm’s incumbent management is called a management buyout. True or
False
44. LBO firms seldom purchase a firm to use as a platform to undertake other leveraged buyouts in the same
industry. True or False
45. A common technique used during the 1990s was to wait for favorable periods in the stock market to sell a
portion of the LBO’s equity to the public. The proceeds of the issue would be used to repay debt, thereby
reducing the LBO’s financial risk. True or False
46. LBO investors have become much more actively involved in managing target firms in recent years than they
have in the past. True or False
47. There is some evidence that the Sarbanes-Oxley Act of 2002 has also been a factor in some firms going
private as a result of the onerous reporting requirements of the bill. True or False
48. The growth in LBO activity is not simply a U.S. phenomenon. Western Europe has seen a veritable explosion
in private equity investors taking companies private, reflecting ongoing liberalization in the European Union
as well as cheap financing and industry consolidation. True or False
49. The promissory note commits the borrower to repay the loan, only if the assets when liquidated fully cover the
unpaid balance. True or False
50. If the borrower defaults on the loan or otherwise fails to honor the terms of the agreement, the lender can seize
and sell the collateral to recover the value of the loan only if the borrower agrees that it is unlikely that the
loan will be repaid. True or False
51. Because term loans are negotiated privately between the borrower and the lender, they are much more
expensive than the costs associated with floating a public debt or stock issue. True or False
52. Limitations the lender imposes on the borrower on the amount of dividends that can be paid, the level of
salaries and bonuses that may be given to the borrower’s employees, the total amount of indebtedness that can
be assumed by the borrower, and investments in plant and equipment and acquisitions are called affirmative
covenants. True or False
53. Secured debt often is referred to as mezzanine financing. True or False
54. Bridge financing is usually expected to be replaced within two years after the closing date of the LBO
transaction. True or False
55. Debt issues not secured by specific assets are called debentures. True or False
56. An indenture is a contract between the firm that issues the long-term debt securities and the lenders. True or
False
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57. Preferred stock often is issued in LBO transactions, because it provides investors a fixed income security,
which has a claim that is junior to common stock in the event of liquidation. True or False
58. The acquirer often is asked for a commitment letter from a lender, which commits the lender to providing
financing for the transaction. True or False
59. If the LBO is structured as a direct merger in which the seller receives cash for stock, the lender will make the
loan to the buyer once the appropriate security agreements are in place and the target’s stock has been pledged
against the loan. The target then is merged into the acquiring company, which is the surviving corporation.
True or False
60. LBOs may be consummated by establishing a new subsidiary that merges with the target. This may be done to
avoid any negative impact that the new company might have on existing customer or creditor relationships.
True or False
61. Management buyouts without a financial equity contributor are relatively rare. True or False
62. LBO exit strategies involving selling to a strategic buyer usually result in the best price as the buyer may be
able to generate significant synergies by combining the firm with its existing business. True or False
63. LBOs normally involve public companies going private. True or False
64. Most highly leveraged transactions consist of acquisitions of private rather public firms. True or False
65. Private equity investments are normally focused on the manufacturing industry. True or False
1. Which of the following is generally not true about leveraged buyouts?
a. Borrowed funds are used to pay for all or most of the purchase price, perhaps as much as 90%
b. Tangible assets of the target firm are often used as collateral for loans.
c. Bank loans are often secured by the target firm’s intangible assets
d. Secured debt is often referred to as junk bond financing.
e. C and D only
2. Asset based lending is commonly used to finance leveraged buyouts. Which of the following is not true about
such financing?
a. The borrower generally pledges tangible assets as collateral.
b. Lenders look at the target firm’s assets as their primary protection.
c. Bank loans are secured frequently by receivables and inventory.
d. Loans maturing in more than one year are often referred to as term loans.
e. The target firm’s most liquid assets generally secure longer-term loans.
3. Security provisions and protective covenants are included in loan documents to increase the likelihood that the
interest and principal of outstanding loans will be repaid in a timely fashion. Which of the following is not
true about security provisions and protective covenants?
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a. Security features include the assignment of payments due under a specific contract to the lender.
b. Negative covenants include limits on the amount of dividends that might be paid
c. Limitations on the amount of working capital that the borrower can maintain.
d. Periodically, financial statements must be sent to lenders.
e. Automatic loan repayment acceleration if the borrower is in default on any loans outstanding
4. Which of the following is not true about junk bonds?
a. Junk bonds are either unrated or rated below investment grade by the credit rating agencies
b. Typically yield about 1-2 percentage points below yields on U.S. Treasury debt of comparable
maturities.
c. Junk bonds are commonly used source of “permanent” financing in LBO transactions
d. During recessions, junk bond default rates often exceed 10%
e. Junk bond default risk on non-investment grade bonds tends to increase the longer the elapsed time
since the original issue date of the bonds
5. Which of the following characteristics of a firm would limit the firm’s attractiveness as a potential LBO
candidate?
a. Substantial tangible assets
b. High reinvestment requirements
c. High R&D requirements
d. B and C
e. All of the above
6. Premiums paid to LBO firm shareholders average
a. 20%
b. 70%
c. 5%
d. Less than typical mergers
e. More than typical mergers
7. Factors that are most likely to contribute to the magnitude of premiums paid to LBO target firm shareholders
are
a. Tax benefits
b. Improved operating efficiency
c. Improved decision making
d. A, B, and C
e. A and C only
8. Which of the following is not true about attractive LBO candidates?
a. Most assets tend to be encumbered
b. Have low leverage
c. Have predictable cash flow
d. Have assets that are not critical to the ongoing operation of the firm
e. Are in mature, moderately growing industries
9. Which of the following is generally not considered a characteristic of a financial buyer?
a. Focus on short-to-intermediate returns
b. Concentrate on actions that enhance the ability of target firm’s ability to generate cash flow to satisfy
debt service requirements
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c. Intend to own the business for very long periods of time
d. Manage the business to maximize return to equity investors
e. All of the above
10. Which of the following are commonly used sources of funding for leveraged buyouts?
a. Secured debt
b. Unsecured debt
c. Preferred stock
d. Seller financing
e. All of the above
11. Fraudulent conveyance is best described by which of the following situations:
a. A new company spun off by its parent to the parent’s shareholders that enters bankruptcy is found to
have been substantially undercapitalized when created
b. An acquiring company pays too high a price for a target firm
c. A company takes on too much debt
d. A leveraged buyout is taken public when its operating cash flows are increasing
e. None of the above
12. LBO investors must be very careful not to overpay for a target firm because
a. Major competitors tend to become more aggressive when a firm takes on large amounts of debt
b. High leverage increases the break-even point of the firm
c. Projected cash flows are often subject to significant error limiting the ability of the firm to repay its
debt
d. A and B only
e. A, B, and C
13. LBOs often exhibit very high financial returns during the years following their creation. Which of the
following best describes why this might occur?
a. LBOs invariably improve the firm’s operating efficiency
b. LBOs tend to increase investment in plant and equipment
c. The only LBOs that are taken public are those that have been the most successful
d. LBOs experience improved decision making during the post-buyout period
e. None of the above
14. Which of the following is not typically true of LBOs?
a. Managers are generally also owners
b. Most employees are given the opportunity to participate in profit sharing plans
c. The focus tends to be on improving operational efficiency though cost cutting and improving
productivity
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d. R&D budgets following the creation of the LBO are always increased significantly
e. All of the above
15. Which of the following tends to be true of LBOs
a. LBOs rely heavily on management incentives to improve operating performance
b. The premium paid to target firm shareholders often exceeds 40%
c. Tax benefits are predictable and are built into the purchase price premium
d. The cost of equity is likely to change as the LBO repays debt
e. All of the above
16. An investor group acquired all of the publicly traded shares of a firm. Once acquired, such shares would no
longer trade publicly. Which of the following terms best describes this situation?
a. Merger
b. Going private transaction
c. Consolidation
d. Tender offer
e. Joint venture
17. The management team of a privately held firm found a lender who would lend them 90 percent of the purchase
price of the firm if they pledged the firm’s assets as well as their personal assets as collateral for the loan. This
purchase would best be described by which of the following terms?
a. Merger
b. Leveraged buyout
c. Joint venture
d. Tender offer
e. Consolidation
Case Study Short Essay Examination Questions
"Grave Dancer" Takes Tribune Corporation Private in an Ill-Fated Transaction
At the closing in late December 2007, well-known real estate investor Sam Zell described the takeover of the Tribune
Company as "the transaction from hell." His comments were prescient in that what had appeared to be a cleverly
crafted, albeit highly leveraged, deal from a tax standpoint was unable to withstand the credit malaise of 2008. The end
came swiftly when the 161-year-old Tribune filed for bankruptcy on December 8, 2008.
On April 2, 2007, the Tribune Corporation announced that the firm's publicly traded shares would be acquired in a
multistage transaction valued at $8.2 billion. Tribune owned at that time 9 newspapers, 23 television stations, a 25%
stake in Comcast's SportsNet Chicago, and the Chicago Cubs baseball team. Publishing accounts for 75% of the firm's
total $5.5 billion annual revenue, with the remainder coming from broadcasting and entertainment. Advertising and
circulation revenue had fallen by 9% at the firm's three largest newspapers (Los Angeles Times, Chicago Tribune, and
Newsday in New York) between 2004 and 2006. Despite aggressive efforts to cut costs, Tribune's stock had fallen more
than 30% since 2005.
9
The transaction was implemented in a two-stage transaction, in which Sam Zell acquired a controlling 51% interest
in the first stage followed by a backend merger in the second stage in which the remaining outstanding Tribune shares
were acquired. In the first stage, Tribune initiated a cash tender offer for 126 million shares (51% of total shares) for
$34 per share, totaling $4.2 billion. The tender was financed using $250 million of the $315 million provided by Sam
Zell in the form of subordinated debt, plus additional borrowing to cover the balance. Stage 2 was triggered when the
deal received regulatory approval. During this stage, an employee stock ownership plan (ESOP) bought the rest of the
shares at $34 a share (totaling about $4 billion), with Zell providing the remaining $65 million of his pledge. Most of
the ESOP's 121 million shares purchased were financed by debt guaranteed by the firm on behalf of the ESOP. At that
point, the ESOP held all of the remaining stock outstanding valued at about $4 billion. In exchange for his commitment
of funds, Mr. Zell received a 15-year warrant to acquire 40% of the common stock (newly issued) at a price set at $500
million.
Following closing in December 2007, all company contributions to employee pension plans were funneled into the
ESOP in the form of Tribune stock. Over time, the ESOP would hold all the stock. Furthermore, Tribune was converted
from a C corporation to a Subchapter S corporation, allowing the firm to avoid corporate income taxes. However, it
would have to pay taxes on gains resulting from the sale of assets held less than ten years after the conversion from a C
to an S corporation (Figure 1).
Figure 13.1
Tribune deal structure.
The purchase of Tribune's stock was financed almost entirely with debt, with Zell's equity contribution amounting to
less than 4% of the purchase price. The transaction resulted in Tribune being burdened with $13 billion in debt
(including the approximate $5 billion currently owed by Tribune). At this level, the firm's debt was ten times EBITDA,
more than two and a half times that of the average media company. Annual interest and principal repayments reached
$800 million (almost three times their preacquisition level), about 62% of the firm's previous EBITDA cash flow of
$1.3 billion. While the ESOP owned the company, it was not be liable for the debt guaranteed by Tribune.
The conversion of Tribune into a Subchapter S corporation eliminated the firm's current annual tax liability of $348
million. Such entities pay no corporate income tax but must pay all profit directly to shareholders, who then pay taxes
on these distributions. Since the ESOP was the sole shareholder, Tribune was expected to be largely tax exempt, since
ESOPs are not taxed.
In an effort to reduce the firm's debt burden, the Tribune Company announced in early 2008 the formation of a
partnership in which Cablevision Systems Corporation would own 97% of Newsday for $650 million, with Tribune
owning the remaining 3%. However, Tribune was unable to sell the Chicago Cubs (which had been expected to fetch as
much as $1 billion) and the minority interest in SportsNet Chicago to help reduce the debt amid the 2008 credit crisis.
The worsening of the recession, accelerated by the decline in newspaper and TV advertising revenue, as well as
newspaper circulation, thereby eroded the firm's ability to meet its debt obligations.
Lenders
Zell
Lenders
Zell
Tribune
Shareholders
ESOP
Tribune
Stage 1
Stage 2
$3.85 Billion
$.25 billion
$4 Billion
$.065 Billion
126 Million Shares
$4.2 Billion
121 Million Shares
$4.05
126 Million Shares
& Loan Guarantee
By filing for Chapter 11 bankruptcy protection, the Tribune Company sought a reprieve from its creditors while it
attempted to restructure its business. Although the extent of the losses to employees, creditors, and other stakeholders is
difficult to determine, some things are clear. Any pension funds set aside prior to the closing remain with the
employees, but it is likely that equity contributions made to the ESOP on behalf of the employees since the closing
would be lost. The employees would become general creditors of Tribune. As a holder of subordinated debt, Mr. Zell
had priority over the employees if the firm was liquidated and the proceeds distributed to the creditors.
Those benefitting from the deal included Tribune's public shareholders, including the Chandler family, which owed
12% of Tribune as a result of its prior sale of the Times Mirror to Tribune, and Dennis FitzSimons, the firm's former
CEO, who received $17.7 million in severance and $23.8 million for his holdings of Tribune shares. Citigroup and
Merrill Lynch received $35.8 million and $37 million, respectively, in advisory fees. Morgan Stanley received $7.5
million for writing a fairness opinion letter. Finally, Valuation Research Corporation received $1 million for providing
a solvency opinion indicating that Tribune could satisfy its loan covenants.
What appeared to be one of the most complex deals of 2007, designed to reap huge tax advantages, soon became a
victim of the downward-spiraling economy, the credit crunch, and its own leverage. A lawsuit filed in late 2008 on
behalf of Tribune employees contended that the transaction was flawed from the outset and intended to benefit Sam
Zell and his advisors and Tribune’s board. Even if the employees win, they will simply have to stand in line with other
Tribune creditors awaiting the resolution of the bankruptcy court proceedings.
Discussion Questions:
1. What is the acquisition vehicle, post-closing organization, form of payment, form of acquisition, and tax
strategy described in this case study?
2. Describe the firm’s strategy to finance the transaction?
3. Is this transaction best characterized as a merger, acquisition, leveraged buyout, or spin-off? Explain your
answer.
4. Is this transaction taxable or non-taxable to Tribune’s public shareholders? To its post-transaction
shareholders? Explain your answer.
5. Comment on the fairness of this transaction to the various stakeholders involved. How would you apportion
the responsibility for the eventual bankruptcy of Tribune among Sam Zell and his advisors, the Tribune board,
and the largely unforeseen collapse of the credit markets in late 2008? Be specific.
11
Financing LBOs--The SunGard Transaction
With their cash hoards accumulating at an unprecedented rate, there was little that buyout firms could do but to invest
in larger firms. Consequently, the average size of LBO transactions grew significantly during 2005. In a move
reminiscent of the blockbuster buyouts of the late 1980s, seven private investment firms acquired 100 percent of the
outstanding stock of SunGard Data Systems Inc. (SunGard) in late 2005. SunGard is a financial software firm known
for providing application and transaction software services and creating backup data systems in the event of disaster.
The company‘s software manages 70 percent of the transactions made on the Nasdaq stock exchange, but its biggest
business is creating backup data systems in case a client’s main systems are disabled by a natural disaster, blackout, or
terrorist attack. Its large client base for disaster recovery and back-up systems provides a substantial and predictable
cash flow.
SunGard’s new owners include Silver lake Partners, Bain Capital LLC, The Blackstone Group L.P., Goldman Sachs
Capital Partners, Kohlberg Kravis Roberts & Co., Providence Equity Partners Inc. and Texas Pacific Group. Buyout
firms in 2005 tended to band together to spread the risk of a deal this size and to reduce the likelihood of a bidding war.
Indeed, with SunGard, there was only one bidder, the investor group consisting of these seven firms.
The software side of SunGard is believed to have significant growth potential, while the disaster-recovery side
provides a large stable cash flow. Unlike many LBOs, the deal was announced as being all about growth of the
financial services software side of the business. The deal is structured as a merger, since SunGard would be merged
into a shell corporation created by the investor group for acquiring SunGard. Going private, allows SunGard to invest
heavily in software without being punished by investors, since such investments are expensed and reduce reported
earnings per share. Going private also allows the firm to eliminate the burdensome reporting requirements of being a
public company.
The buyout represented potentially a significant source of fee income for the investor group. In addition to the 2
percent management fees buyout firms collect from investors in the funds they manage, they receive substantial fee
income from each investment they make on behalf of their funds. For example, the buyout firms receive a 1 percent
deal completion fee, which is more than $100 million in the SunGard transaction. Buyout firms also receive fees paid
for by the target firm that is “going private” for arranging financing. Moreover, there are also fees for conducting due
diligence and for monitoring the ongoing performance of the firm taken private. Finally, when the buyout firms exit
their investments in the target firm via a sale to a strategic buyer or a secondary IPO, they receive 20 percent (i.e., so-
called carry fee) of any profits.
Under the terms of the agreement, SunGard shareholders received $36 per share, a 14 percent premium over the
SunGard closing price as of the announcement date of March 28, 2005, and 40 percent more than when the news first
leaked about the deal a week earlier. From the SunGard shareholders’ perspective, the deal is valued at $11.4 billion
dollars consisting of $10.9 billion for outstanding shares and “in-the-money” options (i.e., options whose exercise price
is less than the firm’s market price per share) plus $500 million in debt on the balance sheet.
The seven equity investors provided $3.5 billion in capital with the remainder of the purchase price financed by
commitments from a lending consortium consisting of Citigroup, J.P. Morgan Chase & Co., and Deutsche Bank. The
purpose of the loans is to finance the merger, repay or refinance SunGard’s existing debt, provide ongoing working
12
capital, and pay fees and expenses incurred in connection with the merger. The total funds necessary to complete the
merger and related fees and expenses is approximately $11.3 billion, consisting of approximately $10.9 billion to pay
SunGard’s stockholders and about $400.7 million to pay fees and expenses related to the merger and the financing
arrangements. Note that the fees that are to be financed comprise almost 4 percent of the purchase price. Ongoing
working capital needs and capital expenditures required obtaining commitments from lenders well in excess of $11.3
billion.
The merger financing consists of several tiers of debt and “credit facilities.” Credit facilities are arrangements for
extending credit. The senior secured debt and senior subordinated debt are intended to provide “permanent” or long-
term financing. Senior debt covenants included restrictions on new borrowing, investments, sales of assets, mergers
and consolidations, prepayments of subordinated indebtedness, capital expenditures, liens and dividends and other
distributions, as well as a minimum interest coverage ratio and a maximum total leverage ratio.
If the offering of notes is not completed on or prior to the closing, the banks providing the financing have committed
to provide up to $3 billion in loans under a senior subordinated bridge credit facility. The bridge loans are intended as
a form of temporary financing to satisfy immediate cash requirements until permanent financing can be arranged. A
special purpose SunGard subsidiary will purchase receivables from SunGard, with the purchases financed through the
sale of the receivables to the lending consortium. The lenders subsequently finance the purchase of the receivables by
issuing commercial paper, which is repaid as the receivables are collected. The special purpose subsidiary is not shown
on the SunGard balance sheet. Based on the value of receivables at closing, the subsidiary could provide up to $500
million. The obligation of the lending consortium to buy the receivables will expire on the sixth anniversary of the
closing of the merger.
The following table provides SunGard’s post-merger proforma capital structure. Note that the proforma capital
structure is portrayed as if SunGard uses 100 percent of bank lending commitments. Also, note that individual LBO
investors may invest monies from more than one fund they manage. This may be due to the perceived attractiveness of
the opportunity or the limited availability of money in any single fund. Of the $9 billion in debt financing, bank loans
constitute 56 percent and subordinated or mezzanine debt comprises represents 44 percent.
SunGard Proforma Capital Structure
Pre-Merger Existing SunGard Debt Outstanding $Millions
Senior Notes (3.75% due in 2009) 250,000,000
Senior Notes (4.785 due in 2014) 250,000,000
Total Existing Debt Outstanding 500,000,000
Debt Portion of Merger Financing
Senior Secured Notes (≤ $5 billion) 5,000,000,000
$1 billion revolving credit facility with
6 year term
$4 billion term loan maturing in 7-1/2 years
Senior Subordinated Notes (≤$3 billion) 3,000,000,000
Payment-in-Kind Senior Notes (≤$.5 billion) 500,000,000
Receivables Credit Facility (≤$.5 billion) 500,000,000
Total Merger Financing (as if fully utilized) 9,000,000,000
Equity Portion of Merger Financing
Equity Investor Commitment ($Millions)
Silver Lake Partners II, LP1 540,000,000
Bain Capital Fund VIII, LP 540,000,000
Blackstone Capital Partners IV, L.P. 270,000,000
Blackstone Communications Partners I, L.P. 270,000,000
GS Capital Partners 2000, L.P. 250,000,000
GS Capital Partners 2000 V, L.P. 250,000,000
KKR Millennium Fund, L.P. 540,000,000
Providence Equity Partners V, L.P. 300,000,000
TPG Partners IV, L.P. 540,000,000
Total Equity Portion of Merger Financing 3,500,000,000
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Total Debt and Equity 13,000,000,000
1The roman numeral II refers to the fund providing the equity capital managed by the
partnership.
Case Study Discussion Questions:
1. SunGard is a software company with relatively few tangible assets. Yet, the ratio of debt to equity of almost 5
to 1. Why do you think lenders would be willing to engage in such a highly leveraged transaction for a firm of
this type?
2. Under what circumstances would SunGard refinance the existing $500 million in outstanding senior debt after
the merger? Be specific.
3. In what ways is this transaction similar to and different from those that were common in the 1980s? Be
specific.
4. Why are payment-in-kind securities (e.g., debt or preferred stock) particularly well suited for financing LBOs?
Under what circumstances might they be most attractive to lenders or investors?
5. Explain how the way in which the LBO is financed affects the way it is operated and the timing of when
equity investors choose to exit the business. Be specific.
HCA'S LBO REPRESENTS A HIGH-RISK BET ON GROWTH
While most LBOs are predicated on improving operating performance through a combination of aggressive cost cutting
and revenue growth, HCA laid out an unconventional approach in its effort to take the firm private. On July 24, 2006,
management again announced that it would "go private" in a deal valued at $33 billion including the assumption of
$11.7 billion in existing debt.
The approximate $21.3 billion purchase price for HCA's stock was financed by a combination of $12.8 billion in
senior secured term loans of varying maturities and an estimated $8.5 billion in cash provided by Bain Capital, Merrill
Lynch Global Private Equity, and Kohlberg Kravis Roberts & Company. HCA also would take out a $4 billion
revolving credit line to satisfy immediate working capital requirements. The firm publicly announced a strategy of
improving performance through growth rather than through cost cutting. HCA's network of 182 hospitals and 94
surgery centers is expected to benefit from an aging U.S. population and the resulting increase in health-care spending.
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The deal also seems to be partly contingent on the government assuming a larger share of health-care costs in the
future. Finally, with many nonprofit hospitals faltering financially, HCA may be able to acquire them inexpensively.
While the longer-term trends in the health-care industry are unmistakable, shorter-term developments appear
troublesome, including sluggish hospital admissions, more uninsured patients, and higher bad debt expenses. Moreover,
with Medicare and Medicaid financially insolvent, it is unclear if future increases in government health-care spending
would be sufficient to enable HCA investors to achieve their expected financial returns. With the highest operating
profit margins in the industry, it is uncertain if HCA's cash flows could be significantly improved by cost cutting, if the
revenue growth assumptions fail to materialize. HCA's management and equity investors have put themselves in a
position in which they seem to have relatively little influence over the factors that directly affect the firm's future cash
flows.
Discussion Questions:
1. Does a hospital or hospital system represent a good or bad LBO candidate? Explain your answer.
2. Having pledged not to engage in aggressive cost cutting, how do you think HCA and its financial sponsor
group planned on paying off the loans?
practices.
Case Study. Sony Buys MGM
Sony’s long-term vision has been to create synergy between its consumer electronics products and music, movies, and
games. Sony, which bought Columbia Pictures in 1989 for $3.4 billion, had wanted to control Metro-Goldwyn-Mayer’s
film library for years, but it did not want to pay the estimated $5 billion it would take to acquire it. On September 14,
2004, a consortium, consisting of Sony Corp of America, Providence Equity Partners, Texas Pacific Group, and DLJ
Merchant Banking Partners, agreed to acquire MGM for $4.8 billion, consisting of $2.85 billion in cash and the
assumption of $2 billion in debt. The cash portion of the purchase price consisted of about $1.8 billion in debt and $1
billion in equity capital. Of the equity capital, Providence contributed $450 million, Sony and Texas Pacific Group
$300 million, and DLJ Merchant Banking $250 million.
The combination of Sony and MGM will create the world’s largest film library of about 7,600 titles, with MGM
contributing about 54 percent of the combined libraries. Sony will control MGM and Comcast will distribute the films
over cable TV. Sony will shut down MGM’s film making operations and move all operations to Sony. Kirk Kerkorian,
who holds a 74 percent stake in MGM, will make $2 billion because of the transaction. The private equity partners
could cash out within three-to-five years, with the consortium undertaking an initial public offering or sale to a strategic
investor. Major risks include the ability of the consortium partners to maintain harmonious relations and the
problematic growth potential of the DVD market.
Sony and MGM negotiations had proven to be highly contentious for almost five months when media giant Time
Warner Inc. emerged to attempt to satisfy Kerkorian’s $5 billion asking price. The offer was made in stock on the
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assumption that Kerkorian would want a tax-free transaction. MGM’s negotiations with Time Warner stalled around
the actual value of Time Warner stock, with Kerkorian leery about Time Warner’s future growth potential. Time
Warner changed its bid in late August to an all cash offer, albeit somewhat lower than the Sony consortium bid, but it
was more certain. Sony still did not have all of its financing in place. Time Warner had a “handshake agreement” with
MGM by Labor Day for $11 per share, about $.25 less than Sony’s.
The Sony consortium huddled throughout the Labor Day weekend to put in place the financing for a bid of $12 per
share. What often takes months to work out in most leveraged buyouts was hammered out in three days of marathon
sessions at law firm Davis Polk & Wardwell. In addition to getting final agreement on financing arrangements
including loan guarantees from J.P. Morgan Chase & Company, Sony was able to reach agreement with Comcast to
feature MGM movies in new cable and video-on-demand TV channels. This distribution mechanism meant additional
revenue for Sony, making it possible to increase the bid to $12 per share. Sony also offered to make a $150 non-
refundable cash payment to MGM. As a testament to the adage that timing is everything, the revised Sony bid was
faxed to MGM just before the beginning of a board meeting to approve the Time Warner offer.
Discussion Questions:
1. Do you believe that MGM is an attractive LBO candidate? Why? Why not?
2. In what way do you believe that Sony’s objectives might differ from those of the private equity investors
making up the remainder of the consortium? How might such differences affect the management of MGM?
Identify possible short-term and long-term effects.
3. How did Time Warner’s entry into the bidding affect pace of the negotiations and the relative bargaining
power of MGM, Time Warner, and the Sony consortium?
4. What do you believe were the major factors persuading the MGM board to accept the Revised Sony bid? In
your judgment, do these factors make sense? Explain your answer.
RJR NABISCO GOES PRIVATE—
KEY SHAREHOLDER AND PUBLIC POLICY ISSUES
Background
