21
• LBOs undertaken following the 2008 recession have tended to be more conservatively financed than those
prior to 2008
_____________________________________________________________________________________
The realization of sustained earnings growth often requires a sizable initial investment. Investments in software and
other intellectual property must be expensed according to Generally Accepted Accounting Principles resulting in an
immediate reduction in earnings. While certain types of investments can be capitalized and depreciated or amortized
over their useful lives, such spending can depress near term earnings. Similarly, acquisitions made to jump start growth
often have a short-term negative impact on earnings as firms write off acquisition related expenses and incur substantial
post acquisition integration costs.
Firms with successful track records in achieving revenue and earnings growth goals such as Facebook, Google, and
Amazon.com often are able to convince investors to be patient following a major investment. However, firms with poor
track records can get hammered by investors immediately following the announcement of an aggressive investment
program. What options are available for such firms?
One alternative is to take the firm private by consolidating ownership among a few investors patient enough to allow
the firm to realize promised returns. This public to private leveraged buyout (LBO) requires an investor group or
financial sponsor (sometimes involving a firm’s management) using a combination of equity and borrowed funds to
acquire publicly held shares.4 This is exactly what data integrator Informatica did. On August 6, 2015, the firm’s
shares were removed from the NASDAQ, retiring the INFA ticker symbol, following the completion of its acquisition
In 1999, the firm displayed a meteoric price to earnings ratio common among internet firms during the dotcom
bubble enabling the firm to reach a multibillion dollar valuation. However, the firm’s valuation collapsed when the
speculative bubble burst in 2000. It would be years before the firm would again be able to reach its pre-2000 valuation.
Like competitor Tibco, Informatica had seen its revenue growth slow due to market maturation after seeing its stock
soar and then crater. Both firms have since seen their valuations grow to multibillion dollar levels, but it has taken years
to get back to where they were before the dotcom debacle. Tibco was taken private in December 2014 for $4.3 billion.
Under private ownership, Informatica will continue to focus on its main product areas, including cloud services, data
security and “big data” analysis. But the company, with the support of its new backers, will also search for potential
takeover targets as part of an effort to be a consolidator in the fragmented data integration industry. The new owners
will be able to provide financing for future takeovers.
4While public to private LBOs get the most publicity because of their size and visibility, most LBOs involve the
leveraging of private firms. The reasons for this are discussed in detail later in this chapter.
22
Financing for the Informatica LBO consisted of $650,000,000 of 7.125% senior notes due in 2023. The notes are,
fully and unconditionally guaranteed, joint and severally, on a senior unsecured basis by each of the Company’s
Berkshire Hathaway and 3G Buy American Food Icon Heinz
______________________________________________________________________________
Case Study Objectives: To illustrate
• Form of payment, form of acquisition, acquisition vehicle, and post-closing organizations and
• How complex leveraged buyout structures are organized and financed.
______________________________________________________________________________
In a departure from its traditional deal making strategy, Berkshire Hathaway (Berkshire), the giant conglomerate run by
Warren Buffett, announced on February 14, 2013 that it would buy food giant H.J. Heinz (Heinz) for $23 billion or
$72.50 per share in cash. Including assumed debt, the deal is valued at $28 billion. Traditionally, Berkshire had shown
a preference for buying entire firms with established brands and then allowing then allowing them to operate as they
had been. Investors greeted the news enthusiastically boosting Heinz’s stock price by nearly 20% to the offer price and
Berkshire’s class A common stock price by nearly one percent to $148,691 a share.
Unlike prior transactions, Berkshire teamed with 3G Capital Management (3G), a Brazilian-backed investment firm
that owns a majority stake in Burger King, a company whose business is complementary to Heinz, and interests in
other food and beverage companies. Heinz’s headquarters will remain in Pittsburgh, its home for more than 120 years.
At 20 times 2013 current earnings, the deal seems a bit pricey when compared to price to earnings ratios for
comparable firms (See Table 13.4). The risks to the deal are significant. Heinz will have well over $10 billion in debt,
compared to $5 billion now. Before the deal, Moody’s Investors Service rated Heinz just two notches beyond junk. If
future operating performance falters, the firm could be subject to a credit rating downgrade. The need to pay a 9%
preferred stock dividend will also erode cash flow. 3G will have operational responsibility for Heinz. Heinz may be
used as a platform for making other acquisitions.
Table 13.4 Food Company Peer Group
Company
Recent price
52 Week
change
2013 Est. P/E
Dividend
Yield
Market Value
($B)
Family Stake
Campbell
$38.72
21.6%
15.2
3.0%
$12
Yes
Hershey
80.89
33.7
22.2
2.1
18
Yes
Hormel Foods
35.91
24
18.4
1.9
9
Yes
Source: Thomson Reuters **since 9/17/12 spinoff
Risk to existing bondholders is that one day they own an investment grade firm with a modest amount of debt and
the next day they own a highly leveraged firm facing a potential downgrade to junk bond status. On the announcement
date, prices of existing Heinz triple B rated bonds fell by over two cents on the dollar, while the cost to ensure such
debt (credit default swaps) soared by over 25% to a new high.
The structure of the deal is described in Figure 13.3. H.J. Heinz Company, a Pennsylvania Corporation, entered
into a definitive merger agreement with Hawk Acquisition Holding Corporation (Parent), a Delaware corporation, and
Hawk Acquisition Sub (Merger Sub), Inc., a Pennsylvania corporation and wholly owned subsidiary of Parent. The
Parent used the $18.24 billion cash injection from Berkshire and 3G (i.e., $14.12 from Berkshire + $4.12 from 3G)
to acquire the common shares of Merger Sub. J.P. Morgan and Wells Fargo provided $14.1 billion of new debt
financing to Merger Sub. The debt financing consisted of $8.5 billion in dollar-denominated senior secured term loans,
The deal does not contain a go shop provision, which allows the target to seek other bids once they have reached
agreement with the initial bidder in exchange for a termination fee to be paid to the initial bidder if the target chooses to
sell to another firm. Go shop provisions may be used since they provide a target’s board with the assurance that it got
the best deal; for firms incorporated in Delaware, the go shop provision helps target argue that they satisfied the so-
H.J. Heinz
$18.24
Billion
Hawk
3G Capital
Management
Berkshire Hathaway
Hawk Merger Sub
$4.12 Billion
Parent
Common
$14.12 Billion
in Parent and
24
Figure 13.3 Berkshire, 3G, and H.J. Heinz Deal Structure
Heinz may not have negotiated a go shop provision which is common in firms seeking to protect their
shareholder interests because it is incorporated in Pennsylvania. Pennsylvania corporate law is intended to give
complete latitude to boards in deciding whether to accept or reject takeover offers because it does not have to consider
shareholders’ interests as the dominant determinant of the appropriateness of the deal (unlike Delaware). Instead, the
Discussion Questions:
1. Identify the form of payment, form of acquisition, acquisition vehicle, and post-closing organization?
Speculate why each may have been used.
Answer: The form of payment was cash, due to its attractiveness to Heinz’s public shareholders. The use of
cash is common in these types of deals. The form of acquisition was the purchase of common stock from
public shareholders, effectively converting Heinz from a public to a private firm. The purchase of stock also
ensured that the acquirer would own all valuable intellectual property owned by Heinz such as product brand
2. How was ownership transferred in this deal? Speculate as to why this structure may have been used?
Answer: The deal structure involved a reverse triangular merger in which Heinz was merged into a wholly
owned subsidiary of Parent, with Heinz surviving. This preserves the Heinz brand name and results in a
holding company structure insulating 3G and Berkshire from Heinz liabilities in the event of bankruptcy. The
use of a subsidiary merger to transfer ownership from the Heinz’s public shareholders to the Parent may also
3. Describe the motivation for Berkshire and 3G to buy Heinz.
Answer: Berkshire saw the business as undervalued, and it fit with the firm’s tendency to invest in firms with
$8.24 Billion
25
4. How will the investors be able to recover the 20% purchase price premium?
Answer: 3G has excellent business connections in Brazil which may enable Heinz to improve its market share
5. Do you believe that Heinz is a good candidate for a leveraged buyout? Explain your answer.
Answer: Yes. In the food manufacturing business for 120 years with a widely recognizable brand, the firm has
a substantial and defensible market share in the United States. Moreover, given the nature of its basic food
6. What do you believe was the purpose of the $1.5 billion senior secured revolving loan facility, and the $2.1
billion second lien bridge loan facility as part of the deal financing package?
Answer: The revolving loan facility is commonly a part of financing such transactions as it provides a source
of financing of short-term working capital requirements and is especially important in meeting unanticipated
7. Why do you believe Berkshire Hathaway wanted to receive preferred rather than common stock in exchange
for its investing $8 billion? Be specific.
Answer: The preferred stock has a $8 billion liquidation preference (i.e., assurance that holders are paid before
common shareholders in the event of liquidation), pays and accrues a 9% dividend (a rate well above
prevailing interest rates at the time), and is redeemable at the request of the Parent or Berkshire under certain
circumstances. The latter factor gives Berkshire management substantial flexibility over the timing of when to
INSIDE M&A: VERIZON FINANCES ITS $130 BILLION BUYOUT OF
VODAFONE’S STAKE IN VERIZON WIRELESS
Key Points
• The timing of buyouts is influenced heavily by equity and credit market conditions.
• To close deals, interim or “bridge financing” often is required and replaced with longer–term or “permanent
financing.”
• How deals are financed can impact a firm’s investment strategy long after the deal is completed.
_____________________________________________________________________________________
In a deal that has been in the making for almost a decade, Verizon Communications agreed to buy British-based
wireless carrier Vodafone’s 45% ownership stake in the Verizon Wireless joint venture corporation for $130 billion.
Formed in 2000, the joint venture serves more than 100 million customers in the United States.
26
Announced on September 2, 2013, the deal marked the crowning event in the careers of Vittorio Colao and Lowell
McAdam, the chief executives of Vodafone and Verizon, respectively. The agreement succeeded in rebuilding relations
between the two firms that had long been strained by clashes about the size of the dividend paid by the JV, matters of
strategy, and who would eventually achieve full ownership.
The timing of the deal reflects the near record low interest rate environment and the strength of Verizon’s own
stock. A higher Verizon share price meant that it would have to issue fewer new shares limiting the potentially dilutive
impact on the firm’s current shareholders. Another major issue was making sure the debt markets could absorb the
sheer amount of new Verizon debt without sending interest rates spiraling upward. The huge increase in Verizon’s
leverage was sure to catch the eye of credit rating agencies charged with evaluating the likelihood that borrowers could
repay their debt on a timely basis. While Verizon’s rating was reduced, it was only one notch from what it had been to
“investment grade,” rating agency jargon for ok for investors to buy.
The record books were shattered when Verizon sold $49 billion in investment grade debt in a single day without
roiling the bond markets. The bond markets absorbed the huge debt issue because of the relative attractiveness of the
yields offered by Verizon. The debt offering included 10-year bonds that yielded 5.3% and 30-year bonds yielding
6.55%. These yields compared to the average BBB-rated industrial bond of 4.16% at the time and BBB bonds for
telecommunications companies averaging 4.34%.
The addition of a massive new debt load on Verizon’s books may tie the company’s hands in making major
investments for some time as its priority during the next several years will be reducing its leverage as quickly as
Hollywood’s Biggest Independent Studios Combine in a Leveraged Buyout
Key Points
LBOs allow buyouts using relatively little cash and often rely heavily on the target firm’s assets to finance the
transaction.
Private equity investors often “cash out” of their investments by selling to a strategic buyer.
______________________________________________________________________________
The Lionsgate-Summit tie-up represented the culmination of more than four years of intermittent discussions between
the two firms. The number of studios making and releasing movies has been shrinking amid falling DVD sales and
27
continued efforts to transition to digital distribution. As the largest independent studios in Hollywood, both firms saw
their cash flow whipsawed as one blockbuster hit would be followed by a series of failures. Film and TV program
libraries offered the only source of cash flow stability due to the recurring fees paid by those licensing the rights to use
this proprietary content.
Lionsgate is a diversified film and television production and distribution company, with a film library of 13,000
titles. The firm’s major distribution channels include home entertainment and prepackaged media (DVDs); digital
distribution (on-demand TV) and pay TV (premium network programming). Summit, also a producer and distributor of
film and TV content, has a less consistent track record in realizing successful releases, with the Twilight “franchise” its
primary success. However, Summit does have strong international licensing operations, with arrangements in the
United States, Canada, Germany, France, Scandinavia, Spain, and Australia. The acquisition also strengthens
Lionsgate
Entertainment
Summit
Entertainment
Merger
Sub Stock
$100 Million in
Cash & $69
Million in
Lionsgate
Merger Sub Merges
With Summit
$284.4
Million in
Excess
Summit
Cash
Table 13.4 summarizes the sources of financing for the buyout and shows how these funds were used to pay for the
deal. Lionsgate financed the total cost of the deal of $953.4 million (consisting of $412.5 million for Summit stock +
the pretransaction term loan of $506.3 million + $34.6 million in transaction-related fees and expenses) as follows:
$100 million in cash from Lionsgate and $69 million in Lionsgate stock + $284.4 million of the $310 million in cash on
Summit’s balance sheet at closing + a new $500 million term loan. Summit’s $506.3 million term loan B was
Table 13.4
Lionsgate-Summit Transaction Overview
• Sources of Funds ($ Millions)
• Uses of Funds ($ Millions)
Lionsgate Cash Consideration1
100.0
Seller Consideration
412.5
Lionsgate Stock Consideration2
69.0
Repay Term Loan
506.3
Summit Cash on Balance Sheet
284.4
Fees and expenses
34.6
New Term Loan
Summit Pro Forma Capitalization
• As of 12/30/11
• Pro Forma
$ Millions
Adjustment ($ Millions)
$ Millions
Cash3
310
(284.4)
25.6
Revolver ($200 million)
Prior Term Loan B Due 9/2016
New Term Loan B Due 9/2016
Total Debt
Contributed Equity5
169.0
Table 13.5 presents the key features of the new term loan B facility. Note how Summit’s assets are used as collateral
to secure the loan. In addition, the lender has first priority on the proceeds from certain types of transactions, giving
Table 13.5
Initial Terms and Conditions of the New Term Loan B Facility
• Item
• Comment
Borrower
Summit Entertainment LLC (Lionsgate subsidiary)
Guarantor
Merger Sub
Security
First priority security interest in tangible and intangible assets
Pledge of equity interests of Summit and guarantor
29
Facilities
$500 million senior secured term loan B
Ratings
B1/B+
Maturity
September 2016
Mandatory
Amortization
$13.75 million, paid quarterly
Pricing
To be determined
Incremental
Facility
None
Discussion Questions
1. What about Lionsgate’s acquisition of Summit indicates that this transaction should be characterized as a
leveraged buyout? How does Lionsgate use Summit’s assets to help finance the deal? Be specific.
Answer: LBOs are characterized by a substantial increase in a firm’s post-LBO debt-to-equity ratio (a
common measure of leverage), usually as a result of the substantial increase in borrowing to purchase stock
held by its pre-buyout private or public shareholders. However, in some instances, a firm’s leverage increases
even though there is no significant increase in borrowing. This may result from the way in which the target
firm’s assets are used to finance the buyout. For example, the investor group or firm initiating the takeover
.
2. How are $34.6 million in fees and expenses associated with the transaction paid for? Be specific.
3. Speculate as to why Lionsgate refinanced as part of the transaction the existing Summit Term Loan B due in
2016 that had been borrowed in the early 2000s.
Optional
Up to one year at the discretion of the borrower
Permitted
Distributions
No distributions before loan facility is 75% amortized
30
4. Do you believe that Summit is a good candidate for a leveraged buyout? Explain your answer.
5. Why is Summit Entertainment organized as a limited liability company?
6. Why did Lionsgate make an equity contribution in the form of cash and stock to the Merger Sub rather than
making the cash portion of the contributed capital in the form of a loan?
Answer: The financial sponsor or parent firm, in this case Lionsgate, makes an equity contribution so as not to
TXU Goes Private in the Largest Private Equity Transaction in History—The Dark Side of Leverage
Key Points
The 2007/2008 financial crisis left many LBOs excessively leveraged.
As structured, the TXU buyout (now Energy Future Holdings) left no margin for error.
Excessive leverage severely limits the firm’s future financial options.
_____________________________________________________________________________
Before the buyout, TXU, a Dallas-based energy giant, was a highly profitable utility. Historically low interest rates and
an overly optimistic outlook for natural gas prices set the stage for the largest private equity deal in history. The 2007
buyout of TXU was valued at $48 billion and, at the time, appeared to offer such promise that several of Wall Street’s
largest lenders –—including the likes of Lehman Brothers and Citigroup—invested, along with such storied names in
private equity as KKR, TPG, and Goldman Sachs. However, the price of gas plummeted, eroding TXU’s cash flow.
Since the deal closed in October 2007, investors who bought $40 billion of TXU’s debt have experienced losses as high
as 70% to 80% of their value. The other $8 billion used to finance the deal came from the private equity investors,
banks, and large institutional investors. They, too, have suffered huge losses. Having met its obligations to date, the
firm faces a $20 billion debt repayment coming due in 2014.
31
with the transaction be held at the level of the Merger Sub Parent holding company so as not to leverage the utility
further.
Subsequent to closing, the new company was reorganized into independent businesses under a new holding
company, controlled by the Sponsor Group, called Texas Holdings (TH). Merger Sub (which owns TXU) was renamed
Energy Future Holdings. TH’s direct subsidiaries are EFH and Oncor (an energy distribution business formerly held by
Table 13.6
EFH Holdings Debt Covenants
• December 31,
2009
• Threshold Level as of
December 31, 2009
Maintenance Covenant
TCEH Secured Facilities: Ratio of Secured debt to
adjusted EBITDA
4.76–1.00
Must not exceed 7.25–1.00
Debt Incurrence Covenants
TCEH Senior Notes:
TCEH fixed charge coverage ratio
TCEH Senior Secured Facilities:
TCEH fixed charge coverage ratio
1.5–1.0
1.5–1.0
At least 2.0–1.0
At least 2.0–1.0
Restricted Payments/Limitations on Investments
Covenants
EFH Corp Senior Notes
General restrictions
EFH Corp fixed charge coverage ratio
EFH Corp leverage ratio
TCEH Senior Notes
TCEH fixed charge coverage ratio
1.2–1.0
9.4–1.0
1.5–1.0
At least 2.0–1.0
≤7.0–1.0
At least 2.0–1.0
32
Things clearly have not turned out as expected. The firm faces an almost-untenable capital structure. The firm’s debt
traded at between 20 and 30 cents on the dollar throughout most of 2012. The $8 billion equity invested in the deal has
Discussion Questions
1. How does the postclosing holding company structure protect the interests of the financial sponsor group
and the utility’s customers but potentially jeopardize creditor interests in the event of bankruptcy?
Answer: A holding company structure was used for two reasons: (1) to limit the risks to the financial and
creditor groups to potential liabilities and (2) to satisfy the requirement by Texas public utility regulators
to insulate the public utility from the additional debt service requirements created by the debt incurred to
finance the LBO. The structure effectively concentrates debt in EFH and TH, while separating the cash
producing assets in other legal entities (i.e., Oncor and Texas Competitive Electric Holdings).
Consequently, EFH and TH could be put into Chapter 11 if need be, while limiting creditor access to
Oncor’s and Texas Competitive Electric Holdings’ assets.
2. What was the purpose of the pre-closing covenants and closing conditions as described in the merger
agreement?
Answer: The purpose of the covenants is to ensure that the target firm will operate its business between
the signing of the agreement and closing in a manner acceptable to the buyer. Also, it gives the buyer a
3. Loan covenants exist to protect the lender. How might such covenants inhibit the EFH from meeting its
2014 $20 billion obligations?
33
Answer: The loan covenants limit EFH’s ability to issue new equity, preferred stock, or to take on new
4. As CEO of EFH, would you recommend to the board of directors as an appropriate strategy for paying the
$20 billion in debt that is maturing in 2014?
Answer: The principal owners private equity buyout firms Kohlberg Kravis Roberts & Co (KKR) and
Texas Pacific Group (TPG), two of the nation’s leading private equity firms, and global investment bank
5. The substantial writedown of the net acquired assets in 2008 suggests that the purchase price paid for
TXU was too high. How might this impact KKR, TPG, and Goldman’s ability to earn financial returns
expected by their investors on the TXU acquisition? How might this writedown impact EFH’s ability
meet the $20 billion debt maturing in 2014?
Answer: The purchase price paid for TXU was clearly too high. Private equity investors were caught up in
the euphoria of 2007 when interest rates were exceptionally low and banks were aggressively competing
Lessons from Pep Boys’ Aborted Attempt to Go Private
Key Points
LBOs in recent years have involved financial sponsors’ providing a larger portion of the purchase price in cash than in
the past.
Financial sponsors focus increasingly on targets in which they have previous or related experience.
Deals that would have been completed in the early 2000s are more likely to be terminated or subject to renegotiation
than in the past.
_____________________________________________________________________________________
It ain’t over till it’s over” quipped former New York Yankees’ catcher Yogi Berra, famous for his malapropisms. The
oft–quoted comment was once again proven true in Pep Boys’ unsuccessful attempt to go private in 2012. On May 30,
2012, after nearly two years of discussions between Pep Boys and several interested parties, the firm announced that a
34
to finance a portion of the purchase price. Furthermore, Gores has experience in retailing, having several retailers
among their portfolio of companies, including J. Mendel and Mexx.
The transaction reflected a structure common for deals of this type. Pep Boys had entered into a merger agreement
with Auto Acquisitions Group (the Parent), a shell corporation funded by cash provided by Gores as the financial
sponsor, and the Parent’s wholly owned subsidiary (Merger Sub). The Parent would contribute cash to Merger Sub,
with Merger Sub borrowing the remainder from several lenders. Merger Sub would subsequently buy Pep Boys’
“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.
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
Stage 1
$3.85 Billion
35
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.
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
Discussion Questions:
Lenders
Zell
Tribune
Tribune
$.25 billion
126 Million Shares
$4.2 Billion
Lenders
Zell
$4 Billion
121 Million Shares
36
1. What is the acquisition vehicle, post-closing organization, form of payment, form of acquisition, and tax
strategy described in this case study?
Answer: The ESOP is the acquisition vehicle and the subchapter S corporation is the post-closing
2. Describe the firm’s strategy to finance the transaction?
Answer: The transaction will be financed primarily by debt. The firm’s free cash flow will be improved by
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.
Answer: The transaction was clearly highly leveraged by most measures. It was financed almost entirely with
debt, with Zell’s equity contribution amounting to less than 4 percent of the purchase price. The transaction
resulted in the Tribune being burdened with $13 billion in debt (including the approximate $5 billion currently
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
37
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
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.
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
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.
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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
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
6 year term
$4 billion term loan maturing in 7-1/2 years
Senior Subordinated Notes (≤$3 billion) 3,000,000,000
Equity Portion of Merger Financing
Equity Investor Commitment ($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
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.
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Answer: In the 1980s, few hi-tech companies were taken private due to their lack of tangible assets and high
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.
Answer: The greater the leverage and non-PIK debt the greater the need to manage the business for cash and
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
Discussion Questions:
1. Does a hospital or hospital system represent a good or bad LBO candidate? Explain your answer.
Answer: Hospitals generally represent bad candidates. Hospital cash flow is heavily dependent on
government reimbursement rates which are likely to be declining in the future as the U.S. government