ET in the classroom: All about leveraged buyouts

With merger and acquisitions gaining momentum, leveraged buyouts or LBOs are back in vogue at least in India, reviving memories that actually had its origin in Wall Street. A few weeks ago, detergent manufacturer Nirma acquired Lafarge assets for about Rs 9,300 crore.

1. What are LBOs?
An LBO is a deal where the acquiring company funds the debt it raises for the acquisition using cash flow of the acquired entity. For example, Nirma would be raising Rs 4,000-4,500 crore via corporate bonds or loans to fund the acquisition. The company will use Lafarge cash flow to repay.

2. What is the criticism against LBOs?
In 1989, US-based RJR Nabisco had strongly criticised LBOs. Such securities were viewed as a way chief executives could earn filthy money through equity ownership rather than salaries or bonus. But small investors might lose out. Critics termed it as a means “to steal the company from its owners”. LBOs used to result in shrinkage of the company’s budget.

3. What is the scene now?
Post 2007, LBOs are happening more in emerging markets, but people are cautious. So are the regulators. Citing Dealogic data, FT reported that another 20 highly leveraged buyout deals, with a total value of $40 billion, are pending completion since 2015.

4. Is there any difference between India and global scenes?
Globally, it is on the decline but India being an emerging market, it tends to rise. The belief is that LBOs continue to be the flavour for corporates in emerging markets unless economic recovery picks up in developed economies. Besides Nirma, Tata Power is raising funds via bond sales to fund its Welspun Energy’s

5. Are LBOs posing any threat to Indian economy?
Experts say this is no violation of regulation. The only thing which needs to be seen is the cash flow of the acquired company. If that is not robust enough, it will increase default risk to lenders. This could have a ripple effect on the economy.