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The difference here is that it's the acquired company that owes the debt, as opposed to the acquiring company owing a debt with the acquired company as collater
by beojan 9y ago
The difference here is that it's the acquired company that owes the debt, as opposed to the acquiring company owing a debt with the acquired company as collateral.
- asmithmd1 9y agoHere is how it worked: Bain Capital decides to acquire Toys-R-Us so they set-up NewToyCo and invest $5B in it. NewToyCo buys Toys-R-Us with that $5B and installs new managers at Toys-R-Us. Since the invested cash was investment and not a loan, NewToyCo owns Toys-R-Us free and clear The new managers of Toys-R-Us get a $5B loan from banks secured by the assets of Toys-R-Us and pay a one time $5B dividend to shareholders of NewToyCo. If everything goes well and Toys-R-Us can service the loan, Bain owns Toys-R-Us for free and sells it or takes it public. If things don't work out, they collected huge management consulting fees for s few years. Bain ran this exact same play on KB Toys with the same (bankruptcy) result.
- ars 9y agoSo it's basically the opposite of going public? You use that $5B to pay all the original owners (shareholders), and now have debt instead.
- kaycebasques 9y agoThis is bizarre. I did not know that leveraged buyouts could work like this.
- mseebach 9y agoIt's just like a mortgage. Even though it's you buying the house, it's in a way the house that ends up owning the mortgage (in many jurisdictions, you can walk away from the house and mortgage, and the bank had no leverage against your person, they can only repossess the house).
- ssharp 9y agoI was trying to explain what a leveraged buyout was and why a company like Toys R Us had so much debt on its books. After trying to talk through it, I used the mortgage analogy and it made a lot more sense.
- beojan 9y agoNo, there the house is collateral. In this case, instead of the lender simply taking over the acquired company, the acquired company declares bankruptcy and is liquidated.
- mseebach 9y agoBut a bank will just hand over money for an LBO without taking collateral?
- yrro 9y ago(FYI this isn't the case in at least the UK...)
- icebraining 9y agoWhat's the difference in practice?
- Marazan 9y agoThere is no* risk for the acquiring company. *Obvious simplification is obvious. The risk is they can't keep acquirred company alive long enough to extract a profit before the husk of a company finally implodes.
- icebraining 9y agoBut is there risk when using the company as collateral? Isn't that the point of collateral? Or do they still have to put up the difference between the current value of the company and the debt?
- mseebach 9y agoUnless the acquired company is obviously healthy enough to service the debt through to maturity, or the bank is really stupid, the acquiring company has to put up non-trivial collateral. Or put another way, if the acquiring company has no risk, then the bank putting up the leverage has it. The risk doesn't just disappear.
- asmithmd1 9y agoThere was very little risk for the acquiring company or banks who loaned the money. Bain partnered with the real estate company Vornado Realty Trust in the Toys-R-Us deal. The bank loans were secured by Toys-R-Us assets that will be auctioned off, and Vornado will re-develop the land that Toys-R-Us stores sit on - everybody wins. Except for the 30,000 Toys-R-Us employees of course.
- mseebach 9y agoIf you can buy a company with the sum of money you can raise by mortgaging the real estate it occupies, the implication is that the company is worth less than this real estate. Considering the kind of real estate Toys-R-Us shops occupied, this is not a good look for them, nor does it speak well for the employees' prospects had the LBO not happened.