What is a 'Buyout'

A buyout is the purchase of a company's shares in which the acquiring party gains controlling interest of the targeted firm. A leveraged buyout (LBO) is accomplished by borrowed money or by issuing more stock. Buyout strategies are often seen as a fast way for a company to grow because it allows the acquiring firm to align itself with other companies that have a competitive advantage.

BREAKING DOWN 'Buyout'

A buyout may occur because the purchaser believes it will receive financial and strategic benefits, such as higher revenues, easier entry into new markets, less competition or improved operational efficiency.

Buyout Process

A complete buyout typically takes three to six months. The purchaser examines the target company’s balance sheet, income statement and statement of cash flows, and conducts a financial analysis on any subsidiaries or divisions seen as valuable.

After completing its research, valuation and analysis of a target company, the purchaser and target begin discussing a buyout. The purchaser then makes an offer of cash and debt to the board of directors (BOD) of the target company.

The board either recommends the shareholders sell the buyer their shares or discourages the shareholders from doing so. Although company managers and directors do not always welcome buyout offers, the shareholders ultimately decide whether to sell the business. Therefore, buyouts may be friendly or hostile. Either way, the buyer typically pays a premium for gaining controlling interest in a company.

After completing the buyout process, the purchaser implements its strategy for restructuring and improving the company. The purchaser may sell divisions of the business, merge the business with another company for increased profitability, or improve operations and take the business public or private.

Leveraged Buyout

The company performing the LBO may provide a small amount of the financing, typically 10%, and finance the rest through debt. The return generated on the acquisition is expected to be more than the interest paid on the debt. Therefore, high returns may be realized while risking a small amount of capital.

The target company's assets are typically provided as collateral for the debt. The buyout firm may sell parts of the target company or use its future cash flows to pay off the debt and exit with a profit.

Examples of Buyouts

In 1986, Safeway's BOD avoided hostile takeovers from Herbert and Robert Haft of Dart Drug by letting Kohlberg Kravis Roberts complete a friendly LBO of Safeway for $5.5 billion. Safeway divested some of its assets and closed unprofitable stores. After improvements in its revenues and profitability, Safeway was taken public again in 1990. Roberts earned almost $7.2 billion on his initial investment of $129 million.

In 2007, Blackstone Group bought Hilton Hotels for $26 billion through an LBO. Blackstone put up $5.5 billion in cash and financed $20.5 billion in debt. Before the financial crisis of 2009, Hilton had issues with declining cash flows and revenues. Hilton later refinanced at lower interest rates and improved operations. Blackstone sold Hilton for a profit of almost $10 billion.

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