Structured Finance

Leveraged Buyouts, Project Finance, Asset Finance and Securitization

Charles-Henri Larreur

• Publisher: Wiley
• Year: 2021
• ISBN:
  9781119371281
• Edition: 1
• Topic: Business
• Subtopic: Finance
• Index: Business

Comprehensive coverage of all major structured finance transactions

Structured Finance is a comprehensive introduction to non-recourse financing techniques and asset-based lending. It provides a detailed overview of leveraged buyouts, project finance, asset finance and securitisation.

Through thirteen case studies and more than 500 examples of companies, the book offers an in-depth analysis of the topic. It also provides a historical perspective of these structures, revealing how and why they were initially created. Instruments within each type of transaction are examined in detail, including Credit Default Swaps and Credit Linked Notes. A presentation of the Basel Accords offers the necessary background to understand the regulatory context in which these financings operate.

With this book, readers will be able to:

• Delve into the main structured finance techniques to understand their components, mechanisms and how they compare
• Understand how structured finance came to be, and why it continues to be successful in the modern markets
• Learn the characteristics of financial instruments found in various structured transactions
• Explore the global context of structured finance, including the regulatory framework under which it operates

Structured Finance provides foundational knowledge and global perspective to facilitate a comprehensive understanding of this critical aspect of modern finance. It is a must-read for undergraduate and MBA students and finance professionals alike.

PART I
Leveraged Buyout (LBO)

An LBO or leveraged buyout refers to the acquisition of a company with a combination of equity and debt. It is a financial technique that slowly emerged at the beginning of the twentieth century. LBOs, however, have only really taken off since the early 1980s, around the same time as project finance, asset finance, and securitization.

Readers with a background in finance are generally more familiar with LBOs than with the other financing techniques analyzed in this book. LBOs are a topic that might have been encountered in previous reading or studied in a course related to business valuation or corporate finance.

Without ignoring the link between corporate finance and LBOs, we think of the LBO as primarily a financing technique. Debt is indeed used to finance the acquisition – via an SPV – of an asset that generates cash flow. LBOs are in this respect similar to the other structures that we will discuss in this book. The main difference is the nature of the asset that is financed. It is a company in the case of an LBO, rather than an infrastructure asset, as in project finance (Part II), a moveable asset, as in asset finance (Part III) or a portfolio of receivables, as in securitization (Part IV).

LBOs combine all the elements of structured transactions: (i) use of an SPV; (ii) recourse to financial leverage; and (iii) tax optimization. They tend to get more media attention than other structured finance techniques, probably due to the fact that some companies taken over via LBOs are extremely well known. It is easier to make headlines in the Financial Times with the acquisition of Burger King or Harley‐Davidson than with the financing of a wind farm in Illinois or Colorado.

LBOs exemplify probably more than any other technique the series of financial revolutions addressed in this book. It is, therefore, only natural to start our journey with a plunge in the intricacies of leveraged buyouts. We hope that readers who are not familiar with the concept will discover its mysteries. For others, we hope that they will rediscover the spark – and the fun! – of this technique.

CHAPTER 1
What is an LBO?

1.1 THE MAIN FEATURES OF AN LBO

1.1.1 Definition

An LBO is an acquisition technique that allows an investor (also called a sponsor) to buy a target company using a large amount of debt. The buyout is structured using an intermediary company established for the sole purpose of acquiring the target company. That intermediary is an investment vehicle and does not have any employees. It is commonly referred to as an SPV (special purpose vehicle), SPC (special purpose company), or SPE (special purpose entity).

This SPV, which we will refer to here as the holding company, or HoldCo, is financed by debt and equity. The exact split between the two depends on the type of target company but also on market conditions at the time of the transaction. The equity is contributed by the buyer interested in the target company while the debt is provided by banks or investors who specialize in debt instruments.

Once taken over, the target company becomes a subsidiary of the HoldCo. The debt is repaid by the dividends paid by the target company. Here lies the magic of an LBO: a buyer can acquire a company while contributing only to a small part of the total amount of the target company value. The balance is supplied by lenders. Figure 1.1 represents a typical LBO structure.

1.1.2 Debt Sizing

Lenders in an LBO take the risk that the target company does not pay enough dividends to repay the debt. The loan provided to the HoldCo is said to be non‐recourse, meaning that in case of default, lenders have no recourse to the sponsor. In other words, lenders do not benefit from any guarantee nor any other type of credit protection from the equity investor. If the target company cannot pay dividends due to underperformance, lenders cannot go to the sponsor and ask for indemnification. Lenders generally only rely on a pledge of the shares of the HoldCo and the target company (a set of securities called a security package). These pledges can be exercised in case the HoldCo is unable to repay the debt. This allows lenders to take control of the companies and try to restructure the transaction or sell the target to repay their loan.

FIGURE 1.1 Simplified LBO Structure

Given the risks, interest rates applicable to LBOs are usually higher than those of traditional corporate financing. To ensure that the target company will distribute enough dividends to repay the debt, lenders size their contribution based on the predicted profits or cash flow of the target company:

• For the acquisition of very small companies (turnover of a few million US$ or below), the total debt amount is usually expressed as a multiple of net profit.
• For larger acquisitions, the acceptable level of debt is expressed as a multiple of EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization). EBITDA equals revenues minus operating costs. It is a measure of the operating profitability of a company regardless of its financial strategy, its tax position, or its investment policy. It is a very good indicator of the potential of a particular company and a pertinent reference to use when it comes to debt sizing in an LBO.

1.1.3 Various Types of LBOs

Behind the generic term of LBO, other acronyms are sometimes used to refer to some specific types of leveraged buyouts.

• An MBO (management buyout) is an LBO in which the management of the target company takes part in the buyout, alone or alongside another sponsor. MBOs are a very common form of LBO. They usually happen when:
  • the owner of a small or medium‐sized enterprise (SME) retires and decides to sell his or her company to the managers who have worked with them for some time (typically their children or right‐hand man);
  • a company is acquired by an LBO firm¹ that wants to retain existing managers. Many LBO firms can offer attractive packages in terms of stocks to key people in the target company. This is a way of aligning the managers' interests with their own interests. These key people are directly incentivized to help grow the company and ensure a successful LBO.
• An MBI (management buy‐in) is an LBO in which the buyers did not work for the target company before the acquisition, but act as managers after the acquisition. MBIs are common when the founder of an SME retires and cannot find a new buyer among his or her employees. In this case, the company is put on the market and acquired by a buyer with no previous connection to the company. An MBI can be carried out by a manager alone, by a group of managers, or by one or several managers co‐investing with an LBO firm.
• A BIMBO (buy‐in management buyout) is a mix of the two previous approaches. It is a buyout in which existing managers and managers from outside the target company collaborate to buy out the target company. Here again, the buyout can be carried out by these managers alone or alongside an LBO firm. A BIMBO generally makes sense if the new managers bring expertise that the existing ones do not have but that is ...

Table of contents

• Cover
• Table of Contents
• Title Page
• Copyright
• Dedication
• Preface
• Introduction
• PART I: Leveraged Buyout (LBO)
• PART II: Project Finance
• PART III: Asset Finance
• PART IV: Securitization
• Conclusion
• APPENDIX A: APPENDIX AHow Banks Set Interest Rates
• APPENDIX B: APPENDIX BSyndication and Club Deals
• APPENDIX C: APPENDIX CCredit Derivatives
• Bibliography
• Acknowledgments
• Index
• End User License Agreement