The Anatomy of an LBO: Leverage, Control and Value

In a typical leveraged buyout, there are three components. The acquirers borrow a significant portion of a publicly traded firm's value (leverage), take a key role in the management of the firm (control) and often take it off public markets (going private). None of these three components is new to markets and there can clearly be good reasons for each of them. Starting with traditional corporate finance first principles, we examine the conditions that are necessary for each component to make sense. Using the aborted Harman LBO, where KKR and Goldman were lead players, as a case study, we argue that choosing the wrong target for a leveraged buyout is a recipe for disaster even for the most reputed players in the business. In other words, no amount of deal expertise can overcome poor financial fundamentals. In closing, we argue that the three components in an LBO are separable and that bundling them together as essential pieces of every deal is a mistake.