The surge in mergers and acquisitions has included many debt-financed takeovers known as leveraged buyouts. In a leveraged buyout, a company is acquired with mostly borrowed funds. The borrowings are paid off over time through asset sales and future earnings taken from the acquired company.
Two of the largest takeovers announced in 1985 -- the $6.2 billion acquisition of Beatrice Cos. Inc. and the $2.5 billion acquisition of Storer Communications Corp. -- were leveraged buyouts led by the New York-based buyout firm of Kohlberg Kravis Roberts & Co. The most controversial takeover bid of 1985 -- Ted Turner's attempt to acquire CBS Inc. -- was an unsuccessful leveraged buyout bid.
KKR is the leading firm specializing in leveraged buyouts. Because its track record of investing in takeovers is so good, KKR has billions of dollars of pension fund assets and bank loans at its disposal to invest in buyouts.
Most of KKR's leveraged buyouts are management buyouts, in which the management of the takeover target both continues to run the company and invests in the deal. Officials at KKR, which serves as the takeover target's board of directors but does not get involved in day-to-day affairs, say they believe that, when executives invest some of their own money in a buyout, they work harder to make the enterprise operate efficiently.
"The financial returns in leveraged buyouts have been very attractive, and the deals are getting bigger," said Martin Sikora, editor of Mergers & Acquisitions magazine. "The leveraged buyout market is very viable and very active.
"There are several different kinds of leveraged buyouts," Sikora said. "One is when a public company is acquired and taken private. Another is when a conglomerate sells one of its subsidiaries. And a third is in the private merger market when the management of a privately held company buys the firm from its owners."
In still another type of leveraged buyout, a public company may acquire a separate public company as a subsidiary.
Sikora said that, in the 1960s, transactions resembling leveraged buyouts were called boot-strap financings. However, giant leveraged buyouts financed with mostly borrowed funds did not emerge as a powerful takeover force until the late 1970s, he said.
According to the Mergers & Acquisitions database, 250 leveraged buyouts worth about $18.6 billion were reported in 1984. In the first three quarters of 1985, 164 buyouts worth about $12.4 billion were reported, but that number does not include the recently announced multibillion-dollar buyouts of Beatrice, Storer and the proposed buyout of R. H. Macy & Co.
The risk of leveraged buyouts is that the acquired company will not perform well enough to pay off its borrowings. Because every buyout creates a riskier enterprise that has additional debt on its balance sheet, the buyout target could be in trouble if performance projections turn out to be too optimistic.
Some economists are concerned that a large number of companies acquired in leveraged buyouts will be forced to declare bankruptcy if interest rates suddenly rise or if they are unable to repay borrowings when business conditions soften during the next recession.
There are several advantages of leveraged buyouts. If a public company is taken private in a leveraged buyout, the company no longer must show quarterly earnings increases to please Wall Street. Instead, long-term planning, which could affect short-term performance adversely, can be done more easily. Stockholders of public companies acquired in a leveraged buyout benefit because they typically receive a premium price for their shares.
Another advantage of leveraged buyouts is that a subsidiary of a giant conglomerate is likely to be operated more efficiently by managers who own a stake in the company.