A leveraged buyout is the acquisition of a public or private company with a significant amount of borrowed funds. A private equity firm (also called a financial sponsor) or group of private equity firms acquires a company using debt instruments as the majority of the purchase price. After the purchase of the company, the debt/equity ratio is usually greater than 1.0x (usually use debt for 50-80% of the purchase price). During the ownership of the company, the company’s cash flow is used to service and pay down the outstanding debt. The overall return the consortium group of investors in an LBO is determined by the exit cash flow of the company (EBIT or EBITDA), the exit multiple and the amount of debt that is paid off over the time horizon of the investment. Companies of all sizes and industries have been targets of leveraged buyout transaction.
In many cases, private equity firms work with existing management (management buyout) or new management (management buy-in) teams to invest in an LBO transaction. The management team is selected by the private equity firm to co-invest in an LBO and therefore use the team to create a leaner or more efficient business with the same steady cash flows which will ultimately increase the overall IRR return on investment. For example, a private equity firm will find a management team that has great experience and past success running supermarket chains. The private equity firm, along with the management team, will co-invest in a company such as Safeway, Inc. The private equity firm might also offer the management team, for example, a % increase in ownership 1 year into the investment holding period if the management team hits a milestone such as a 30% YoY increase in EBITDA. In this way, the management team stays incentivized to outperform and ultimately increase the value of the company.
KKR, Vestar Capital Partners and Centerview Partners entered into an agreement to acquire Del Monte Foods for $19.00 per share in cash. The three investors are also collectively called the “Sponsors.” The transaction is valued at approximately $5.3 billion, including the assumption of approximately $1.3 billion in net debt. This price represents a premium of approximately 40% over Del Monte’s average closing share price during the past three months prior to November 18, 2010, when market rumors of a transaction began, and is also higher than any price the Company’s stock has ever achieved according to KKR. Del Monte has built its business over the years into a leading branded pet and consumer products company with more than $3.7 billion in revenue.