Leveraged Buyout Refers to the Acquisition Strategy Term Paper

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Leveraged buyout refers to the acquisition strategy whereby the target companies is acquired with the help of borrowed money usually bonds or loans. The acquiring company usually borrows money to buy another company and thus minimum equity is involved. Usually LBOs work on the principle of 90/10 debt-equity ratios where 10% money comes from the acquiring company while ninety percent is borrowed funds. Li JIN and Fiona WANG (2001) write: "Most financial dictionaries define a leveraged buyout (LBO) as a debt-financed transaction, typically via bank loans and bonds, aimed at taking a public corporation private. Because of the large amount of debt relative to equity in the new corporation, these bonds are typically rated below investment-grade, and are properly referred to as high-yield or junk bonds." There are five important characteristics of LBOs including 1) less equity more debt 2) the bonds are known as junk bond because of their below-investment status 3) LBOs take place when a public company is turned private 4) or when a divestiture is involved 5) It is a high-risk acquisition. LBOS have their merits and demerits because of its high-risk nature. Some researchers believed the LBOs have a positive impact on the acquired firm because there are fewer management conflicts. PHILIPPE DESBRIERES AND ALAIN SCHATT write: "The LBO is generally supposed to bring about a positive transformation in the organization's structure and in the contractual relations between the firm's managers and its various financiers. Jensen (1989) reports that organizations involved in LBOs, in particular those engaged in low-growth or no-growth sectors, will face fewer problems concerning management incentives and control than other companies." But there is a downside to LBOs too. Since a major portion of funds has been taken from banks or other financial institutions, there is a risk of possible early exit too. If a company fails to stay productive and profitable in the first few years, there is a chance that it might fail to repay the loan, which can annulment of acquisition.

Merger and joint ventures are completely different forms of cooperation and therefore must be studied as such. Merger refers to collaboration of two separate companies whereby one company feels it can benefit by joining forces with the other and this results in a bigger and more powerful but one company. The separate organizations may or may not retain their individual names but according to the law, they would be regarded as one. The following definition of merger is taken from a website: "A merger is an integration that includes the integration of all programmatic and administrative functions to increase the administrative efficiency and program quality of one or more organizations. Mergers occur when one or more organizations dissolve and beco4me part of another organization's structure. The surviving organization may keep or change its name. A merger also occurs when two or more organizations dissolve and establish a new structure that includes some or all of the resources and programs of the original organizations." (see reference 3)

In a joint venture on the other hand two companies decide to invest in one project and profits are shared according to the level of investment made by each. In joint ventures, both companies retain their identity and are legally regarded as separate corporations but they decide on enter a project or venture together. The website adds: "A joint venture corporation is an integration that includes the creation of a new organization to further a specific administrative or programmatic end of two or more organizations. Partner organizations share governance of the new organization."(see reference 3) These two types of cooperation between organizations are dissimilar in most ways and the legal restrictions that apply to them differ subsequently. However the only similarity between joint venture and merger stems from the fact that now two instead of one company would be governing of the new organization or project.

Divestiture refers to forced separation of one organization's various units. This separation is ordered by the court; as the result of which one large organization is divided into one or more companies and some parts of the organizations are sold off to the general public. This is mostly done to mitigate the influence of one monopolistic corporation as we saw in the case of Microsoft. "Divestiture broke up the network services of AT&T into separate long-distance and local service companies. AT&T would retain the right to offer long-distance services, while the former Bell operating companies were grouped into new regional Bell operating companies to offer local telecommunications services." (See reference 4) The main motive behind divestiture is dispersion of power. Since in a monopoly, one organization has all the control over that industry, court would sometimes force the owners to sell off some parts of the organizations in order to mitigate power. This helps in dispersion and equal distribution of power and more people can be encouraged to enter the industry. Divestiture helps in making an industry more competitive and it has many advantages when seen from this viewpoint.


Merck is a world famous name in the drug and pharmaceutical industry and in 1993 it acquired Medco, which was popular for its mail order service. One large and another reasonably successfully corporation became one legal entity in 1993 but unlike some other mergers, this merger proved to be a highly successful marriage between two drug companies. The main reason behind this merger was Medco's successful pharmacy business, which focused on mail order delivery of prescriptions. The best thing about this merger was its complementary nature whereby the units of Medco did not interfere with previous operations of Merck but only complemented them. The merger has worked primarily because Merck did not try to alter Medco's business operations but learned from them and added them to their own value chain. Similarly Merck used its own expertise in the area of drugs and treatment to give a further boost to Medco's mail order business. One writer discusses the successful merger techniques of Merck and Medco in these words:

The merger of Merck and Medco gave Merck competitive advantages that other drug companies tried to replicate and have so far failed. Since government regulations have dictated that the PBM must remain separate business units, drug manufacturers cannot integrate the two companies as much as they want. While other drug manufactures are seeing their bottom line deteriorate because of their mergers, Merck-Medco have flourished because of Medco's mail order sales division that has high margins and more chronically ill people are utilizing. Although time will tell if these mergers were good for the drug companies, I feel the value added services that PBM's bring to drug manufactures will generate higher returns for the drug companies. Since the development of value creation activities are capital intensive to produce, drug manufactures bottom line is suffering." (See reference 5)

Hostile takeover refers to forced acquisition of a company by large organizations but since in this case force or coercion is used for acquiring the other firm, it is seen as a hostile move, which is often seriously resented, by company employees and management. For this reason, some companies believe it taking measures that would ensure defense against hostile takeover. They have certain strategies that protect them from forced acquisition. The first most common method is saying no to the bidder. But while this may sound like an effective legal strategy, it lacks any practical values because stockholders play an important role in this decision. If for some reason, they feel that the company is not being run successfully by the present management, they would also side with the bidder and this may make the 'saying no' strategy futile.

Most companies are therefore advised to have a poison pill defense available. This wards off any potential threat of a hostile takeover and…

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