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The Impact of leveraged buyouts in post-crisis Euro countries
The effects of leveraged buyouts on firm performance
Bachelor Thesis
Student: Duco Stoffer Faculty: Economics and Business
2 Statement of Originality
This document is written by Duco Stoffer, who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document are original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
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The Impact of leveraged buyouts in post-crisis Euro countries
Abstract
Leveraged buyouts (LBO) are a way of financing a company takeover. This method has frequently been used in popular waves of the 1980’s and early 2000’s. The effects of these buyouts are broadly covered by academic literature from these periods. Conclusions in these papers overall were that LBO’s led to improved company performance. More recent research uses different indicators to assess performance, compared to literature from the 1980’s. This paper analyzes the effects of LBO’s on performance and variables related to this performance of 117 European firms that went through an LBO since the end of the crisis. Using multiple variables that relate to different aspects of firm performance, it will be assessed whether the buyout has resulted in an improved company performance. This paper aims to contribute to the existing literature by focusing solely on Euro-currency countries and by examining buyouts that have taken place after the end of the financial crisis.
4 Table of Contents Page number 1. Introduction………..5 2. Literature review………..6 2.1 Types of LBO……….6 2.2 Company performance………..7 2.3 Indicators of performance………8 2.4 Relevant literature………..9 2.5 Post-crisis performance……….10 2.6 Hypothesis………11 3. Data………12 3.1 Collection process………12 3.2 Sample characteristics………..13 3.3 Limitations………..15 4. Methodology………..15 4.1 Performance variables………..15
4.2 Pre- and post-data……….16
5. Results………..18 5.1 Financial performance………18 5.2 Rate of return………..20 5.3 Employees………..21 5.4 Significance ………21 5.5 Discussion………23 6. Conclusion……….24
5 1. Introduction
If a company acquires or takes over another company using a significant amount of borrowed funds to meet the cost of acquisition, this is referred to as a Leveraged Buyout (LBO). Due to the high amount of debt used in these transactions and because the assets of the company acquired are often used as collateral for the loans, these transactions are referred to as ‘leveraged’. A leveraged buyout’s main advantage is to allow companies to make large transactions without having to commit a lot of equity. The high use of debt, which has a lower cost of capital than equity, serves to reduce the overall cost of financing the acquisition.
This way of financing a takeover first started to occur in the USA from the 1970’s and in Europe from the 1980’s 1. Most buyout deals in the 1980’s had a relatively small impact on
employment, research and development and maintenance expenses (Helwege and Opler, 1993). Early studies performed by Kaplan (1990) and Smith (1991) show that leveraged buyouts conducted between 1977 and 1986 significantly improved overall operating efficiency. The findings of these academic papers have been strengthened by various other academic studies, that came to similar results (Bull, 1992; Opler, 1992; Phalippou, 1990). Due to these findings, among other, leveraged buyouts became positively associated with improved firm performance and efficiency.
Due to the large positive effects found in early LBO transactions, there has been a lot of academic research on the effects of these buyouts. Baker and Wruck (1989) as well as Kaplan (1989) looked at the effects of LBO’s and the value creation in companies during the first LBO-wave of the 1980’s. Liechtenberg and Siegel (1990) compared plant-productivity data pre- and post-LBO to investigate the effect on company performance. More recent studies, such as Desbrieres and Schatt (2002) and Weir (2006) have focused on the second LBO wave of the late 1990’s and early 2000’s. These papers found a positive effect of a leveraged buyout on several variables that were related to firm performance.
It can clearly be seen that LBO’s and the effect of a buyout on company performance has been the subject of many academic studies. Despite these previous academic studies, research on the influence of LBO’s on the performance of acquired companies post-crisis is nonexistent. Research has mainly focused on the past LBO waves of the ’80 and ‘2000’s. On top of this most of these past papers have focused solely on buyouts that took place in the USA and the UK, with the exception of research done on LBO’s in France (Boucly, 2010; Desbrieres and Schatt, 2002). This paper aims to contribute to the literature on leveraged buyouts by investigating the effects of such transactions on companies in post-crisis Euro-countries. Empirical studies so far have focused particularly on LBO’s in the USA and to a lesser extent in the UK. This thesis will focus solely on the European market and aims to contribute by providing new insights in European based companies undergoing LBO’s. Secondly, this paper is among the first to examine post-crisis company LBO behavior and effect. Many empirical studies have been conducted on the effects of LBO’s during the waves of the 1980’s and 2000’s. Not yet has any study conducted research on this effect post-crisis.
The main goal of the paper is to investigate whether the use of an LBO leads to an improved company performance. The performance of companies both Pre-LBO and post-LBO will be compared and analyzed with the use of a statistical analysis. As mentioned above, for contribution purposes, the research will focus solely on European euro-currency countries. And since the private equity had
1 Hurduzue, G. and Popescu, M.F. (2015); The history of Junk bonds and leveraged buyouts. Procedia Economics and Finance, volume 32, 1268-1275
6 recovered at the end of 20112, only companies from 2012 and onwards will be taken into account.
Even though these criteria greatly contribute to the originality of the research, the method comes with limitations. These will be discussed later in the paper.
In order to conduct this research, similar methods of previous research will be used. The company balance sheets, profit and loss accounts and income statements of acquired firms are analyzed and compared. Using different indicators of performance, quantified in several accounting ratios, the change in company performance before and after the buyout will be determined and assessed whether it has improved.
The remainder of this paper is structured as follows. In the next section, previous academic papers and findings on LBO’s will be presented. The different types of LBO’s as well as different measurements of the effect of buyouts found in relevant papers will be discussed. Afterwards the related literature and the hypotheses will be discussed. The data collection process, sample characteristics and limitations will be presented in section III. This is followed by an explanation of the performance indicators used and the statistical analysis that has been chosen. The results of this analysis are presented and discussed in section V. A summary and concluding remarks are given in the final section.
2. Literature Review
2.1 Types of LBO
A leveraged buyout is generally conceptualized as a financial transaction in which a company is purchased with a combination of equity and debt, such that the acquired company’s cash flow is the collateral used to secure and repay the borrowed money3. In the academic literature, LBO’s are
generally seen as a single entity, however, they can be divided in four categories (Renneboog and Simons, 2005). A common form of takeover occurs when a management team takes over the firm, this is called a Management Buyout (MBO). In an MBO, the management acquires equity stakes of the firm themselves. A Management-buy-in (MBI) occurs when an outside management team acquires a firm and takes it private. The difference with MBO’s is that in this example, an outside management team replaces the current management team. Since outside management teams do not have the same level of private information as current managers, MBI’s are less common than MBO’s4. If a firm is completely taken over by an institutional investor (or private equity firm), this is
referred to as an Institutional Buyout (IBO). Typically for IBO’s where the management stays on, managerial performance is rewarded with equity stakes in the new private firm, inducing them to perform better. The main difference with an MBO and an IBO is that the management team in the former gains its equity interest through being part of the bidding group, whereas in the case of an
2 Davies, J. (2018, February 19). Dry powder drives deal sizes to post crisis high. Retrieved from:
https://www.penews.com/articles/dry-powder-drives-deal-pricing-to-post-crisis-high-20180216
3 Macarthur, H. (2016, April 7). Private equity returns recover as post-crisis pain fades. Retrieved from:
https://www.forbes.com/sites/baininsights/2016/04/07/private-equity-returns-recover-as-post-crisis-pain-fades/#49e6f724517a
4 Renneboog, L. and Vansteenkiste, C. (2017); Leveraged buyouts: A survey of the Literature. Center Discussion Paper, volume 15
7 IBO, it is gained through a remuneration package. Finally, if the bidding team consists of members of the incumbent management team and an outside management team (backed by third-party private equity investors), this is referred to as a buy-in-management buyout (BIMBO).
Some academic papers have focused on the effects of specific types of LBO’s. Baker and Wruck (1989) looked at a company specific MBI, Drathen and Faleiro (2007) investigated the impact of IBO’s in the UK and several others focused on the effects of MBO’s (Harris, Siegel and Wright (2005); Kaplan (1989)). The results of these papers give similar results, compared to papers that disregarded the different types of LBO’s, with similar research questions. Furthermore, the papers that influence this thesis the most (Desbrieres and Schatt (2002); Jensen (1989); Liechtenberg and Siegel (1989); Weir (2006)) do not distinguish between the different types of LBO’s in the research. For simplicity reasons, this paper will follow their example and will not differentiate between the different types of buyouts.
2.2 Company performance
How can company performance accurately be measured? As mentioned before, there have been multiple academic papers that have investigated the effects of a leveraged buyout on company performance. The earliest academic paper on the wealth gains from leveraged buyouts comes from Jensen (1989). In his widely cited paper it is argued that organizational changes lead to
improvements in firm’s operating results. According to Jensen (1989), the increased management ownership and high financial leverage associated with the buyout result in monitoring the managers of the company. This provides strong incentives for managers to increase company performance. Therefore, the operating performance and investment decisions post-LBO are likely to be superior to these of the firm pre-LBO. There have been multiple articles5 that provide evidence supporting this
proposition. However, the way company performance is measured, differs among the research studies. Of these papers, the different methods can be split into two general approaches that serve as an umbrella for several sub-methods.
The first method of examining how a firm is performing is by analyzing the financial performance. This overall, or umbrella, method is split in sub-methods that analyze different variables related to a firm’s financial well-being. Both Kaplan (1989) and Smith (1989) used the difference in cash flow and operating profits as a benchmark to determine a company’s
performance. Their papers formed a hypothesis, stating that the change in ownership structure after a buyout results in an incentive effect to increase returns. Liechtenberg and Siegel (1989) regard total factor productivity, plant-output, annual profit and employee wage growth, as a benchmark for financial performance.
The second overall method to measure a firm’s performance is to analyze the (annual) returns. According to Nikkolaisen and Wright (2005) a company’s realized returns give the best indication of performance. These returns are indicators of how specific company variables perform, relative to each other. Desbrieres and Schatt (2002) strengthen this theory and state that realized returns give a more stable and realistic view of a company’s performance, than cash flow or profit measurements. Weir (2006) sub-divides return in three return ratios (profitability, indebtedness and efficiency) that are measured separately via several accounting ratio’s.
8 A final sub-method is defined by Amess and Wright (2007) who state that employee
contribution and wage growth defines a firm’s financial well-being. This method cannot be placed directly in either of the umbrella methods, and shall therefore be regarded as a separate method.
2.3 Indicators of performance
What indicators are used to measure firm performance? As mentioned before, company
performance is measured via two main methods. These are split in several sub-methods, that all use different ways to measure performance.
Financial performance can be analyzed in different ways. One of the most common methods is to examine the difference in cash flow and operating profits. Kaplan (1989) and Smith (1989), mentioned above, were among the first to use this method. Both book value of total assets and equity, as well as operating income are examined. Smith argues that a firm’s turnover and (use of) total assets are regarded as the determinants for a firm’s stock price, and therefore it is performance as it is perceived by stockholders. The papers of Bull (1992) and Cohn (2013) both use operating income as a benchmark to determine firm performance. Interestingly these papers examine two different time frames, the LBO-waves of the 1980’s and 2000’s respectively, but make use of the same variable in their research. A final determinant of financial performance is the use of Earnings Before Income Taxes, Depreciation and Amortization (EBITDA). In his paper, Guo et all (2011) aim to examine whether buyouts in the second LBO wave create value. The authors follow previously laid theories on cash flow as a determinant of firm performance (Jensen (1989); Kaplan (1989); Smith (1989), but argue that the EBITDA is the strongest indicator of financial health. An important note is that all of these variables are measured before the deduction of taxes. This is of importance since leveraged buyouts have large effects on the taxes paid by buyout companies6. Kaplan and Stromberg
(2008) even find an increase of over 40% two years after the LBO has taken place.
To examine a company’s return, several return ratios can be taken into account. A widely used return in academic papers is the Return on Assets (ROA). This measurement has a prominent role in the academic research of both Boucly (2010) and Cohn (2013). Here, and in many studies alike, this ratio is used as one of the main explanatory variables of company performance, both before and after a buyout. Other studies examining company ratios analyze multiple ratios at a time in order to conclude whether a buyout is favorable for company performance. Desbrieres and Schatt (2002) conducted research where company performance is determined by five different returns. Besides ROA, these indicators are: Return on Investment (ROI), capital structure, liquidity and profit margin. Of these, liquidity and profit margin are mentioned to be the most important. Weir (2006) compares company performance based on three financial variables, profitability, indebtedness and efficiency. Profitability is measured by means of three ratios, return on capital employed (ROCE), return on equity (ROE) and earnings before interest, tax, depreciation and amortization (EBITDA). Indebtedness is analyzed using the ratio of total debt to total assets. This includes both short term and long term debt. Finally, efficiency, is measured by means of profit per employee and total asset turnover.
6 Kaplan, S., Strömberg, P. (2008). Leveraged buyouts and private equity. Journal of Economic
9 This paper will make use of the variables that relate the most to a firm’s performance, as reviewed by the literature as well as variables that have been proven to react strongly to a leveraged buyout. To analyze the performance of the firm, a similar method of Weir (2006) will be used. The two main methods of assessing firm performance are sub-divided in separate variables. Each related to a specific aspect of the firm performance. The financial performance of the firm is subdivided into profitability and efficiency. For profitability, the EBITDA will be examined, as it has been proven to be a strong indicator of financial health (Jensen, 1989). For efficiency, the total amount of assets as well as the turnover will be taken into account. As for the return ratios, it can be assessed that returns on assets, as well as return on equity, are among the most widely used determinants of firm
performance7. Returns related to profitability are the return on capital employed and the profit
margin. Since the current ratio is a determinant of company liquidity, this return will also be taken into account.
A final method to analyze firm performance that will be taken into account is that of employee contribution and wage growth. This however can’t be placed in one of the two umbrella methods and must be seen as a separate measuring variable. This is because more employees and a higher wage per employee do not necessarily imply firm profitability. Shleifer and Summers (1988) form the hypothesis that buyouts and takeovers create wealth to investors by laying off employees and reducing their wages. Their theory argues that an improved operating income, after the buyout, comes from cutting costs through wage decreases and employee layoffs. Several papers provide evidence for this theory (Kaplan (1989); Smith (1989); Liechtenberg and Siegel (1990)), however, all of these findings proved to be insignificant. Both the number of employees as well as the employee wage decreased, but this could not be directly attributed as a result of the leveraged buyout. Recent research however is able to significantly conclude that the number and wages of employees
drastically decreases as a result of a company buyout. In line with Jensen’s (1989) theory, Amess and Wright (2007) argue that organizational changes following an LBO provide an opportunity to
renegotiate implicit and explicit contracts with employees. The organizational changes may also lead to a correction level in employment. This paper will examine the effects of the buyout on total number of employees as a secondary hypothesis. Comparing the wage growth requires an analysis of multivariate statistics and the use of compound annual growth rate (CAGR). Since this research focuses on variables of interest only, this will be left out of the analysis.
2.4 Related literature
Leveraged buyouts have shown to increase company performance in many academic papers. One of the first studies on company performance was conducted by Kaplan (1988). In his study, he investigated the effects of a management buyout on operating performance. 48 buyout companies were investigated on percentage changes in cash flows during the first three years after the buyout. For operating income, capital expenditures and net cash flow, he found that operating income, as well as net cash flow, remained unchanged for the first two years post-buyout and were 24% higher in the third year, compared to 1 year before the buyout had taken place. Smith (1989) strengthens Kaplan’s findings by looking at the changes in operating performance of 58 management buyouts of
7 Gallo, A. (2016, April 04). A refresher on return on assets and return on equity. Retrieved from:
10 public companies completed during 1977-1986. The findings show that operating returns increase significantly from the year before to the last year after the buyout. Opler (1992) investigates 44 LBO’s that occurred between 1985-1989. He finds that as a result of the buyouts, operating cash flow to sales ratio median increases over 11%. Backer and Wruck (1989) apply the method used in Kaplan’s and Smith’s study on a single company in order to find out whether the performance had improved after the buyout.
Bull (1992) investigates the consequences of leveraged buyouts on operating performance for 44 leveraged buyout transactions, using an operating cash flow to sales ratio as the most important benchmark. After comparing the median of the ratio pre- to post-LBO, he finds that the ratio rises by 11.6%. His findings are comparable to those of Kaplan and Smith, a fact that he points out in his research as well.
Based on the hypothesis that firm performance can be explained by ratios of return,
Desbrieres and Schatt (2002) regresses French companies on pre- and post-LBO performance. Using five indicators of performance, subdivided in ten different measurements, the paper shows a decrease in return on equity for acquired firms after the buy-out compares to industry counterparts. The same feature is observed in return on investment and margin ratios. Boucly (2010) also analyzed the growth of French companies following a buyout using return ratio’s. Using a data set of 839 French deals, he found that the target companies become more profitable and grow much faster relative to a peer group. Both capital expenditure and the issuance of debt increased.
Using similar performance indicators, Weir (2007) looked at the effects of PTP (private-to-public) LBO’s in the United Kingdom between 1998-2004. The median profitability, based on several variables indicating company performance, was found to be lower after the LBO than before. Over a period of five years, Return on Capital employed (ROCE) decreased with over 55.1%, Return on Equity (ROE) decreased by 56.4% and EBITDA decreased by 58.4%. Weir’s research differs from most of the other academic papers, both in outcome and in data sample (using a more recent sample compared to the other academic papers).
For a sample of over 1200 United Kingdom based LBO’s, ranging from 1994 to 2004, Amess and Wright (2007) find that, relative to non-LBO’s, wage growth is lower and employment growth is higher. However, in their study a distinction is made between MBO’s and MBI’s. For LBO’s in general, they find no significantly different employment effects resulting from LBO’s. Liechtenberg and Siegel (1990) also determine the effects of LBO’s on employment and wage growth. Using a large, plant-level database to investigate the difference in total productivity pre- and post-LBO, they find evidence for employment losses (among white-collar workers. Evidence had not been significant to assess the same for blue-collar workers). These findings are contradictory to the findings of Palepu (1990). After analyzing company productivity and operating performance, it was found that these improve in the years following a buyout. There was little evidence of a decline in employment levels or average wage rates.
2.5 Post-crisis performance
Do the performance variables indicating firm performance change after, or as a result of, a financial crisis? In the paper of Notta and Vlachvei (2014), the performance of Greek food manufacturing firms is analyzed, before and during the recent economic crisis. To assess performance, the authors formulate a model to identify and quantify factors that explain
11 profitability. Profitability is measured via a ratio of turnover, EBITDA and a return on assets. The creation of their model was influenced by the papers of Claessens et all (2011) who examined the performance of firms using cross-country data and variables related to performance. The variables were similar to those used in previous academic papers8. Gunnarskog et all (2016) even find
evidence that a relationship between firm performance before the crisis, and how firms were impacted by the crisis was non-existent. Their study suggests that explanatory variables used to assess firm performance before a financial crisis, are not affected in their ability to measure firm performance after the crisis. As a result of these findings, this paper will not deviate to use the variables that were found in previous papers to measure firm performance.
2.6 Hypothesis
This paper aims to find out whether the effect of a leveraged buyout is favorable for overall company performance. To conduct the research, it follows the methods of previous conducted academic research. Therefore, the results found in previous research is expected to be found again in this paper. Based on the theoretical and empirical foundation outlined in the previous section, the following main hypotheses are formulated;
H1; Company performance, as measured by financial ratios, of the firms that went through a
leveraged buyout has increased.
H2; Company performance, as measured by return ratios, of the firms that went through a leveraged buyout has increased.
Since these hypotheses can be regarded as too broad, they will be explained in more detail; According to the literature reviewed, firm performance measured by financial ratios consider all variables that are related to a firm’s financial well-being. Both Kaplan (1989) and Smith (1989) find great increases in operating income. Research done by Opler (1992) and Guo et all (2011) provide evidence for an increase in EBITDA and total assets. Therefore, the hypotheses are
formulated as follows;
H1a; The operating profit of companies that went through a leveraged buyout has increased, as
compared to the performance before the buyout.
H1b; The amount of total assets of companies that went through a leveraged buyout has increased,
as compared to the performance before the buyout.
H1c; The earnings before income tax, depreciation and amortization of companies that went through
a leveraged buyout has increased, as compared to the performance before the buyout.
8 The paper examined the effect of the Asian crisis at the end of the millennium. Using ROA, ROE, profit margin and EBIT as a determinant of firm performance.
12 The second hypothesis is formed by the findings of academic papers that use return ratios to compare pre- with post-LBO company performance. Both Bull (1992) and Boucly (2010) concluded that the ROA increased. Besides the ROA, Desbrieres and Schatt (2002) find that the current ratio and profit margin increase as well. Other ratios, such as ROCE and ROE, however, have been found to decrease, as presented by Weir (2006). Based on these findings, the hypotheses are formulated as follows;
H2a; The return on assets of firms that went through a leveraged buyout have increased, as
compared to the performance before the buyout.
H2b; The current ratio of firms that went through a leveraged buyout have increase, as compared to
the performance before the buyout.
H2c; The profit margin of firms that went through a leveraged buyout have increased, as compared to
the performance before the buyout.
H2d; The return on equity of firms that went through a leveraged buyout have decreased, as
compared to the performance before the buyout.
H2e; The return on capital employed of firms that went through a leveraged buyout have decreased,
as compared to the performance before the buyout.
Finally, based on the findings of Amess and Wright (2007) and Palepu (1990) this paper will analyze whether the hypotheses that the number of employees decrease as a result of a leveraged buyouts. As mentioned before, the wage growth will not be examined.
H3; The number of employees working at a company that went through a leveraged buyout has decreased, as compared to the amount before the buyout.
3. Data
This section will discuss the collection process of the data used in this thesis. The sample is gathered from two different data bases, one for the deals and one for the individual company financials. The characteristics of the final sample will be presented thereafter. Finally, limitations on the data sample will be discussed.
13 3.1 collection process
In order to perform the analysis needed to answer the central questions of this paper, detailed accounting data is needed for Dutch companies that went through a leveraged buyout. As
mentioned before, the data required for this research comes from company balance sheets, profit and loss accounts and income statements. Since this paper only makes use of buyout deals completed since 2012 that occurred only in euro-currency countries, the ‘Zephyr’ database was used. This database enables to search for specific requirements for each buyout deal. The search entry provided a list of 194 separate companies, of which the company financials were traced using the databases of ‘Orbis’ and ‘Datastream’. Orbis allowed access to post-LBO company financials, whereas Datastream provided pre-LBO company financials. To accurately measure the impact of the buyout, this paper requires data from at least two years before and two years after the transaction had taken place. As a result, the dataset of firms was reduced to 125 companies. Moreover, after a more accurate inspection, it appeared that only 117 of these companies had a balance sheet and profit and loss account, which contained financials that were complete enough to do the analyses. The collection process ended in a final sample of 117, euro-currency based, companies that have gone through an LBO since 2012. The characteristics of this sample will be discussed hereafter.
3.2 Sample characteristics
The sample companies’ size varies largely in terms of number of employees. With an average of 2208 employees, a minimum of 3 and a maximum of 215,789, the number of employees in the sample is very diverse. As can be seen in Table 1, only 34% of the companies had more than 100 employees, while companies with less than 50 employees represent over 46% of the sample.
Table 1 – number of companies classified by number of employees
No of Employees No of Companies 0-50 55 51-100 22 101-250 23 251-500 7 501-1000 3 1001 and more 8 Total 117
14 The sample is further split by total assets and turnover as can be seen in Table 2. From this table, it can be concluded that over 56% of the sample companies have both total assets and revenues below 20 million Euro. Only 10% of the companies in the sample have revenues and assets with a worth of over 100 million Euro. The average total assets of the sample is 20,74 million Euro and the turnover mean is 38,54 million Euro.
Table 2
Euro (in Millions) Turnover Total assets
0-20 65 83 21-50 32 23 51-100 11 7 101-500 7 4 More than 500 2 0 Total 117 117
Finally, the sample is classified by all major industry sectors9. Using the ISIC classification,
the sample companies are arranged according to the main activity they carry out. The construction, wholesale and retail trade and the other services account for over 63% of the sample. The industries which contributes most to the size of the samples assets is the other services industry. An interesting observation is that the food and beverages industry, which accounts for a mere 5% of the sample, represents more than 20% of the total assets. Regarding the number of employees, the sample is overwhelmingly dominated by the construction sector, which accounts for 87% of the sample. Table 3
Industry No of companies % of assets % of employees
Banks 2 0.02% 0.019%
Chemicals 5 2.99% 0.197%
Construction 11 4.91% 87.13%
Education, health 1 1.16% 1.10%
Food, beverages 6 20.72% 2.021%
Gas, water, electricity 1 0.009% 0.089%
15
Machinery, equipment 8 2.71% 0.495%
Metals & metal products 6 17.18% 0.6%
Other services 43 27.19% 6.91%
Primary sector 1 0.071% 0.008%
Publishing, printing 3 1.74% 0.082%
Textiles, leather 2 0.53% 0.134%
Transport 5 2.65% 0.207%
Wholesale & retail trade 20 15.31% 0.98%
Wood, cork, paper 3 2.81% 0.134%
Total 117 100%
3.3 Limitations
The dataset presented above has been carefully gathered in order to accurately measure the impact of leveraged buyouts on firm performance. However, there are several limitations attached to this dataset. Due to the requirements of the sample, time period and geographic region, the number of companies in the sample size becomes small. I have considered to include European countries that do not use the Euro as their currency (Sweden, Switzerland, United Kingdom), however that would be detrimental to the originality and contribution of this paper to the existing literature. Also, due to the limited time frame on which the research focuses, the effects following an LBO can only be observed for no more than two years following the buyout. This makes it more difficult to accurately measure the effect of the buyout on company performance.
4. Methodology
The purpose of this paper is to analyze the impact of a leveraged buyout on the performance of firms. This is done with the use of specific company performance related variables and statistical analysis. This section will explain which variables are chosen and what methodology will be used to determine whether these have improved.
4.1 performance variables
The empirical part of this paper is based on the combined works of Bull (1992), Desbrieres and Schatt (2002), Kaplan (1989) and Weir (2007). These papers try to assess the post-LBO performance of companies, compared to their pre-LBO performance. The papers rely on different indicators of performance, measured by a number of accounting ratios, to determine the change in performance
16 between the pre- and post-LBO period. This paper combines several of these variables for this research. As mentioned before, firm performance will be measured using two different indication methods and the measurements of these indicators. These measurement for firm performance are based on variables relating to the financial performance and to the retuns. The financial
measurement consists of the company EBITDA, turnover and total amount of assets. The return ratio’s examined are; return on assets (ROA), return on equity (ROE), return on capital employed (ROCE), the current ratio and the profit margin.
Finally, regarding the hypothesis formed by Schleifer and Summers (1988), the difference in number of employees employed will be examined and compared to the findings of relevant
literature (Amess and Wright, (2007); Schleifer and Summers (1988); Liechtenberg and Siegel (1990)). All of the relevant papers found evidence for the employment theory, however they proved to be insignificant. Both the number of employees as well as the employee wage decreased, but this could not be directly attributed as a result of the leveraged buyout. This paper gathered data on the number of employees employed for the companies in the sample. Using the same methodology as used for the financial performance and return ratio’s, the change in number of employees will be examined and tested for significance.
The ratio’s and variables that are used in the performance analysis will be explained in Appendix A. An overview of how these are calculated is shown in Appendix B.
4.2 pre- and post-data
Post-LBO operating changes for representative firms can be observed by measuring the median change in operating performance variables before and after LBO’s (Opler, 1992). For each firm, the change in any given indicator of performance is measured by comparing the firm’s median value post-LBO with median value pre-LBO. The percentage change of these variables will indicate
whether the variable increased or decreased. In order to accurately measure this impact, the data of each of the variables is gathered two years before and two years after the date of the buyout. A summary of these descriptive variables is given below.
In table 1, the mean, median and standard deviation of the performance ratios of return before the buyout is given.
Table 4; summary of pre-LBO return variables
Variable Median mean Standard Deviation N
Firm performance two years before LBO
ROA 1.61 1.98 2.51 117
ROE 15.54 16.055 59.89 114
ROCE 15.25 16.35 32.76 96
Profit margin 4.34 4.34 14.51 117
17
Turnover* 11,824 43,048 17,075 117
Total assets 7,884 25,784 6,931 117
EBITDA 0,770 1,702 5,231 113
Firm performance one year before LBO
ROA 1.51 2.06 2.76 116 ROE 20 20.85 37.6 113 ROCE 18 19.67 26.75 97 Profit margin 4.15 6.17 10.21 117 Current ratio 1.43 1.98 1.86 113 Turnover 14,325 41,986 16,936 117 Total assets 9,409 24,281 6,200 117 EBITDA 0,841 1,561 5,302 113
* The amount of turnover, total assets and EBITDA is given in millions of Euro
The mean, median and standard deviation for the performance return ratios after the LBO has taken place is given in table 2.
Table 5; Summary of post-LBO variables
Variable Median mean Standard Deviation N
Firm performance one year after LBO
ROA 1.55 1.89 2.32 116 ROE 25.91 29.64 59.43 116 ROCE 19.28 19.097 31.59 97 Profit margin 4.52 6.87 14.31 117 Current ratio 1.48 1.98 2.41 113 Turnover* 12,471 32,077 85,698 117 Total assets 9,802 22,461 5,046 117 EBITDA 0,961 2,134 3,758 113
18 Firm performance two years after LBO
ROA 1.64 1.94 2.19 111 ROE 26.3 31.59 37.88 109 ROCE 18.42 23.001 41.42 93 Profit margin 5.32 8.401 10.61 109 Current ratio 1.88 2.01 2.43 107 Turnover 13,349 33,269 80,653 111 Total assets 9,228 19,899 3,508 111 EBITDA 1,059 2,602 4,707 107
The difference in these two statistical variables is then tested for significance using the paired-samples t-test. One of the requirements for this test is that the sample must be normally distributed. To normalize the sample, the performance of the variables at time T (the moment of buyout) is used as a benchmark in order to determine the percentage change in pre- and post-LBO performance. This benchmark is subtracted from each of the other years in the sample, resulting in percentage changes relative to the benchmark year. From these results it will be assessed whether the change in the variables, after the LBO has taken place, is significant.
5. Results
The results of the statistical analysis will be discussed and presented in this section. First, the results of the percentage change of variables related to the firm’s financial performance will be presented and explained. Secondly, the same will be done for the different rates of return of the firms. In subsection 5.3, the difference in number of employees employed will be examined and compared to the findings of relevant literature. Afterwards, in subsection 5.4, the significance of each variable, that was obtained via the statistical method as discussed above, will be presented and analyzed. Based on the findings, the main research questions will be discussed. Finally, limitations to this study and ideas for future research are discussed
5.1 Financial performance
Table 6 presents the percentage change of the variables related to the financial performance of the firm. The performances are compared annually, for the years before and after the buyout has taken place. The two years following the buyout are also compared with each other, resulting in 5 percentage change observations.
19 Turnover is found to be lower in the first two years following the buyout, as compared to the year immediately preceding the LBO. The two years following the buyout show a decrease of 12.39% and 6.81% respectively compared to the year before the buyout. In this paper, turnover is computed as the company’s annual revenues, so the best interpretation for these decreases is that there has been a reduction in the revenues following the buyout. This result is not consistent with previous findings, as both the research of Opler (1992), as well as the widely cited papers of Kaplan (1989) and Smith (1989), depend on improved operating turnover as one of the determinants for value creation in LBO’s. Kaplan observed strong positive margin ratios after the LBO, Opler found an increase in the median post-LBO value of operating income of more than 11%.The observed decrease in turnover in this paper is not necessarily contradicting to previous findings. As can be seen, the turnover increases in the second year following the buyout, compared to the previous year, promising a further increase in the future. Since Kaplan (1989) pointed out, turnover only starts to substantially increase in value after the third year following the buyout.
The results for total assets are very fluctuating. The first year after the LBO shows an average increase of 14% over the last two years before the buyout had taken place. The second year after the buyout however shows an average decrease of 8.5% over the last two years. Total assets have increased the first year following the buyout, but decreased with 5.8% the year after. This result is not consistent with previous findings, where it was assessed that assets significantly increase after a buyout. A possible explanation for this outcome is that the firm sold off part of the assets in order to pay for the debt that was acquired to finance the takeover10.
As for the results in EBITDA, in line with previous findings (Opler (1992); Guot et all (2011); Weir (2006)) it can be observed that the value increases substantially after the company buyout. After analyzing the results, it can be assessed that the EBIT is increased after the buyout has taken place. Compared to the last year, the average EBIT increases with 14% and 37% in respectively the first and second year after the buyout. These high returns are similar to findings of Kaplan and Stromberg (2008), who found an increase of over 40% two years after the buyout was completed.
Table 6; summary of annual changes for financial firm performance
Variable t+1/t-2 t+1/t-1 t+2/t-1 t+2/t-2 t+2/t+1
Turnover 5.47% -12.39% -6.81% 12.89% 7.04%
Total assets 24.32% 4.17% -1.92% 17.05% -5.86%
EBITDA 24.805% 14.27% 37.53% 25.92% 1.02%
20 5.2 Rate of return
Table 7 presents the percentage change of the ratios related to rates of return of the firm. The performances are compared annually, for both years before and after the buyout has taken place. The two years following the buyout are also compared, resulting in 5 percentage change
observations. The table shows that most of the variables are found to be increasing. As was hypothesized, the return on assets shows an increase in result after the LBO. The first two years following the buyout, the ROA increases with an average of 6%, when compared to the performance in the final year preceding the LBO. This is interesting since the total assets have been found to be decreasing. Since ROA is calculated as the net income divided by total assets, one of the possible reasons to explain the positive result is that net income substantially increased.
The possible increase in net income can also be assessed from the increased returns in profit margin. The profit margin, calculated as net income divided by sales, is shown to be improving in the years following the company buyout. After initially increasing with over 8% the first year following the buyout, this substantially rises to over 22% in the second year. The second year post-LBO is more than 17% higher than the first year post-LBO. Also the current ratio (current assets divided by current liabilities) is found to be increasing. The return shows an increase of 3.5% and over 30% in respectively the first and second year following the buyout, compared to the final year before the buyout. Interestingly, when compared to the first year after the LBO, the second post-year is substantially higher (27.3%). A similar observation is found for the profit margin (calculated as net income divided by net profits). Both the profit margin as well as the current ratio have been shown to increase post-LBO, as was expected in the hypothesis. Interestingly, both the ROE and the ROCE did not decrease, as was initially expected. Following the findings of Weir (2006), it was
hypothesized that these results would significantly decrease. As can be seen however, the first year following the buyout shows an increase of 7% for return on capital employed and an increase of over 30% for the return on equity, when compared to the final year before the buyout.
From the results, it can be assessed that the second year post-LBO shows substantially improved results compared to the first-year LBO. Besides the ROCE, all of the returns show overall higher results. Both the current ratio as well as the profit margin even increased over 15% compared to the first year following the buyout.
Table 7; summary of annual changes for return ratios
Variable -2 to +1 -1 to +1 -1 to +2 -2 to +2 +1 to +2 ROA -3.73% 2.64% 8.61% 13.10% 5.81% Profit margin 4.14% 8.91% 22.58% 28.19% 17.70% Current ratio 2.07% 3.49% 31.46% 29.65% 27.03% ROE 66.73% 29.55% 69.93% 31.5% 0.73% ROCE 26.43% 7.1% 19.61% 2.3% -4.46%
21 5.3 Employees
Table 8 represents the percentage differences on the number of employees employed of the companies in the sample. As was expected, it can be shown that the number of employees substantially decreased after the LBO had occurred. Compared to the year immediately preceding the buyout, the number of employees dropped with over 10% in the first year after the buyout. Interestingly, it increases the year thereafter and increases in one year with over than 13% (nevertheless, the amount is still lower than it had been before the buyout).
Similar to the findings of several academic literature (Amess and Wright, (2007); Schleifer and Summers (1988); Liechtenberg and Siegel (1990)) the results are shown to be decreasing post-LBO compared to the results pre-post-LBO. However, similar to the results of the literature, the results are insignificant. Therefore the decreasing results can’t be attributed as an effect of the LBO.
Table 8 results t+1/t-2 t+1/t-1 t+2/t-1 t+2/t-2 t+2/t+1 perc. Difference -12.27% -18.02% -0.38% -6.89% 13.55% T-test outcome 1.184 1.137 1.175 1.140 1.220 Sign. (2-tailed) .239 .258 .243 .257 .225 5.4 Significance
As mentioned before, the percentage differences that were calculated and presented above, will be tested for significance using the paired-difference test (Students t-distribution). For each variable, two pairs are matched, the year preceding the buyout with the year following the buyout and the two years before and after the buyout. As explained before, the data of the specific variable at time T (the moment of buyout) is used as a benchmark for the difference in the results. The results of the significance test are presented below;
22 Variable pair T-test outcome significance (2-tailed) degrees of freedom
Turnover T+1 /T-1 1.220 .225 116 T+2/T-2 1.196 .234 116 T+2/T+1 -.395 .694 116 Assets T+1 /T-1 -.992 .323 116 T+2/T-2 1.263 .209 116 T+2/T+1 1.063 .290 116 EBITDA T+1 /T-1 -1.107 .271 116 T+2/T-2 -1.264 .209 116 T+2/T+1 ** ROA T+1 /T-1 1.031 .305 110 T+2/T-2 .359 .720 .720 T+2/T+1 .411 .682 110 Profit margin T+1 /T-1 .593 .554 116 T+2/T-2 1.498 .137 116 T+2/T+1 ** Current ratio T+1 /T-1 -2.208 .029* 116 T+2/T-2 -.595 .553 116 T+2/T+1 -3.508 .001* 116 ROE T+1 /T-1 -1.418 .141 116 T+2/T-2 -2.368 .020* 116 T+2/T+1 .008 .994 116 ROCE T+1 /T-1 .158 .875 116 T+2/T-2 -1.179 .141 116 T+2/T+1 .599 .550 116
* Significant at a 5% significance level.
23 As can be seen in the table, only a few of the changes in percentages are statistically significant (5% significance), whereas this can’t be inferred on the rest of the variables. One of the possible reasons for which not all the changes are statistically significant can be the fact that the sample includes only two years preceding and two years following the buyout. It is possible that the full years chosen for this paper do not accurately represent the full impact that can be attributed to an LBO. It has been proven that in some cases, the effects of LBO’s are only visible after several years11.
Another explanation can be that the accounting data used was not optimal. Sometimes the
accounting data from the year immediately preceding the LBO can purposely be made less accurate on purpose, so it will value more to investors. In some cases, it will even try to reduce the company’s value using managerial manipulation12, to make it more attractive to investors.
5.5 Discussion
Do the results provide sufficient evidence to infer that the performance of firms that went through a buyout has improved? After analyzing the results of the different percentage changes several remarks can be made. The return ratios have predominantly been found to be increasing. Even the variables were it was hypothesized that they would decrease, have (substantially) increased. Apart from the ROCE, it was also evident that the second year after the buyout saw an improvement in the returns, compared to the first year of the buyout. From these observations, two conclusions could be implied. Firstly, since the returns have all increased in the years after the LBO, compared to the years before the LBO, it can be implied that the leveraged buyout has a positive effect on these returns, and therefore a positive effect on firm performance. Secondly, it can be assessed that the second year post-LBO performance substantially improves, compared to the first year post-LBO.
Somewhat more diverse are the results of the variables related to the financial performance of the firm. Two of the three hypotheses did not turn out as was expected. Both the turnover as well as the amount of assets was lower in the second year after the buyout, as compared to the final year preceding the buyout. For the assets, one of the possible explanations is that companies, post-LBO, used some of the existing assets to pay off the debt acquired to finance the takeover. Regarding the turnover, it is thought that this will show an increase in the third year (as was the case in Kaplan’s (1989) study). Since two of the three variables related to financial performance show a decrease, this implies that a leveraged buyout is unfavorable for a firm’s financial performance. When comparing the overall results of the performance of the firm pre-LBO and post-LBO however, it can be said that most of the variables have substantially been improved. This infers that firms that went through a buyout have improved their performance. However, before this can be concluded, an important aspect must not be overlooked. After performing statistical analysis to check for significance, it was found that the variables were mostly insignificant. This indicates that the differences in results of performance before and after the leveraged buyout has taken place do not differ enough for it to be statistically relevant.
11Kaplan, S. 1989. The effects of management buyouts on operating performance and value. Journal of
Financial Economics, 24(2): 217–54
24 5.6 Limitations and future research
Besides the insignificance of the variables, there are some other limitations on the conclusion of this paper. First of all, this research only makes use of the first two years after a buyout.
Occasionally, in this paper, a variable was found to be lower immediately after the LBO, but
increasing the year thereafter. To accurately capture the full effect of an LBO, more years should be taken into account. For this research, that proved to be impossible due to the very recent time frame the paper makes use of. The time frame presents the second limitation to this research. Since the paper investigates the period immediately following the economic crisis, the attracting economy could be a factor that influences the (improved) firm performance. Future research should take this into account by either comparing the results to a peer group of firms that did not experience an LBO, or by comparing the results to an industry average. If all these factors are taken into account, the results should prove to be significant and it can be assessed whether the use of an LBO, in post-crisis euro countries, leads to an improved firm performance.
6. Conclusion
Leveraged buyouts are a popular method of firm acquisition via the use of debt. This method became popular in the 1980’s and saw a rise again in the early 2000’s. This article aimed to find out whether the use of a leveraged buyout resulted in an improved firm performance. Hereby it focuses on buyouts conducted after the financial crisis, and those that only occurred in euro-currency
countries. After analyzing relevant literature, two separate ways of analyzing firm performance could be distinguished. In some papers, firm performance was determined by variables related to the financial performance of a firm. Other papers made use of return ratios to conclude whether firm performance had improved after the use of a leveraged buyout. This paper combined these methodologies and examined eight different variables that were related to both the financial performance and the rates of return. Over a timespan of four years, two years preceding and two years following a buyout, the variables of 117 companies were analyzed in order to determine whether their performance had improved after going through a leveraged buyout.
The sample companies showed an increase in return on assets, return on capital employed, return on equity, current ratio, profit margin and earnings before income tax, depreciation and amortization. These results are supported by findings in the academic field. Contrary to findings in relevant academic papers, the amount of assets and turnover were found to decrease. The workforce of the sample firms decreased substantially as was expected, supporting the literature that post-LBO shareholder wealth comes at the expense of employees.
After analyzing the results with statistical analysis, the results proved to be insignificant. An explanation for this insignificance can be the consideration that numerous other factors that have not been taken into account in this paper also influence firm performance. Future research should include these omitted factors to examine whether a significant conclusion can be brought forward.
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27
Appendix
Table A: ratios used to measure firm performance Rates of return
• Return on equity Net income/Shareholders equity • Return on assets Net income/Total assets
• Return on capital employed EBIT/Capital employed
• Profit margin Net income/Net sales (Revenue) • Current ratio Current assets/Current liabilities
Table B: explanation of ratios from Table A
Variable Definition
Equity Book value of shareholders equity
Total assets Total assets on the Balance Sheet
Current ratio liquidity ratio that measures a company’s ability to pay short-term and long-term obligations
Profit margin profitability ratio
Capital employed Total amount of capital that a company has utilized in order to generate profits.
EBITDA Earnings before Income Tax, Depreciation and Amortization. An indicator of a company’s financial performance
Turnover accounting term that calculates how quickly a business collects cash from accounts receivable.
Number of employees Total amount of employees employed, no distinction between blue-collar and white-collar workers.
