Liberty University
BUSI536
Hostile Takeovers & LBOs
Diego Abreu
02/07/2025
Author Note
Diego Abreu
I have no known conflict of interest to disclose.
Correspondence concerning this article should be addressed to Diego Abreu
Email: [email protected]
1. Why were hedge funds developed? What role do they play in the market today?
The goal behind developing head funds was to minimize risks by investing in
long-term equity positions of undervalued stocks and, simultaneously, investing in short-
term equity positions in overvalued stocks, thus balancing market risks (Genin et al.,
2023). In today’s market, hedged funds continue to play a critical role in risk
management, allowing investors to generate significant returns and liquidity due to the
high level of transitions in the short-term position. Additionally, current funds have
focused on maximizing returns by investing in specific corporations going under change,
such as bankruptcy, restructuring, or M&A.
2. What created the change in the activist acquisition targets?
Studies have found that as around fifty percent of all mergers and acquisitions
fail to provide the necessary returns, investors have started to look for alternative ways
to influence the results of an investment (Angwin et al., 2022). The shift of strategy from
M&A to more active involvements led to an increase in cost reduction strategies for
organizations that had not reached their full potential or were underperforming in
comparison to their peers. This shift to a more active presence on the invests aligns well
with Proverbs 4:11-12 (New International Version, 2011) as it shows that by leading, we
accomplish more, "I instruct you in the way of wisdom and lead you along straight paths.
When you walk, your steps will not be hampered; when you run, you will not stumble."
3. Why is Jeff Smith known as one of the most aggressive activists? What was
the result of his actions?
Jeff Smith is mainly known as one of the most aggressive activist investors due
to his innovative and daring strategies. Strategies that land him complete control of
Darden's board in 2014 with less than 10% of the stock while competing against a board
of directors supported by leading investment banks and a well-known law firm. Allowing
him to change the company's strategy and goals (Gaughan, 2017).
4. What is the difference between a leveraged buyout and a going-private
transaction?
In a leveraged buyout strategy, organizations, primarily private equities, use debt
from borrowed funds to acquire another company. The assets from the acquired
company are generally used as collateral for the borrowed loans, minimizing the risk
involved in this transaction (Hermawan et al., 2022). On the other hand, going-private
transactions happen when an organization purchases a publicly traded company and
removes it from the stock market, intending to minimize market pressure. According to
Gaughan (2017, P. 305), “such a transaction is financed with some debt and some
equity” at a lower average premium than mergers or acquisitions.
5. How have the trends in leveraged buyouts changed since their origination in
the 1980’s?
In the last forty-plus years, the trends in leveraged buyouts have shifted from
taking complete control upfront and making aggressive changes the right way to a more
well-balanced and cautious approach. This change better reflects current trends in the
economic environment (Kaplan & Strömberg, 2009). Additionally, in the last few years,
modern leveraged buyouts have often focused on well-paced operational improvements
and long-term value creation, with an increased emphasis on sustainability,
environmental, and social factors.
6. RJR Nabisco is ranked as one of the largest leveraged buyouts; discuss
another recent leveraged buyout. How does this LBO differ from what happened
at Nabisco??
According to Michel and Shaked (1991), the RJR Nabisco case features the use
of “high-yield junk bonds to finance the buyout, resulting in a significant debt burden on
the company” (p. 25). This issue created significant tangible and intangible damages to
the company’s profitability and employee morale. Since then, leverage buyouts have
faced more regulatory scrutiny, as well as a massive increase in the number of required
disclosures. From a biblical point of view, Proverbs 22:16 (New International Version,
2011) emphasizes the morel implication of exploiting others for personal gains. This
issue can clearly be found in the RJR Nabisco case, as the organization cut costs and
oppressed their employees as they chase higher margins.
7. Discuss some of the potential conflicts of interest that take place in a
management
buyout.
According to Gaughan (2017), there are some clear conflicts of interest in
management buyouts, as managers are responsible for maximizing the financial results
of stockholders. At the same time, those same managers must present an offer to buy
the company. In summary, they must raise the organization's value while trying to find
ways to undervalue it since they are trying to buy it.
8. How does debt have a lower cost than equity? How does this impact the
company’s tax position?
Debt typically has a lower cost than equity as interest payments are usually a
fixed value that is agreed upfront, minimizing the risk of market changes. Additionally,
debt holders have priority in case of liquidity, meaning they would be given priority when
paid. In a tax position, interest on debt is considered tax deductible, which reduces the
taxable income, while equity is not included in the tax-deductible category (Martins,
2018).
9. List at least two ways of financing a leveraged buyout. Which method would
you choose if you were brokering the LBO?
High-yield bonds and Bank Loans are two ways of financing a leveraged buyout.
Each one of those strategies has its pros and cons, with bank loans providing a less
risky alternative, as bank loans normally come with well-structured fixed payment values
and low interest rates. On the other hand, High-Yield Bonds allow investors to have a
higher level of flexibility in terms of payments and the size of the loan (Gaughan, 2017).
Therefore, which method would be a better fit depends on the investor's financial
situation and risk tolerance.
References
Angwin, D. N., Urs, U., Appadu, N., Thanos, I. C., Angwin, D. N., Thanos, I. C.,
Vourloumis, S., & Kastanakis, M. N. (2022). Does merger & acquisition (M&A)
strategy matter? A contingency perspective. European Management Journal,
40(6), 847–856. https://doi.org/10.1016/j.emj.2022.09.004
Gaughan, P. A. (2017). Mergers, acquisitions, and corporate restructurings (7th ed.).
John Wiley & Son.
Genin, V. E., Gadmaliyev, E., & Genin, V. E. (2023). Exploring Hedge Funds: A
Comprehensive Look at Their History, Current Status, Analyses, and Emerging
Trends. Actual Problems of International Relations., 156, 67–73.
https://doi.org/10.17721/apmv.2023.156.1.67-73
Hermawan, D., Tanuwijaya, E., Aditama, J., Kusno, J. I., & Teja, A. (2022). A model to
identify the potential target for leveraged buyout. Journal of Finance and
Banking, 26(1), 111-125. https://doi.org/10.26905/jkdp.v26i1.6265
Kaplan, S. N., & Strömberg, P. (2009). Leveraged buyouts and private equity. Journal of
Economic Perspectives, 23(1), 121-146. https://doi.org/10.1257/jep.23.1.121
Martins, J. C. T. (2018). The New Tax Laws on Interest Deductibility and the Choice of
Valuation Method. Open Journal of Economics and Commerce, 1(1), 51-54.
https://doi.org/10.22259/2638-549X.0101006
Michel, A., & Shaked, I. (1991). RJR Nabisco: A Case Study of a Complex Leveraged
Buyout. Financial Analysts Journal, 48(6), 24-35.
https://www.jstor.org/stable/4479535
New International Version (2011). The Bible Gateway.
https://www.biblegateway.com/passage/?search=Proverbs%204%3A11&version
=NIV
