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Homework: Hostile Takeovers & lBOs Assignment
Carolyn DeClusin
Liberty University
BUSI 536 Mergers and Acquisitions
Dr. Jeffrey Woo
April 14, 2024
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1.
Hedge funds are similar in nature to mutual funds but with some marked differences.
“Hedge funds were developed as an alternative to open-end investment funds or mutual funds.”
(Gaughan, 2018) Hedge funds are not as regulated by the SEC, they do not have the same
reporting requirements as other types of investments do making it a little bit harder for potential
investors to get a good idea of what type of returns the fund gets. The fees in a hedge fund are
also usually higher with the manager getting a percentage of the profits of the fund. This
difference causes managers to make more risky plays to get higher returns than managers of
funds where they do not get a cut of the profits.
Hedge funds are less regulated and tend to use different tactics that may make the
investments more risky hedge funds are usually limited to wealthier investors who can take the
hit if the investment goes south. “You generally must be an:accredited investor, which means
having a minimum level of income or assets, to invest in hedge funds.” (Hedge funds) This
makes them not usually the investment of choice for regular working folks who are looking to
put money into investing for retirement. Because of the higher risk, it would not be wise to put
all one’s retirement into such a fund in case it did not do well and then the retirement is all gone.
Two types of hedge funds are applicable to mergers and Acquisitions, risk arbitrage
hedge funds and activist hedge funds. Activist hedge funds usually are actively trying to get a
company's stock price to increase rapidly. “Activists are short-term investors.” (Gaughan, 2018)
They try to encourage or bully a company into quick decisions that will cause the stock price to
increase so that they can buy low and sell high. Board seats are often a focus as having a seat or
many seats on a board can have a great influence on the decisions that are made about a
company.
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3.
Activists had often targeted smaller companies rather than large ones because the small
size made it much easier to take control of the company. They could buy up a majority or a large
portion of the company’s stocks and then push the company to do what they wanted them to do.
In a large company, millions of dollars’ worth of shares could be purchased but the fund may not
have enough to even have a small say in the running of the company. The goal of a hedge fund is
to get big returns. This is one reason activists started going after larger companies, “larger targets
are needed to produce more significant returns.” (Gaughan, 2018) This change in activists
beginning to go after large companies started between 2012 and 2014. After this, no company
was safe from becoming the target of activists even some of the largest companies such as Apple
were targeted. One method used was to get members onto the board, such as a person who is
already a leader of the hedge fund that is targeting the said company in order to get the company
to move faster or lean the way the fund wants it to go.
In 2018 pressure was put on Apple to help lessen smartphone addiction among kids.
“Activist fund Jana Partners and a giant California public pension fund launched a new kind of
activist campaign over the weekend, joining forces to urge Apple Inc. to take action to curb
smartphone addiction among children.” (Orol, 2018) This was a little odd as it used a different
tactic than the traditional drive to make stock prices of the target company quickly rise in order
to make money instead focusing on relationships with heads or other funds and businesses. “The
investment will almost certainly help Rosenstein (The Director of the fund) as he seeks capital
allocations from public pension funds for his traditional activist fund and its more aggressive,
less friendly agitations.” (Orol, 2018) :
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4.
There are many investors and activists in the investing world, many are known to be
tough or ruthless. But one name comes out as being the most ruthless activist around today. Jeff
Smith founder of Starboard Value Fund which was created in 2002. Jeff Smith became known as
one of the most aggressive activists around when in 2014 Smith was able to replace the entire
board of the restaurant company Darden even though the fund only had 10% of the company's
stocks. Gaughan says “This is even more notable when one considers that Darden actually had a
competent and well-informed board.” (Gaughan, 2018) He then filled the board with himself and
several associates whom he handpicked. This seems a little shady, but it did turn out for the best
in this instance as with some modifications Darden who owned Olive Garden began to be more
profitable.
In 2020 Jeff Smith was “Famously called the ‘most feared man in corporate America’
by:Fortune”. (Saleem, 2021) It seems like his overall investment strategy is pretty simple, he
finds businesses that are not doing well but could be, takes them over makes them do a ton of
hard work to make themselves better. Then he sells all the shares he had bought of those
companies while they were not doing well once he has brought them up to snuff. But this is only
a good model if it works. Of the campaigns that Starboard Value has been a part of around 80%
have been profitable. Which is pretty good.
The Bible says in Proverbs 13:11 “Wealth gained hastily will dwindle, but whoever
gathers little by little will increase it.” What is considered little by little? Would what is
happening in a hedge fund with riskier investments gained hastily? It could be, with greater risk
a greater reward but, you do risk losing it if you slowly put money away slowly with less risk
will ultimately increase it.
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5.
Going private is when a publicly traded company is bought out and turned into a private
entity. This can be done through Tender offers, management buyouts, and private equity buyouts.
Often this is done through LBO-leveraged buyouts. A leveraged buyout is where a company
decides that they do not want the shareholders to have a say in how the company is run or that
they do not like the direction the board and shareholders are pushing the company. Usually, the
company does not have very much equity and must borrow most of the money. This is done by
taking out a lot of debt in order to be able to afford to buy the company back from the
shareholders. An example of this in the textbook is the Ford Motor Company. Gaughan says
“The Fords wanted to be free to manufacture and sell their Model Ts at ever-decreasing prices,
which would come from reinvesting profits in the company as opposed to distributing them to
shareholders.” (Gaughan, 2018) Ford then borrowed a lot of money to buy all their stocks back
so that they could run the company as they saw fit.
Private equity firms often use LBOs when purchasing a public company to turn it private.
“In a typical buyout, the private equity firm agrees to buy a company with 60 to 90 percent debt
—hence the term ‘leveraged buyout.’” (Going Private, 2010) The firm would provide the rest of
the cash. There are many reasons a company would choose to take the risk of debt to go private a
couple include replacing management and downsizing for optimal performance.
From a biblical perspective, this is not the best idea. In Proverbs 22:7 it says, “The rich
rules over the poor, and the borrower is the slave of the lender.” (ESV, 2016) Instead of having to
answer to the board and their shareholder they now have to answer to whomever they got the
loan from. While this may seem preferable make sure all the costs are counted and that the loan
can be paid back.
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In the 1980’s many of the LBOs were being financed at 85-90% of a company's equity.
Which is a very high number, this rate of financing caused many of these LBOs to fail because
they were so heavily leveraged. This caused the places providing the financing to require higher
equity participation. The shift that happened during the 1980s was also in part due to the rate of
returns on these LBOs despite those that failed. When something is working well it inspires
competition which then drives prices down. “Cao and Lerner have reported that while the
average buyout firm formed between 1980 and 1985 generated an impressive 47% internal rate
of return, those funds established between 1986 and 1999 earned less than 10%.” (Gaughan,
2018) Surprisingly this did not end LBOs they actually became more numerous just slightly
changing form from mega-big buyouts to smaller ones. A study was done of firms filing for
bankruptcy “Andrade and Kaplan (1998):finds that 23% of the larger public to private
transactions from the 1980s had defaulted by 1995” (Ayash, 2020) This would explain the shift
from large buyouts to smaller ones. LBOs have become more and more common especially when
the economy is doing well, as interest rates fall and stock market prices increase it makes it
easier for companies to finance larger amounts of money more easily available. Predictably
LBOs hit a low after the recession of 2008. I think this type of transaction is very risky and, in
most cases, probably not worth it. As mentioned earlier Proverbs says the borrower is a slave to
the lender no matter if it is personal debt or business debt. The lender will have some control
over the company maybe not in the everyday running like the board of directors, but it will
ultimately affect the decisions made because there is a debt that must be repaid at a certain time.
This might cause decisions to be made in order to get revenue that might not otherwise have
been made.
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7.
One of the biggest LBOs up until 2006 was the LBO of RJR Nabisco. This company
comes from a merger between the Nabisco food company and the Reynolds tobacco company.
This company suffered from bad leadership by a man named Ross Johnson. Johnson did not look
out for the good of the shareholders but for the management, creating massive incentives and
compensations for those in management. “Management salaries and perks quickly grew to
outsized proportions.” (Beattie, 2023) The first offer for this company came from a management
firm in which Johnson was the CEO, this offer was a lowball and started a bidding war. When
the deal was eventually finalized Nabisco had $25 Billion in Debt.
This past year a big LBO that has been in process is that of Tobisha. This is a Japanese
company that has had issues with heavy losses, accounting scandals, and attempts to block
foreign shareholders from annual meetings. Thus in 2022, a buyout process was initiated. Several
companies made offers for this company and it seems like the process was pretty calm with the
management looking out for shareholders’ interests. :“The management also believes that a
privatization is the best strategic alternative for our stakeholders.” (Tobisha, 2023) The buyout
was for over $15 billion to Japan Industrial Partners with over 20 Japanese firms helping to
finance the deal.
The Tobisha deal differs from the Nabisco deal in that a member of the board was not
seeking to undermine the company, though many iffy or shady things did take place at Tobisha
over the last few years. One big thing that stands out to me is how selfish people can be most if
not all the problems these companies had could have been avoided if the people who were in
management and or worked there had lived by biblical ethics or morals. The way Johnson acted
brings to mind Philippians 2:4 “Let each of you look not only to his own interests, but also to the
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interests of others.” (ESV, 2016) If Johnson had done this and looked out for the shareholders of
the good of those working in his companies and not only for himself the company may not have
had all the issues that it did.
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Management buyouts can take place for several different reasons one might be that the
original owner wants to retire and asks that someone in management buy him out. “They are
undertaken by management teams because they want to get the financial incentive for the
company’s potential growth more explicitly than they can otherwise do so as employees.”
(MBO, 2023) Many times this type of deal appeals to companies because in this type of deal
management teams are more likely to stay in place and layoffs and downsizing will usually be
minimal.
However, several concerns also arise with this type of acquisition. Conflicts of interest
and not doing what is actually best for the company and shareholders among the top. This was
seen in the RJR Nabisco LBO with Ross Johnson using his position to attempt to take over the
company. “Another concern and potential conflict involves ‘earnings management’ prior to an
MBO.” (Gaughan, 2018) This would be not properly reporting or hiding earnings to make the
company look less profitable so that it is easier for the company to be bought out. Several
solutions have been proposed to help mitigate the obvious conflicts of interest in these cases.
One has to do with voting, not allowing the board member making the bid to vote in the matter.
This might work but, in some states, the state law would not allow this to be possible. Another
path is to hire an independent financial advisor to help make things fairer. (Gaughan, 2018) I
don’t think it will be possible for it ever to be completely fair because of the insider knowledge
that the manager will have just simply due to the nature of his or her job. Deuteronomy 25:15
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says “A full and fair weight you shall have, a full and fair measure you shall have, that your days
may be long in the land that the:Lord:your God is giving you.” It is important that if a manager
or director is going to pursue this path that they do it in the fairest way possible and consider the
shareholders and employees in their decisions.
9.
In the world of Mergers and acquisitions everywhere I go it says that Debt is cheaper than
equity. This seems a little backwards to me but as I have researched this it is beginning to make
sense. The tax code is written in such a way that when a company has debt or a loan the interest
that is paid on that loan can be at least partially written off on the company's taxes.” Because
payments on debts are often tax-deductible, businesses account for the corporate tax rate when
calculating the real cost of debt capital by multiplying the interest rate by the inverse of the
corporate tax rate.” (Boyte-White,2021) This lowers the overall cost of debt capital, along with
the fact that getting a loan from the bank does not entitle the bank to any say in how the company
operates or runs making using debt a very attractive option for companies.
Equity financing on the other hand gives a piece of the equity of the company to someone
else in the form of shares, securities, etc… In return, the shareholders expect a return on their
investment in the form of dividends. “The costs of equity financing are less favorable from a tax
perspective. Dividend payments and return of capital are not deductible to the business.”
(Jourdan, 2024):Shareholders who hold enough of the company can sometimes be given seats on
the board and now have a say in how the company is run, something that does not happen with
debt financing.
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Debt financing seems to be a way for businesses to lower the taxes that they have to pay
every year. Careful consideration should be given to see if that is actually in the best interest of
the company or if the tax benefit is just a benefit of doing something unwise.
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Leveraged buyouts can be financed in several different ways. Two of those ways are
senior debt and subordinated debt. “Senior debt consists of loans secured by liens on particular
assets of the company.” (Gaughan, 2018) Because the loans are backed by an asset that could be
sold if the company fails these loans are very secure and thus have a lower interest rate than
other types of financing. The terms of these types of loans are usually between five and ten years.
Subordinated debt gets its name because payment must first go to Senior debt before it
can go to subordinate debt making the debt under or subordinate to the senior debt. The term on
this type of debt is usually longer than the senior debt between six and ten years, and the interest
rate is higher. Most LBOs use a combination of different types of financing.
If I were to broker an LBO I would say that cash is king and as much as possible should
be done with cash and not be financed but, if there is not enough cash then use secured debt such
as senior debt where the debt is tied to specific assets. “This type of:debt financing:comes with
strict terms and conditions and sits above all other types of debt. It is often secured by assets and
typically has lower interest rates but higher criteria for qualification.” (Leveraged buyout
financing) This is the least risky. If the company were to fail then the assets could be sold to
cover the debts. As a believer, I am not a big fan of having any sort of debt, while the bible does
not say that it is wrong or a sin, it does warn about debt being a type of slavery. I would want to
manage the deal in such a way as to have the least amount of debt with the shortest payoff time
possible and the least amount of risk.
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References
Ayash, B. (2020). The origin, ownership and use of cash flows in leveraged buyouts. The
Quarterly Review of Economics and Finance, 77, 286–295.
https://doi.org/10.1016/j.qref.2019.10.004
Boyte-White, C. (2021, June 6). How do cost of debt capital and cost of equity differ?.
Investopedia. https://www.investopedia.com/ask/answers/032515/what-difference-
between-cost-debt-capital-and-cost-equity.asp
Beattie, A. (2023, July 17). Corporate kleptocracy at RJR Nabisco. Investopedia.
https://www.investopedia.com/articles/stocks/09/corporate-kleptocracy-rjr-nabisco.asp
CNBC. (2023, March 23). Toshiba Board accepts Japan Industrial Partners’ $15 billion buyout
proposal. CNBC. https://www.cnbc.com/2023/03/23/toshiba-board-accepts-japan-
industrial-partners-15-bln-buyout-proposal.html
Gaughan, P. A. (2018). Mergers, acquisitions, and corporate restructurings. Wiley.
Going private. The University of Chicago Booth School of Business. (2010).
https://www.chicagobooth.edu/review/going-private
Hedge funds. Hedge Funds | Investor.gov. (n.d.). https://www.investor.gov/introduction-
investing/investing-basics/investment-products/private-investment-funds/hedge-funds
Jourdan, H. B. (2024, January 10). Tax implications of debt and equity financing: Carr, Riggs &
Ingram. Carr, Riggs & Ingram CPAs and Advisors. https://cricpa.com/insight/tax-
implications-of-debt-and-equity-financing/
Leveraged buyout financing: Navigating the process. Leveraged Buyout Financing: Navigating
The Process | Saratoga Investment Corp. (n.d.).
https://saratogainvestmentcorp.com/articles/leveraged-buyout-financing/#:~:text=There
%20are%20two%20major%20types,and%20grow%20the%20acquired%20company.
Management buyout (MBO). Corporate Finance Institute. (2023, December 7).
https://corporatefinanceinstitute.com/resources/valuation/management-buyout-mbo/
Orol, R. (2018, January 12). With Apple (AAPL) campaign, activist Jana Partners polishes its
brand - thestreet. The Street. https://www.thestreet.com/markets/mergers-and-
acquisitions/with-apple-campaign-jana-partners-burnishes-its-brand-14446299
Taub, S. (2020, February 10). Starboard Lagged Activist Peers in 2019. Institutional Investor,
NA.https://link.gale.com/apps/doc/A715835727/GBIB?
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Toshiba Corp Revised Opinion of Scheduled Commencement of the Tender Offer for the
Company Shares - Final. (2023, Jun 08).:Fair Disclosure
Wire:https://go.openathens.net/redirector/liberty.edu?url=https://www.proquest.com/wire-
feeds/toshiba-corp-revised-opinion-scheduled/docview/2828385302/se-2
Saleem, F. (2021, March 16). “most feared man in corporate America” Jeff Smith’s top 10 stock
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