Elon Musk pulled one of the biggest leveraged buyouts in history when he took Twitter private in a deal worth $43bn.
14 April 2022, Elon Musk made a “take private” cash offer of $54.20 per share to buy all the shares in Twitter that he didn’t own already. This valued Twitter at $43bn. Between January 2022 to April 2022 Elon spent $2.64bn to get 9.2% of Twitter.
Why do leveraged buyouts lead to job losses?
One of the biggest pitfall of a leveraged buyouts is that the acquired company spends a lot time cutting costs post-buyout in order to pay back the debt more quickly. Due to salaries and wages being the biggest expense item for many companies, LBOs sometimes result in retrenchments.
What is a leveraged buyout (LBO)?
A leveraged buyout is when one company acquires another using a significant amount of debt to fund the acquisition. This allows the acquiring company to make a big acquisition without committing a lot of its own capital/equity.
Here is an example of how buyers in a LBO transaction always put in low equity relative to debt. In 2021, Hellman & Friedman and Bain Capital bought US healthcare technology company Athenahealth in a $17bn deal. $7bn of the $17bn was financed with equity and the $10bn was debt.
The company doing the acquiring in a leveraged buyout, usually a private equity firm, will use its assets as security on the loans taken. The assets and cash flows of the company that is being acquired are also (mainly) used as collateral and to pay for the financing cost.
LBO’s lead to listed companies being taken private.
Interest rates on the debt taken can be very high at times depending on the type of debt (secured, credit rating, currency etc). Cash flows generated by the acquired company are used to service.
Companies with the following characteristics are suitable for a LBO:
- Balance sheet with no or low amount of outstanding debt: the target can then be able to take on more take due to the LBO,
- Low future capital expenditure and working capital requirements to preserve cash
- Steady and predicable cash flows (needed to service the debt loaded)
- having underperforming/non-core assets and sold. Proceeds of which will be used to pay down the debt pile.
14 April 2022, Elon Musk made a “take private” cash offer of $54.20 per share to buy all the shares in Twitter that he didn’t own already. This valued Twitter at $43bn. Since the end of Jan 2022 Elon has spent $2.64bn to get 9.2% of Twitter.
Let’s look at the funding of the Twitter LBO.
1) $13bn debt split as follows;
- senior secured term loan of $6.5bn,
- senior secured revolving facility of $500m,
- senior secured bridge loan facility of $3bn
- senior unsecured bridge loan facility $3bn
2) Margin loan: $12.5bn. This was the initial margin loan which subsequently changed.
3) Elon’s equity: $21bn also changed from the time the deal was initially announced.
1) Morgan Stanley, which was advising Elon committed to put up the above $13bn of debt financing along with several big banks. The $13bn debt was 9x Twitter’s 2022 estimated EBITDA.
2) Lenders had extended a $12.5bn margin loan secured against his unencumbered Tesla shares. At a loan-to-value ratio of 20%. Elon would’ve pledged $62.5bn of his Tesla holdings.
Elon Musk later raised $7.14bn from a group of investors. The margin loan then reduced from $12.5bn to $6.25bn and increased his equity contribution portion to $27.25bn.
Late May 2022, Elon eliminated the remaining $6.25bn margin loan, and increased his equity commitment by the same $6.25bn. This means that the new financing package is as follows; $33.5bn equity and $13B LBO financing from banks led by Morgan Stanley. This financing has changed from $27.25bn equity, $13bn LBO and the $6.25bn margin loan.
3) Elon’s $27.25bn of equity. Where could come this come from?
- his own cash,
- private equity sponsors (theres a long list of groups that joined including, Fidelity Management & Research Company, Qatar Holding, Sequoia Capital Fund, Prince Alwaleed bin Talal confirmed that he and his Kingdom Holding Company rolled over a combined $1.89 billion in existing Twitter shares, making them Twitter’s largest shareholder after Musk).
Now you might be asking yourself why would Elon use debt when he is rich? Some reasons are as follows;
- debt usually has a lower cost of finance vs equity.
- debt does not provide an ownership stake.
- interest on debt is a deductible business expenses for tax purposes. No tax deduction on equity.
- debt tends to be less complicated to arrange than equity financing and may not require shareholder approval.
- once the debt is repaid, it leaves your balance sheet. Equity remains outstanding unless repurchased by the company, which typically requires the shareholder’s approval.
LBOs are back and the growth of private debt is fuelling this growth. Private debt is the 3rd largest alternative asset class in the world and private debt is expected to grow at a compound annual growth rate of 11.4% per annum to $1.46 trillion at the end of 2025.
Here’s an example of how private debt was used in a recent LBO. Early 2022, Thoma Bravo, a leading software investment firm agreed to buy SailPoint Technologies Holdings (the leader in enterprise identity security) in an all-cash transaction that valued SailPoint at $6.9 billion. Financing for the transaction is being provided by Golub Capital, Blackstone Credit and Owl Rock Capital.
The biggest LBOs to date are:
- TXU Energy: $32.1bn
- First Data: $25.7bn
- Alltel: $25.1bn
- RJR Nabisco: $25.1bn
- H.J. Heinz: $23.5bn
- Heathrow Airport Holdings: $21.8bn
- Dell: $21.5bn
- HCA Healthcare: $21.2bn
- Hilton: $20.2bn
- Alliance Boots: $19.6bn.
In conclusion
The debt from the LBO starts weighing heavily on the balance sheet.
Margins get suffocated, obligations need to be met, there aren’t many non-core assets to sell to meet those obligations, FCF is on a free fall so you go for the employees. You get the picture.
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