By John Thackray
If denunciations could have put a stop to leveraged buyouts,
there would be none today. In the summer of 1984 the LBO was a
target for virulent criticism by Paul Volcker, chairman of the
Fed, by John Shad, chairman of the Securities and Exchange
Commission, by Felix Rohatyn, senior panner of Lazard Freres,
and by Barry Sullivan, chairman of First Chicago.
The gist of all the denunciations was that top-heavy
reversed pyramids of debt were being created; and they would
soon come crashing down, destroying assets and jobs.
All this had some effect - for a time. "In the spring of
1984 there were lots of banks looking for deals. In the summer
it went to zero," a major player in the LBO market
Ralph McDonald Jr., an, executive vice president with
Bankers Trust, said: "There were tremors in the banking
community, and good deals got tougher to do because of
"There is still insecurity in the LBO industry, because
there is still a lot of public criticism," said Carl Ferenbach
of Thomas H. Lee.
However, there has been a spectacular rise in the number and
scale of LBOs. This highly geared form of financing is probably
here to stay. Because there is a huge number of private
business sales richly financed with debt, comprehensive
statistics on LBO activity nationwide are impossible to find.
But the growth of public deals has been astonishing, and these*
numbers tell us much about the rising impact of formally
organized and professionally managed institutional LBO
According to data provided by Merrill Lynch Capital Markets,
in the eleven and a half months to mid-December 1985 a record
$31.5 billion of LBOs were completed; double the volume of a
year earlier and three times that of 1983.
"In the late 1970s nobody knew what an LBO was. I mean
nobody at the big investment banks - not just the cocktail
party crowd," said Theodore Forstmann, partner in Forstmann
"It used to be just a few people buying companies
selectively. I never thought it would be the size of today, -
said Ira Hechler, a private investor who did dozens of deals
alongside Oppenheimer and Company in the 1970s.
"Just a few years ago this used to be a mom-and-pop
industry. Now we've grown to be a highly examined and
well-publicized activity," observed Joseph Rice, managing
partner of Clayton and Dubilier.
For all this publicity, there is still little understanding
of this diverse market. There are purely tax-driven LBOs,
junk-bond driven ones and those dependent on employee stock
ownership programmes (ESOPs). There are bust-up LBOs (that is,
the company's assets are sold off to finance the acquisition)
and those designed for longterm appreciation. There's leverage
predicted on cash flows, or on fixed-asset values and,
increasingly, on sanguine growth forecasts.
There is a new genre, the hostile LBO, and there are both
fiduciary and principal investors. "There are many segments and
cross-currents in the market," said Forstmann. "Seven or eight
years ago it was a very simple business and everybody worked
along roughly the same lines. But now it is difficult to figure
out who is doing what, and, often, to make sense of what's
There are three sectors of the market: senior bank debt,
mezzanine subordinated debt and - the hardest of all to raise
equity. Who's who in each category?
In bank debt, Manufacturers Hanover Trust is clearly the
front runner - although its lead has shrunk in the last year.
Bankers Trust is also important, and has a close relationship
with Kohlberg, Kravia, Roberts and Company (KKR). Citicorp,
once strictly an asset-based lender, has aggressively expanded
into the mainstream of cash flow lending.
Morgan Guaranty is smaller. But it has a strong appetite for
transactions where it not only lends the senior debt, but gets
a fair slice of the mezzanine and equity also. "Most banks like
an equity kicker. But we don't always get it. Morgan says it
always requires one, but I suspect that's not true," said the
head of a specialist LBO team at a rival bank.
Chase and Chemical are at present episodic LBO lenders. So
is First Chicago, notwithstanding the anti-LBO rhetoric of
Sullivan. Its Chicago neighbour,Continental Illinois, is
reported to be back in the marketplace in a small way. Security
Pacific, Wells Fargo, Marine Midland, Bank of Boston, Bank of
New York, Irving Trust, the Candian big four and some regional
banks have all done deals.
For commercial banks, LBOs represent one of the few areas of
high-profit lending today. The agent on a bank syndicate can
command fees of 1% of the transaction size, get around 0.75 %
on the portion of the loan taken down, and frequently charge
fees for hedging the LBO's floating-rate debt.
"The flow of LBOs is created by lenders. They don't just
support the market; they make it happen," claimed Robert E.
Koe, president of Heller Financial, which, along with General
Electric Credit and Citicorp, is a significant asset-based
lender to the LBO trade.