The Leveraged Buyout Boom
It was too perfect a symbol, too convenient a metaphor to slip into the first paragraph of a story about leveraged buyouts, but there it was, sitting on the top of Leonard Shaykin's desk: a croupier's stick -- that long, graceful object with the slightly curved tip that croupiers use to maneuver gambling chips. Lacking a pointer at a speech he had given, Shaykin had improvised with the stick, which he had found in the bottom of a closet. Since then he has kept it in his office.
Now the stick was in his hand, punctuating his remarks about leveraged buyouts, or LBOs The principal purpose of the capital-raising technique, he was saying, was to maximize the number of chips while significantly reducing the risks.
"In a leveraged buyout," Shaykin explains for perhaps the dozenth time that week, "we take a financial risk, but, hopefully, not a business risk." Shaykin, who had set up Citicorp's leveraged buyout unit before joining with venture capitalist Fred Adler to form Adler & Shaykin (a partnership that is raising $100 million to do LBOs), has been talking about leveraged buyouts a lot recently. The LBO has become a phenomenon, a device whose popularity is attested to by everything short of buttons and bumper stickers.
Every other day, it seems, The New York Times or The Wall Street Journal reports on another LBO development -- the bidding war over Norton Simon Inc.; the purchase of the McCulloch Corp. by an investment group headed by McCulloch president Donald V. Marchese; the creation of LBO units by E. F. Hutton Group Inc. and Oppenheimer & Co. The New York Times observed, parenthetically, that in an LBO, "a management group puts up a relatively small amount of money and uses the company and its assets as collateral to borrow a relatively large sum to buy the outstanding equity.
"There's still a need to explain what LBOs are," notes Shaykin, "but that's changing quickly."
Specifically, LBOs are transactions in which buyers borrow against a company's assets at extraordinarily high debt-to-equity ratios, sometimes as high as 12-to-1. LBOs also happen to be one of the hottest items to hit the business and investment communities in nearly a decade W T. Grimm & Co., a Chicago-based merger broker that tracks management buyouts (the purchase of a company by memters of the management team), many of which are highly leveraged, reports that the number of management deals has more than doubled since 1980, while the size of the average deal has shot from $24 million to more than $33 million during the same period. The Merrill Lynch White Weld Capital Markets Group, which has itself invested around $30 million in LBOs, has tracked a 116% increase in LBO activity since 1979, and believes that the volume will be up significantly this year. "As much as 20% of all the acquisitions done this year," claims James J. Burke Jr., of Merrill Lynch's LBO team, "will be financed as leveraged buyouts." Shaykin expects that number to eventually approach 50%.
Shaykin, 39, a tall, trim man who refers to himself as "the better-looking half" of Adler & Shaykin, compares the situation to the one that prevailed in venture capital in the early '70s, when that industry was still finding itself. "I remember having a series of discussions back then," he recalls. "We were all relatively young, and we'd been making investments and doing all of the right things, but we weren't making any money -- and venture capital began to look fragile. If Federal Express, which had tied up $70 million of the total venture capital pool, had failed, it could have seriously affected the shape and direction of the entire venture capital industry. And the question we were asking was, 'Is this really a business, or are we just a group of smart young men making a mistake?' "
In the case of LBOs, that question has already been answered. "It is a business," says Shaykin, who, during his four years at Citicorp, oversaw the investment of $30 million in 12 transactions. During the same period of time, between 1978 and '82, the LBO market has shot to between $4 billion and $5 billion a year, more than twice the size of the venture capital market.
"There's an opportunity now to raise pools of capital and invest in these transactions before it becomes as fashionable as venture capital currently is," says John J. Murphy, a partner at A&S.
If Shaykin's experience is any indication, LBOs are about to explode. A partnership formed in February of this year, A&S attracted more than $50 million in its first eight weeks of fund raising, and transformed Shaykin's normally methodical routine into "one crazy . . . life." "We're being approached by investment bankers who want to bring us transactions," he explains "by lenders, by attorneys, by companies that want to be sold. . ." The croupier's stick taps against the palm of his hand as Shaykin counts off all of the players that want into the LBO game.
Why LBOs? Why LBOs now? The explanations are as numerous as the deals. They were triggered by inflation, with buyers hoping to pay off the debt in ever-cheaper dollars from sales that were inflating at double-digit rates, they were created by the banking community's desire to lend money at above-prime rates; they were sparked by "deconglomerization," the increased spinoff of divisions by U.S. corporations (see INC., February, page 41); they were fueled by changes in Federal Reserve regulations two years ago, which enabled investment banks to arrange financing for the acquisition of stock in public companies. But Shaykin sees something simpler at work. "I don't think it's inflation-driven, or economy-driven, or interest-rate-driven," he says. "I think it's really driven by the American dream -- the desire of management to own a piece of the company they're running, to control their own destinies. . . It has to do with the entrepreneurial spirit."
Adler, best known for his role in the founding of Data General Corp. and Lexidata Corp., agrees. "I really don't even like the phrase 'leveraged buyout,' " he says, "To me, the key phrase is 'management buyout,' because management is what these deals are really all about."
In fact, LBOs are used to achieve a number of ends: to take a public company private, to buy a division shed by a corporation, or to satisfy the needs of a founder who is selling a privately held company and is concerned about liquidity.
In the first case, explains Shaykin, an otherwise solid company may be out of favor in the public market, resulting in low prices and possibly inviting takeovers by "the sharks that swim in the water." Or, the company may feel that it needs to make strategic changes that won't sit well with stockholders. "Does it allow itself to be taken over or to make the wrong decision, or does it say, 'We have to maintain control . . . by going private?' "
