Getting Started
A “leveraged buyout” is when a company’s own assets are used as collateral to support a loan that is then used to purchase that same company. It has been described as the company buying itself. In the 1980s, leveraged buyouts became popular as a way to extract more value for shareholders. The approach was highly successful, with several billionaires created in the process. However, this high-risk approach also has serious ethical and financial consequences. It leaves a company saddled with an enormous pile of debt. Frequently the company is stripped of its brands or dismantled to repay the debt. While shareholders and executives may benefit, creditors, suppliers, or employees are often harmed. With this assignment, you will have the opportunity to evaluate a real-life leveraged buyout of your choice, and to carefully consider the ethical and financial implications of the decisions made by executives and their advisors.
Upon successful completion of this assignment, you will be able to:
Understand innovative approaches to the use of debt in business.
Evaluate the implications and appropriateness of the aggressive use of debt.
Resources
Video: Basic Leveraged Buyout (LBO)
Video: KKR Henry Kravis
Background Information
The leveraged buyout (LBO) has become a famous, perhaps infamous, approach to corporate finance. Whenever people talk about corporate raiders, they are probably referring to leveraged buyouts. The method has been featured in several movies, including Wall Street and The Boiler Room. The record-breaking 1989 acquisition of RJR Nabisco by famed private-equity firm KKR was even featured in a TV movie Barbarians at the Gate.
While it is easy to disparage such an aggressive and risky maneuver, there are many examples of where a leveraged buyout has resulted in not only great profits but also greatly improved businesses. When a company is purchased through an LBO, it is taken private, meaning its shares are no longer publicly traded. This frequently gives the company the space and discretion it needs to restructure itself.
For example, in 1986 supermarket chain Safeway was purchased by KKR, using only $129 million in cash but over $5 billion in debt. Safeway divested some of its assets and closed many of its unprofitable stores. However, by 1990 the company had greatly improved its profitability and revenue. The company went public again, resulting in $7.2 billion in profits for KKR. Safeway continues to operate successfully to this day, employing some 140,000 people. In 2015, the company was purchased by Albertson’s for $9.4 billion.
In this assignment, you will investigate an example of a real-life leveraged buyout that is of interest to you. You will then have the opportunity to analyze whether the decision to take the company private through an LBO was appropriate, not only in terms of its financial results for the company’s owners but also in consideration of the impact to the firm’s other stakeholders.
Instructions
Review the rubric to make sure you understand the criteria for earning your grade.
View the video Basic Leveraged Buyout.
View the video KKR Henry Kravis. Carefully consider the financial and ethical implications of the company’s approach to financing.
Study this workshop’s devotional about the implications of debt.
Research and identify an example of a recent leveraged buyout that interests you. You may choose any company you like, as long as it involves an LBO transaction and you can find enough information to shed light on the deal. Use OCLS and the internet to conduct research on the reasons for the transaction and the outcome.
Prepare a paper analyzing the ethical and financial implications of the selected company’s LBO transaction:
Provide a brief summary of the company and its LBO transaction.
Explain the justifications given for the company’s decision to execute an LBO.
Evaluate the impact of the LBO on the company’s stakeholders, including its shareholders and employees.
Assess whether the LBO was considered successful and explain why.
Explain, based on your informed opinion and research, whether executing the LBO was a good decision.
Review the 5.1 Exercise regarding the biblical perspective on debt. Evaluate the LBO strategy based on biblical principles and cite a Bible verse that supports your position.
Be sure to provide a detailed analysis and assessment that demonstrates your critical thinking and understanding of financial analysis. Your finished paper should be 500–600 words in length and include at least three sources in addition to your biblical reference.
Background Information
Debt is an extremely useful tool. For example, without debt, most people would have to save their money for decades in order to purchase a home. By the time an average family is able to afford such a purchase, they may be too old to truly enjoy it. Those of us who were able to have a childhood home likely did so thanks to our parents’ mortgage.
Similarly, in the business world, debt allows us to pursue new products and projects when we believe the timing is right, rather than simply when our budget allows it. Imagine if a company had developed an innovative new product but was unable to launch it for years due to lack of funding. They may miss the opportunity entirely.
Unfortunately, many people underestimate the risks and the costs of debt. By definition, debt presumes upon the future. This is the basic premise behind a mortgage. With a mortgage, we promise our future in return for a better today. This enables us to have a home while our kids are still young enough to enjoy it, but it also ensures we will pay much more for that home (with interest) and be saddled with an obligation that looms over us for many years.
While the Bible never says debt is a sin, it does repeatedly caution against its perils. Perhaps the best-known Bible verse about debt comes from Proverbs 22:7: “The rich rule over the poor, and the borrower is servant to the lender” (New International Version).
If you have ever been burdened with excessive debt, you can certainly identify with this feeling of servitude. Debt changes relationships. It often hides deeper issues, like “greed, self-indulgence, impatience, fear, poor self-image, lack of self-worth, lack of self-discipline, lack of faith, and perhaps many others” (Blue & Blue, 2016, p. 57). Debt creates a commitment we are expected to honor. While incurring debt may not be a sin in itself, failing to repay debt certainly is. Psalms 37:21 states, “The wicked borrow and do not repay, but the righteous give generously.”
So as Christians, how should we approach debt in our personal and professional lives? Finance guru Ron Blue sets out four biblically based criteria:
It must make economic sense. This means not only that the cost of borrowing must exceed the benefits received, but also that we must have a guaranteed way to repay. If we cannot guarantee we can meet the obligations of the debt, then we shouldn’t make the commitment.
There must be absolute unity. For instance, if one spouse has anxiety over the debt, then it should not be undertaken. Debt can alter and strain relationships and may create significant stress.
There must be spiritual peace. When you envision yourself taking on the debt, if you experience any lack of peace, then do not move forwards. This may be the Holy Spirit speaking to you! Pray for wisdom and for God’s will to be made known.
It must be aligned with God’s priorities. You should carefully consider what God-given goals you are pursuing. If your objectives do not align with God’s, or if there is any better way to achieve those objectives, then now is not the time to go into debt!
Reference
Blue, R., & Blue, M. (2016). Master your money: A step-by-step plan for experiencing financial contentment. Moody Publishers.
