ANALYZING MANAGEMENT AND LEVERAGED BUYOUTS

The first section, when describing the different types of acquisitions, pointed out two important differences between mergers and buyouts. The first is that, unlike a merger, a buyout does not involve two firms coming together and creating a consolidated entity. Instead, the target firm is acquired by a group of investors that may include the management of the firm. The second is that the target firm in a buyout usually becomes a private business. Some buyouts in the 1980s also used large proportions of debt, leading to their categorization as leveraged buyouts. Each of these differences does have an effect on how we approach the valuation of buyouts.

Valuation of a Buyout

The fact that buyouts involve only the target firm and that there is no acquiring firm to consider makes valuation much more straightforward. Clearly, there is no potential for synergy and therefore no need to value it. However, the fact that the managers of a firm are also the acquirers of the firm does create two issues. The first is that managers have access to information that investors do not have. This information may allow managers to conclude, with far more certainty than would an external acquirer, that their firm is undervalued. This may be one reason for the buyout. The second is that the management of the firm remains the same after the buyout, but the way in which investment, financing, and dividend decisions are made may chan....