A leveraged buyout occurs when one company (often a financial services company) buys another company (often a true business) and uses the purchased company’s cash flow and assets to secure and repay the debt incurred by the purchase. The debt acts as a lever to increase returns, which gives rise to the term leveraged buyout, or LBO for short. In common language, LBOs usually involve a financial services firm buying a business in trouble with the confidence that its acumen will turn the company around. Sometimes LBO models work, sometimes they don’t.
LBOs reached a peak in 2005-08, before our current economic slowdown, thus any ranking of the biggest LBOs in history will take a good look at that era. Many of the LBOs that occurred at this time were thought to be headed for disaster when the market boom of 2005-07 went bust. Surprisingly, most of them have survived the downturn of the past five years, but the investment returns on them have been modest. Very few have recorded massive earnings.
It is entirely subjective to rank the top three biggest LBOs in history, but here is one attempt:
- KKR Buys RJR Nabisco for $31.1 billion in 1989 ($55.38 billion in today’s dollars)
KKR gained legendary fame with this bold move to acquire the tobacco and food giant because many analysts see this purchase as the start of a 20-year spree of LBOs. The deal was so dramatic that it gave birth to both a best-selling book and a TV movie, “Barbarians at the Gate.” The book and movie focused on the intense competition for RJR Nabisco, and how that competition both inflated the price and drew in stark contrasts the competing philosophies of the firms wanting to make the purchase. The deal is still seen as one of the biggest game-changers in Wall Street history. That seems accurate, given the lack of movies made of other giant LBO models.
- KKR, TPG and Goldman Sachs Buy Energy Future Holdings for $44.37 billion in 2007
Some analysts believe that KKR, TPG and Goldman Sachs were challenged by Blackstone’s move to acquire Equity Office (see below), so they made a comparable move to show that they were in the action, too. The purchase of this Dallas-based electric utility company was Texas-sized, and the $44+ billion deal was the largest amount ever paid in a private equity deal. The change in ownership also brought in James Baker III to serve as the advisory chairman. Despite his efforts, and others’, the aftermath has not been very pretty. Energy Future Holdings reported a loss of $1.9 billion in 2011 amidst record low natural gas prices. The retail arm has lost 17% of its customers over the past three years to rivals, and the debt load of $35 billion remains. Ironically, that debt was added to the balance sheet to finance the buyout, as is often done in LBOs. In summary, most, if not all, of KKR’s original $8.3 billion investment in this deal has been wiped out, and unless the price of natural gas increases steadily over the short term, this LBO model might be a stinkO.
- Blackstone Buys Equity Office Properties for $38.9 billion in 2007
This deal would be worth $41.4 billion in today’s dollars. Blackstone took a true risk by fattening its commercial property portfolio, the nation’s largest, right at the time that the mortgage crisis was beginning to gain steam. In fact, a whopping $16 million that Blackstone spent was used to assume Equity Office’s huge debt. Blackstone immediately sold many of the buildings purchased in this LBO model and two others for $36 billion. It now wants to possibly get completely out of the office buildings sector, according to a recent article in The Wall Street Journal, and might unload its remaining properties for a cool $20 billion. One of the biggest buyers of property in the world, Blackstone is moving to seller as the office building market remains fairly stagnant. If it is able to sell its remaining office properties for near their $22 billion value, it would mark a small profit overall on its 2007 LBO of Equity Office Properties.