Electronic copy available at: http://ssrn.com/abstract =1669698 Evidence on how private equity sponsors add value from a comprehensive sample oflarge buyouts and exit outcomes * Jarrad Harford Foster School of Business University of Washington Seattle, WA 98195 [email protected]and Adam Kolasinski Foster School of Business University of Washington Seattle, WA 98195 [email protected]August 31, 2010 We examine a comprehensive sample of 788 large US private equity buyout transactions from 1993-2001, tracking exit status through 2009. About 90% are exited other than through IPO. We test whether, on average, private equity sponsors create value or transfer value to themselves. All of our evidence is consistent with value creation. While private, portfolio companies reduce overinvestment, but do not underinvest. Special dividends to sponsors are rare and are not correlated with future portfolio company distress. The most common exit is to a strategic buyer, where announcement and long-run return results establish that value is created. Almost a third of portfolio companies are sold to another financial buyer. Such companies tend to be held longer and also tend to be in concentrated industries, suggesting that such secondary buyouts are motivated by liquidity needs as well as a desire to help monopolistic companies avoid the disclosure costs and public scrutiny that accompany public listing. * We thank Rocky Higgins, Paul Malatesta, Jon Karpoff, Jennifer Koski and participants at a University ofWashington Finance Brown Bag for helpf ul comments. Jared Stanfield, Robert Schonlau, and Wei Ming Lee provided excellent research assistance.
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8/8/2019 Biz School Study on Buyouts
http://slidepdf.com/reader/full/biz-school-study-on-buyouts 1/35Electronic copy available at: http://ssrn.com/abstract=1669698
Evidence on how private equity sponsors add value from a comprehensive sample of large buyouts and exit outcomes*
Jarrad HarfordFoster School of BusinessUniversity of Washington
We examine a comprehensive sample of 788 large US private equity buyout transactions from 1993-2001,tracking exit status through 2009. About 90% are exited other than through IPO. We test whether, onaverage, private equity sponsors create value or transfer value to themselves. All of our evidence isconsistent with value creation. While private, portfolio companies reduce overinvestment, but do notunderinvest. Special dividends to sponsors are rare and are not correlated with future portfolio companydistress. The most common exit is to a strategic buyer, where announcement and long-run return resultsestablish that value is created. Almost a third of portfolio companies are sold to another financial buyer.Such companies tend to be held longer and also tend to be in concentrated industries, suggesting that suchsecondary buyouts are motivated by liquidity needs as well as a desire to help monopolistic companiesavoid the disclosure costs and public scrutiny that accompany public listing.
* We thank Rocky Higgins, Paul Malatesta, Jon Karpoff, Jennifer Koski and participants at a University of Washington Finance Brown Bag for helpful comments. Jared Stanfield, Robert Schonlau, and Wei MingLee provided excellent research assistance.
8/8/2019 Biz School Study on Buyouts
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1
Private equity is controversial. Prominent personalities within the investment
community, such as Warrant Buffet, have opined that the returns generated by private
equity sponsors are a result of wealth transfers rather than value creation (The Times of
London, 2006). Articles in the popular press frequently use words such as “locusts” and
“rape-and-pillage” when referring to private equity sponsors (eg., Forbes, 2006, Der
Spiegel, 2006). In contrast, in a recent survey article, Kaplan and Stromberg (2009)
conclude that the bulk of the evidence suggests private equity sponsors create value.
However, they note that much of this is based on either reverse leveraged buyouts (e.g.,
Cao and Lerner, 2009) or on somewhat mixed evidence regarding operating
improvements (eg., Kaplan, 1989, Guo, Hotchkiss and Song, 2010, Litchenberg and
Siegel, 1990, Smith, 1990). Critics would respond that reverse leveraged buyouts are a
special sample of successful transactions, and that even evidence of operating
performance improvements under private equity sponsor ownership leaves open the
question of whether they came at the expense of long-term value.
In this paper we attempt a comprehensive empirical analysis of large private
equity buyouts performed from 1993 to 2001. We test and reject the hypothesis that
private equity sponsors transfer wealth to themselves or achieve short-term improvements
at the expense of the long-term. We further investigate several specific avenues of value
improvement or wealth transfers.
Specifically, for the companies bought out by private equity sponsors (i.e.
“portfolio companies”) in our sample with outstanding public debt, we confirm the short-
term profitability improvement found in previous research. Portfolio companies exhibit
ROA that is higher than a control group’s following the buyout. We also add a new
Next, for each buyout in our sample, we determine whether the private equity
sponsor or syndicate exited the investment, and if so, how. We check for exit via IPO
and merger and acquisition (M&A) using Capital IQ and SDC. We classify IPOs and
M&As as exits if a controlling stake of the portfolio company was sold to the public or
some entity or syndicate that did not participate in the initial buyout.1 For those portfolio
companies for which no exit can be found in the databases, we obtain exit information
from stories in the business press, company and private equity sponsor websites,
bankruptcy filing databases, and, in a few instances, with a phone call to the portfolio
company or private equity sponsor.
2
We place each exit outcome in one of five
categories: IPO, sale to strategic buyer, sale to financial buyer, restructured, or still held.
Following industry nomenclature, we classify as “strategic buyers” firms who do not
conduct buyouts in the ordinary course of business. “Financial buyers” are private equity
sponsors. We classify as “restructured” all buyouts in which the private equity sponsor
or syndicate lost its controlling stake due to a bankruptcy, workout, or other debt
restructuring resulting from financial distress. We count as “still held” those portfolio
companies where the original sponsor or syndicate, or some subset thereof, continued to
hold a controlling stake as of September 30, 2009. In each case, we confirm that a
company for which we could find no exit outcome was still held. In the case of a
“rollup”, in which two or more portfolio companies held by the same sponsor or
syndicate are merged with one another before exit, we assign to each individual portfolio
1 IPO’s in which only a minority stake is sold to the public are not counted as IPO’s. It is not uncommon inour sample for private equity sponsors to sell a small stake in an IPO, only to have a strategic buyer acquire100% of the portfolio company a short time later. We label these exits as sales to strategic buyers.2 In one instance, the private equity sponsor revealed that when its portfolio company was nearing financialdistress, it had a fortuitously timed fire. The insurance payout provided enough capital for the portfoliocompany to recover, and it was eventually sold to another financial buyer.
first percentile in the sample of deals for which a transaction value was disclosed (see
Table V). As a robustness check, we re-estimate the above specifications dropping deals
for which the transaction value was not disclosed, and we report the results in columns
(3) and (4) of Table VI. They are qualitatively unchanged.
E. Evidence from Long-run Post-acquisition Returns
Prior studies have found long-run underperformance following acquisitions
(Loughran and Vijh, 1997; Rau and Vermaelen, 1998). Thus, it is possible that the
announcement returns do not present the full picture of the effect of purchasing the
portfolio firm. In this section we test the hypothesis that public acquirers of portfolio
firms underperform acquirers of public companies.
We construct long-short portfolios that buy the acquirers of portfolio companies
and short the buyers of public companies.3 Portfolios are rebalanced monthly, so an
acquirer is added to the portfolio during the calendar month after the acquisition took
place and is kept in the portfolio for 36 months. We equally weight the portfolios, but
our results are robust to market-cap weighting. After constructing a time series of returns
for the portfolios of strategic acquirers and public acquirers, we subtract the risk-free rate,
the one-month t-bill return over that month. We obtain the French-French factors from
Ken French’s website.
We present two sets of results in Table VII. The first regresses the returns of the
long portfolio of strategic buyers of private equity portfolio companies on the Fama-
French factors. The long portfolio’s alpha is negative, but insignificant. The second
3 In the present draft, for ease of computation, we limit this analysis to domestic acquirers and foreignacquirers that are either listed on a US exchange or have ADR’s. In future drafts we will expand thisanalysis to include all foreign acquirers.
Boulcly, Q., D. Srarer and D. Thesmar, 2008, Do leveraged buyouts appropriate workerrents? Evidence from French data. Working paper, HEC Paris.
Bergstrom, Grub, and Jonsson, 2007, The operating impact of buyouts on Sweden: astudy in value creation, Journal of Private Equity 11, 22-39.
Cao, and J. Lerner., 2009, The performance of reverse leveraged buyouts, Journal of Financial Economics 91, 139-157.
Degeorge, Z. and R. Zeckhauser, 1993. The reverse LBO decision and firm performance:theory and evidence. Journal of Finance 48, 1323-1348.
Der Spiegel, 2006. The locusts. Staff writer, March 22, 2006.
Forbes, 2006. Private inequity. Weinberg, N. and N. Vardi, March 13, 2006.
Holthhausen, R., and D. Larcker, 1996. The financial performance of reverse leveragedbuyouts. Journal of Financial Economics 42, 293-332.
Mian, S. and J. Rosenfeld, 1993. Takeover activity and the long-run performance of reverse leveraged buyouts. Financial Management 22, 46-57.
Muscarella, C. and M. Vetsuypens, 1990. Efficiency and organizational structure: a studyof reverse LBO’s. Journal of Finance 45, 1389-1413.
Guo, S., E. Hotchkiss and W. Song, 2010, Journal of Financial Economics, Forthcoming.
Harris, R., D. Siegel and M. Wright, 2005, Assessing the impact of management buyoutson economic efficiency: plant-level evidence from the United Kingdom, TheReview of Economics and Statistics 87, 148-153.
Kaplan, S., 1989, The effects of management buyouts on operating performance andvalue, Journal of Financial Economics 24, 217-254.
Kaplan, S. and A. Schoar, 2005, Private equity returns: persistence and capital flows,Journal of Finance 60, 1791-1823.
Kaplan, S. and P. Stromberg, 2009, Leveraged buyouts and private equity, Journal of Economic Perspectives 23, 121-146.
Lichtenber, F. and D. Siegel, 1990, The effects of leveraged buyouts on productivity andrelated aspects of firm behavior, Journal of Financial Economics, 27 165-194.
Masulis, R., C. Wang and F. Xie, 2007, Corporate governance and acquirer return,Journal of Finance 62, 1851-1889.
Masulis, R. and R. Nahata, 2010, Venture Capital Conflicts of Interest: Evidence fromAcquisitions of Venture Backed Firms, forthcoming in Journal of Financial and
Quantitative Analysis.
Smith, A., 1990, Capital ownership structure and performance: the case of managementbuyouts, Journal of Financial Economics 27, 143-521.
Times of London, 2006, No silverware and Buffet’s buffet. Staff writer, May 8, 2006.
Table IIThis table presents pre- and post-buyout industry-adjusted capital expenditures, operatingmargins and ROA for portfolio firms with public debt. We subtract the 4-digit NAICS industrymedian in order to make the industry adjustment. “Chang in” variables are computed as the firm-specific difference in the variable for the post-buyout years (up to 3) compared to year -1 relativeto the buyout. None of the “Change In” variables are statistically different between the subsample
that paid a special dividend and the subsample that did not.Mean Median Std Dev 25th pctl. 75th pctl.
Table IIIDescriptive statistics for portfolio companies with public debt & the control group
Each portfolio company with public debt is matched to a public firm in the same 4-digitNAICs industry with the closest pre-transaction sales. The summary statistics for thevariables used in the investment-to-cash flow sensitivity regression in Table IV are
The dependent variable is capital expenditures scaled by assets. The sample consists of all LBO firms that have public debt, so that we can track their investment while private,and matching firms chosen for each buyout firm as the public firm in its 4-digit NAICs
industry closest in pre-transaction sales. Industry median q is calculated as the medianmarket-to-book of assets for the firm’s 4-digit NAICS industry that year. EBITDA/Assets(Negative, Positive) are EBITDA scaled by assets if negative and if positive,respectively. Post-buyout is a dummy equal to 1 for buyout firms while it is private and iszero otherwise. Post-buyout is also interacted with the EBITDA variables. Paid SpecialDividend is a dummy variable set equal to 1 if the firm paid a special dividend whileprivate and is zero otherwise. The regression is estimated with fixed firm effects and thestandard errors are reported in parentheses. ***, **, and * indicate significance at the 1, 5and 10% levels.
Table VDescriptive statistics on strategic acquisitions & acquirers
The sample consists of all acquisitions of private equity portfolio companies by public strategic
firms not in the business of buyouts. CAR is the cumulative abnormal return on the acquirer’s stoday window around the acquisition announcement date. Other variables are as follows: relsize istransaction value to the acquirer’s equity market capitalization two days prior to the acquisition; sindicating that acquirer stock was used as consideration; ndirectors are the number of directors onbefore the acquisition; ind_board is an indicator variable for a majority of independent directors;managerial entrenchment index that counts the following antitakeover provisions for the acquirerboard, CEO golden parachute, and super majority requirements for mergers, charter amendments amendments; Q is the ratio of the acquirer’s equity market capitalization plus liabilities to total aslength of time the acquisition target was held as private equity portfolio company prior to the acqacquirers equity market capitalization as of two days prior to the acquisition.
n mean stddev min 1st pctl 25th pctl Median 75th pctlCAR 191 0.021 0.077 -0.203 -0.159 -0.012 0.010 0.047
Table VIRegression analysis of strategic buyer announcement returns
The dependent variable is the cumulative abnormal return to the strategic buyeracquiring an private equity portfolio company during the 3-day window around
the acquisition announcement date. Independent variables are defined in Table IVabove. Columns (1) and (2) are run on a sample of all strategic acquisitions,including those for which a transaction value was not disclosed. In the latter case,the 1st percentile of relsize was imputed. Columns (3) and (4) are run on a samplethat exclude acquisitions for which the transaction value was not disclosed.
(1) (2) (3) (4)
relsize 0.037*** 0.043 0.037*** 0.043
(0.007) (0.037) (0.008) (0.040)
log(mktcap) -0.003 -0.007* -0.003 -0.008*
(0.003) (0.003) (0.004) (0.004)
stock -0.039*** -0.044*** -0.038*** -0.045***
(0.013) (0.013) (0.014) (0.014)
Q -0.003 -0.002 -0.003 -0.002
(0.002) (0.002) (0.002) (0.002)
TimeHeld 0.003 0.003 0.004 0.003
(0.002) (0.002) (0.003) (0.003)
ndirectors 0.003 0.004
(0.002) (0.003)
ind_board -0.012 -0.016
(0.013) (0.017)
eindex 0.001 0.001
(0.004) (0.005)
relsizexind_dum 0.057** 0.061**
(0.023) (0.026)
relsizexbn -0.004 -0.005
(0.003) (0.003)
relsizexeindex -0.009 -0.010
(0.007) (0.008)
Constant 0.033 0.036 0.030 0.041
(0.026) (0.030) (0.033) (0.039)
Observations 191 191 157 157
R-squared 0.24 0.28 0.26 0.30Standard errors in parentheses
* significant at 10%; ** significant at 5%; *** significant at 1
Table VIIAnalysis of the strategic buyer portfolio returns
Column (1) below regresses the excess returns of the equal-weighted portfolio of strategic acquirers of private equity buyout targets on the Fama-French factors.
Column (2) contains an analysis of a long-short portfolio, where the dependentvariable is the return on the portfolio of strategic acquirers of private equitybuyout targets less the return on the portfolio that contains all acquirers of publiccompanies. Acquirers are added to their respective portfolio in the calendarmonth immediately following the acquisition and dropped 36 months later.
Table VIIIMultinomial logistic regression analysis wherein we model the probability of fivedifferent buyout exit types: IPO, sale to a strategic buyer, sale to financial buyer,distressed restructuring, or still held by the sponsor as of Sept. 30, 2009. IPO is thereference exit type, so the parameter estimates in the table constitute the respective
variable’s marginal effect on the log-odds of the exit type indicated at the top of thecolumn relative to that of an IPO. The variables prefund, preotherpri, and presub aredummies indicating that the portfolio company, before the buyout, was, respectively,owned by a private equity fund, held by some other private owner, or was an operatingsubsidiary of a parent company that does not conduct buyouts in the ordinary course of business. The variable lbovalue is the enterprise value of the buyout in question. Thevariables roa and salesgrowth are the cross-sectional median return on assets and salesgrowth of the portfolio company’s 4-digit industry, averaged over the time periodbeginning two years prior to the buyout and ending two years afterward. The variableherf is the herfindhal index of the industry averaged over the same time period.Compustat segments data were used to compute all industry variables.