Hedge funds and Private Equity - PES

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2.8 When targeting a company
When targeting a company, LBOs are typically acting in accordance to a common set of
patterns, as we can deduce when we look at their practical leverage buy-outs in our case studies
and in accessible studies.
Extremely inexpensive loans have funded the acquisitions, because the funds usually only bring a
small capital contribution and very large loans, which the companies afterwards have to pay back.
This means that the LBOs see as target companies:
Who has stable cash flow so that the repayment is secured?
Who is fundamentally sound with a strong internal economy, high internal capital? This means
that the LBO as new majority shareholder can decide on an extra shareholder dividend.
Who – in some cases – can be acquired in the market at a price under the real market price?
Who – in the case of stock market notifications – can be delisted immediately after an LBO
acquisition?
Who has a management amenable to “reasonable arguments”, as many LBOs put it, these
being extraordinary bonuses, stock options to the company managements in the case of a
realised acquisition?
Who has a strong position within the specific market segment? Many infrastructure operators
spanning the public sector and private market operations seem especially attractive to
private equity funds. That is because the LBOs are looking for investment opportunities in
highly imperfect markets, especially if the infrastructure operator is fully privatised and the
management is “receptive” to a cooperative leverage buy-out.
It is worthwhile underlining that the LBOs increasingly look at companies as bundles of assets
and liabilities to be traded and not as much as companies with employees, jobs, and economic
potential to develop further in the globalised economy.
At the time investors – typically pension funds – buy into an LBO fund, they have no idea of what
companies the fund will invest in.
As part of the fund’s investment policy, the manager will invest according to the business opportunities
generated by him or her. There is no performance projection or guaranteed return.
Although historical results secured by a management team are good indicators of its skills, they
cannot be considered as a guarantee of future results. Accordingly, the relationship between
investors and managers is based on a high degree of trust. The managers, limited only by their
contract, have a great degree of freedom to choose, follow up and sell the portfolio investments
during the life of the fund.
The private equity manager virtually always invests with a short term holding strategy. The typical
stated holding period for a later stage investment is 3 to 5 years based on the team’s strategy
and business plan for extracting value in the business. In practice we can see that the holding
period is even shorter in many cases, down to 1-2 years and thereafter reselling.
Unlike investors on the stock market who have access only to public information without being
able to directly influence the behaviour of the companies in which they are shareholders, LBOs
always go for direct management control. That is why LBOs nearly always go for majority shareholder
positions.