The Global Economic Impact of Private Equity Report 2008 - World ...

data, on which we base our sample selection, do not enableus to study the capital structures of these transactions. 2In order to assess the role of private equity in the economyit is important to understand how long firms stay in LBOownership. The academic discussion on the longevity ofleveraged buyouts can be summarized in two disparateviews. One extreme is provided in Jensen (1989), whichargues that the LBO organizational firm is a long-termsuperior governance structure that imposes strong investormonitoring and managerial discipline through a combinationof ownership concentration and substantial leverage. Thanksto these benefits, Jensen predicted that leveraged buyoutswould eventually become a dominant organizational form,implying that LBO ownership is a long-term optimalstructure. The other extreme, represented by Rappaport(1990), views LBOs as a short-term “shock therapy” thatallows inefficient, badly performing firms with inferiorcorporate governance to enter a quick but intense periodof corporate and governance restructuring, in order toreturn to public ownership in a few years. Kaplan (1991)found a median time in private ownership of 6.8 years andconcluded that leveraged buyouts are “neither short-livednor permanent”. After these original academic contributions,a common view of leveraged buyouts has been that it is atemporary governance structure, particularly aimed atimproving governance in public companies with dispersedownership structures that have an excess of free cash flowrelative to investment opportunities. After management payperformanceincentives are imposed, previous inefficientinvestments are divested and free cash flow is being paidout to investors, the firm is then ready to return to thepublic market. 3Although this view may have been representative of theLBO boom in the 1980s, it is not clear how well it describestoday’s private equity market. The number of private equitytransactions is an order of magnitude larger in 2007 than itwas in the 1980s. The motivation behind leveraged buyoutsis no longer primarily about solving governance problems inUS publicly traded conglomerates. Rather, LBO transactionsoccur worldwide in a variety of industries and target bothprivate and public companies. In addition, there seems tobe an increase in so-called “secondary buyouts”, where oneLBO sponsor exits its investment by selling the firm to a newLBO fund sponsor, which could imply that the organizationalform is becoming more permanent.To address these issues we construct a new large-sampledatabase of leveraged buyout transactions, based on theCapital IQ database, which contains 21,397 leveraged buyouttransactions across the world over the period 1 January 1970to 30 June 2007, involving 19,500 distinct firms. We thenutilize various other data sources and web searches to trackdown the ultimate outcomes of these transactions.We start by documenting the dramatic growth of this industryin the last decade. Out of the 21,397 leveraged buyouttransactions that took place from 1970 to 2007, more than40% took place after 1 January 2004. We estimate the totalvalue of firms (both equity and debt) acquired in leveragedbuyouts to be $3.6 trillion over our sample period, of which$2.7 trillion worth of transactions occurred between 2001and 2007. We also show that public-to-private transactions,which have been the focus of most earlier LBO research,only account for 6.7% of all transactions, representing 28%of the combined values of firms acquired. Most leveragedbuyouts are acquisitions of private firms or divisions of othercompanies. We also show that public-to-private buyoutsexhibit higher cyclicality than other types of transactions andthat they represent a smaller fraction of activity now comparedwith during the 1980s. On the other hand, divisional buyoutsand secondary buyouts have increased in importance over time.We also confirm that the LBO market is no longer primarilya US phenomenon. The non-US private equity activity hasgrown to be larger than that of the US in the last few years,where the growth of Continental European LBOs has beenparticularly pronounced. Still, LBO transactions outsideNorth America and Western Europe are relatively fewand only account for approximately 12% of global LBOtransactions in number and 9% in value over the periodfrom 2001 to 2007.The caricature of LBOs occurring in old and decliningindustries is no longer true and never really has been. In fact,LBOs have always taken place in a wide range of industries.Although mature industries such as chemicals, machineryand retailing still provide popular buyout targets, the fractionof LBOs undertaken in high-growth, “high-tech” sectors suchas computers and biotech, has been growing significantly inthe last decade.We then go on to analyse the holding periods and exits forindividual LBO transactions. As is well known, most LBOsare sponsored by private equity funds, which have a limitedlife and therefore a limited investment horizon, after whichthey have to exit their investments. The ability to achieve asuccessful exit before the end of the fund life is consideredto be crucial for the financial performance to a private equityinvestor. The most common exit route, for private equity andmanagement buyout deals alike, is trade-sales to anothercorporation, accounting for 39% of all exits. The secondmost common exit route is secondary buyouts (24%), whichhave increased in importance over the last decade consistentwith anecdotal evidence. In contrast, IPOs only account for13% of exits and this exit route seems to have decreased inrelative importance over time.Around 6% of all leveraged buyout transactions end inbankruptcy or financial restructuring. While this numberimplies a higher failure rate compared with bankruptcy rates2Axelson et al (2007) provide a recent empirical analysis on the evolution and determinants of capital structure in LBO transactions.3Baker and Wruck (1989) is one of the few more nuanced views of LBO transactions, going beyond the simple going-private, “free cash flow” stories.Large-sample studies: DemographyThe Global Economic Impact of Private Equity Report 2008