Design and impacts of securitized leveraged buyouts

Laurent Bouvier,Tahir M Nisar

doi:10.1080/23322039.2015.1009307

Laurent Bouvier, Tahir M Nisar

Open Access

https://doi.org/10.1080/23322039.2015.1009307

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Abstract

AbstractPrivate equity investors have traditionally used innovative financial methods in structuring their leveraged buyouts (LBO) deals. In recent years, they have frequently employed securitization to raise funds on the back of their acquisitions’ operating assets. A distinctive feature of these transactions is that they aim to enhance the securitizing LBO’s debt pay capacity through a set of structural enhancements including operating debt covenants. Operating covenants—supported by legal security arrangements—mitigate an LBO’s financial and operating risks and improve its cash generation potential. We test this hypothesis by examining changes in the operating income of Hertz LBO. The results show that, within the operating framework adopted by Hertz LBO, securitization improved the transaction’s debt service capacity.

Highlights

In recent years, private equity firms have raised funds from structured credit markets to finance their acquisitions
Using a case study of Hertz, a US-based car rental firm, we analyze the transactional features of its leveraged buyout (LBO) securitization and examine the extent to which its inherent business and financial risks are sufficiently mitigated through structural enhancements and various other support mechanisms
When private equity firms finance LBO through securitization bonds, it involves securitizing the acquired company’s ongoing assets and supporting the business operator in managing its performance risk. This means that the LBO firm must adhere to a specified minimum level of performance, as well as adopting other specified operational plans and targets

Summary

Introduction

Private equity firms have raised funds from structured credit markets to finance their acquisitions. Using a case study of Hertz, a US-based car rental firm, we analyze the transactional features of its LBO securitization and examine the extent to which its inherent business and financial risks are sufficiently mitigated through structural enhancements and various other support mechanisms. To follow through the conditions stated in a performance plan, a securitized LBO structure allows all creditors including private equity sponsors to adopt an intensive interactive approach with the operators of the securitized assets This may take the form of investors appointing board members, designating special advisers or experts, or holding regular meetings with the operators of the securitized business to exchange information (S&P, 2006). Actual incentive payments were put on hold for some period due to the current difficult financial circumstances (Hertz, 2010)

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