Chapter 7. Leveraged Buyouts

A leveraged buyout (LBO) is a financing technique used by a variety of entities, including the management of a corporation, or outside groups, such as other corporations, partnerships, individuals, or investment groups. Specifically, it is the use of debt to purchase the stock of a corporation, and it frequently involves taking a public company private.

The number of large LBOs increased dramatically in the 1980s, but they first began to occur with some frequency in the 1970s as an outgrowth of the 1960s bull market. Many private corporations took advantage of the high stock prices and chose this time to go public, thereby allowing many entrepreneurs to enjoy windfall gains. Even though some of these firms were not high quality, their stock was quickly absorbed by the growing bull market. When the stock market turned down in the 1970s, the prices of some lower-quality companies fell dramatically. The bulk of this falloff in prices occurred between 1972 and 1974, when the Dow Jones Industrial Average fell from 1036 in 1972 to 578 in 1974. In 1974, the average price-earnings (P/E) ratio was six, which is considered low.

When the opportunity presented itself, managers of some of the companies that went public in the 1960s chose to take their companies private in the 1970s and 1980s. In addition, many conglomerates that had been built up in the 1960s through large-scale acquisitions began to become partially disassembled through selloffs, a process that is ...

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