Resurgence of Leveraged Buyouts
Private equity in the 1980s was a controversial topic, commonly associated with corporate raids, hostile takeovers, asset stripping, layoffs, plant closings and outsized profits to investors. As private equity reemerged in the 1990s it began to earn a new degree of legitimacy and respectability. Although in the 1980s, many of the acquisitions made were unsolicited and unwelcome, private equity firms in the 1990s focused on making buyouts attractive propositions for management and shareholders. According to The Economist, “ig companies that would once have turned up their noses at an approach from a private-equity firm are now pleased to do business with them.” Additionally, private equity investors became increasingly focused on the long term development of companies they acquired, using less leverage in the acquisition. This was in part due to the lack of leverage available for buyouts during this period. In the 1980s leverage would routinely represent 85% to 95% of the purchase price of a company as compared to average debt levels between 20% and 40% in leveraged buyouts in the 1990s and the 2000s (decade). KKR's 1986 acquisition of Safeway, for example, was completed with 97% leverage and 3% equity contributed by KKR, whereas KKR's acquisition of TXU in 2007 was completed with approximately 19% equity contributed ($8.5 billion of equity out of a total purchase price of $45 billion). Additionally, private equity firms are more likely to make investments in capital expenditures and provide incentives for management to build long-term value.
The Thomas H. Lee Partners acquisition of Snapple Beverages, in 1992, is often described as the deal that marked the resurrection of the leveraged buyout after several dormant years. Only eight months after buying the company, Lee took Snapple Beverages public and in 1994, only two years after the original acquisition, Lee sold the company to Quaker Oats for $1.7 billion. Lee was estimated to have made $900 million for himself and his investors from the sale. Quaker Oats would subsequently sell the company, which performed poorly under new management, three years later for only $300 million to Nelson Peltz's Triarc. As a result of the Snapple deal, Thomas H. Lee, who had begun investing in private equity in 1974, would find new prominence in the private equity industry and catapult his Boston-based Thomas H. Lee Partners to the ranks of the largest private equity firms.
It was also in this timeframe that the capital markets would start to open up again for private equity transactions. During the 1990-1993 period, Chemical Bank established its position as a key lender to private equity firms under the auspices of pioneering investment banker, James B. Lee, Jr. (known as Jimmy Lee, not related to Thomas H. Lee). By the mid-20th century, under Jimmy Lee, Chemical had established itself as the largest lender in the financing of leveraged buyouts. Lee built a syndicated leveraged finance business and related advisory businesses including the first dedicated financial sponsor coverage group, which covered private equity firms in much the same way that investment banks had traditionally covered various industry sectors.
The following year, David Bonderman and James Coulter, who had worked for Robert M. Bass during the 1980s, together with William S. Price III, completed a buyout of Continental Airlines in 1993, through their nascent Texas Pacific Group, (today TPG Capital). TPG was virtually alone in its conviction that there was an investment opportunity with the airline. The plan included bringing in a new management team, improving aircraft utilization and focusing on lucrative routes. By 1998, TPG had generated an annual internal rate of return of 55% on its investment. Unlike Carl Icahn's hostile takeover of TWA in 1985., Bonderman and Texas Pacific Group were widely hailed as saviors of the airline, marking the change in tone from the 1980s. The buyout of Continental Airlines would be one of the few successes for the private equity industry which has suffered several major failures, including the 2008 bankruptcies of ATA Airlines, Aloha Airlines and Eos Airlines.
Among the most notable buyouts of the mid-to-late 1990s included:
- Duane Reade, 1990, 1997
- The company's founders sold Duane Reade to Bain Capital for approximately $300 million. In 1997, Bain Capital then sold the chain to DLJ Merchant Banking Partners Duane Reade completed its initial public offering (IPO) on February 10, 1998
- Sealy Corporation, 1997
- Bain Capital and a team of Sealy's senior executives acquired the mattress company through a management buyout
- KinderCare Learning Centers, 1997
- Kohlberg Kravis Roberts and Hicks, Muse, Tate & Furst
- J. Crew, 1997
- Texas Pacific Group acquired an 88% stake in the retailer for approximately $500 million, however the investment struggled due to the relatively high purchase price paid relative to the company's earnings. The company was able to complete a turnaround beginning in 2002 and complete an initial public offering in 2006
- Domino's Pizza, 1998
- Bain Capital acquired a 49% interest in the second-largest pizza-chain in the US from its founder and would successfully take the company public on the New York Stock Exchange (NYSE:DPZ) in 2004.
- Regal Entertainment Group, 1998
- Kohlberg Kravis Roberts and Hicks, Muse, Tate & Furst acquired the largest chain of movie theaters for $1.49 billion, including assumed debt. The buyers originally announced plans to acquire Regal, then merge it with United Artists (owned by Merrill Lynch at the time) and Act III (controlled by KKR), however the acquisition of United Artists fell through due to issues around the price of the deal and the projected performance of the company. Regal, along with the rest of the industry would encounter significant issues due to overbuilding of new multiplex theaters and would declare bankruptcy in 2001. Billionaire Philip Anschutz would take control of the company and later take the company public.
- Oxford Health Plans, 1998
- An investor group led by Texas Pacific Group invested $350 million in a convertible preferred stock that can be converted into 22.1% of Oxford. The company completed a buyback of the TPG's PIPE convertible in 2000 and would ultimately be acquired by UnitedHealth Group in 2004.
- Petco, 2000
- TPG Capital and Leonard Green & Partners invested $200 million to acquire the pet supplies retailer as part of a $600 million buyout. Within two years they sold most of it in a public offering that valued the company at $1 billion. Petco’s market value more than doubled by the end of 2004 and the firms would ultimately realize a gain of $1.2 billion. Then, in 2006, the private equity firms took Petco private again for $1.68 billion.
As the market for private equity matured, so too did its investor base. The Institutional Limited Partner Association was initially founded as an informal networking group for limited partner investors in private equity funds in the early 1990s. However the organization would evolve into an advocacy organization for private equity investors with more than 200 member organizations from 10 countries. As of the end of 2007, ILPA members had total assets under management in excess of $5 trillion with more than $850 billion of capital commitments to private equity investments.
Read more about this topic: Private Equity In The 1990s, The Second Private Equity Boom and The Origins of Modern Private Equity
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