[Video] Rise of Leveraged Buyouts

Finance | Provided by Katie Robinette

Katie Robinette and Mark Wilkerson of Cornerstone Advisors explore the modern private equity landscape by looking back on the first of four market cycles that shaped the industry, specifically leveraged buyouts. Exploring the time from 1980 to 1991, this episode looks back on the rise of KKR, the takeover of RJR Nabisco and the Barbarians at the Gate time of greed.

Over the past 30 years Private Equity has weathered four major markets cycles that have shaped the industry.

It is helpful to discuss these four major markets cycles to give you some context for thinking about WHAT is PE, WHY invest in PE and HOW to invest in PE. Today we will discuss the first market cycle that begins in the 1980s with the rise of the leveraged buyout.

In the 1980s, Corporate raiders begin using the leveraged buyout strategy to launch hostile takeovers of public companies against management’s will.

These deals were often financed with 95% debt and 5% cash. Given Katie’s mortgage example using 95% debt and 5% cash? Result in a return of ~21x your investment!

Once they owned the company, corporate raiders would often cut costs and sell of pieces of the business to make debt payments.

If the company could not pay back the debt, the company would go bankrupt not the individual. This limited downside and large potential upside led to a proliferation of corporate raiders.

Corporate raiders were just individual investors, but soon enough the buyout firms emerge. These firms begin forming pools of investor capital using the fund structure Mark described earlier, and then competing with the corporate raiders by positioning themselves as a friendly alternative for management (although largely still making their money the same way – by slashing costs).

There are a handful of firms doing this, but Kohlberg Kravis and Roberts (better known as KKR) is dominating. Their spectacular returns are attracting more and larger investors year after year.  And so they begin raising bigger and bigger funds which allows them to buy bigger and bigger companies and they’re utilizing more and more leverage, which is also getting easier to come by.

This all culminates in KKR’s massive takeover of RJR Nabisco for $31B. And just to give you some perspective, a deal of this size is not done again for almost another 20 years. And in this $31B transaction, KKR invests a mere $1.5B of equity and uses a massive amount of debt to finance the rest.

This deal was famously profiled in Barbarians at the Gate as the quintessential story of greed and excess and came to define this market cycle.

And there was so much excess and greed in the 80s that the book is over 600 pages. Despite its length, it is a great read. But with it KKR and Buyout Firms became synonymous with the corporate raiders.

Unfortunately, shortly after the deal closes the US economy goes into recession and the investment goes south for KKR and its creditors. Financing vanishes from LBOs. and this ends the era of big ticket takeovers for the buyout firms.

In the next episode we will discuss the events that shaped the next private equity market cycle in the 1990s.

What Is Private Equity Investing: A Five-Part Video Series From Cornerstone Advisors

Living and working in the Pacific Northwest, ‘investing in private equity’ is an oft heard phrase. But what exactly is meant by private equity and how does this investment differ from other investments? How can an investor access private equity investments and does private equity have a place in the traditional portfolio?

In this easy-to-understand five-part series, Katie Robinette and Mark Wilkerson of Cornerstone Advisors introduce you to the world of private equity investing. They’ll explain private equity investing, discuss the structure of these investments and also the different types of returns generated. The series goes on to explore the four market cycles that have occurred since 1980 and what each one means to today’s investor interested in private equity.

Check out the other videos in this series: