Investing in buyouts – a foolproof strategy?

When you hear the term ‘buyout’ mentioned, it might conjure up visions of a struggling company’s management and staff getting together to buy it in an attempt to keep their jobs and replace an incompetent owner or board of directors. However, more often than not, a buyout is more likely to be a method by which a company looking to expand quickly into new markets is able to cut the time it might otherwise take by buying out a business already operating successfully in the target sector.

In order to achieve such large purchases, it will often be necessary for the acquiring company to raise the necessary funds by way of a leveraged buyout (LBO), which involves either a share issue or taking out a loan. Loans are usually secured against the assets of both the acquiring company and the one being acquired. There is a view that it is a sad state of affairs when a hostile buyout might only be made possible due to the success of the target company, because its own assets can be used to enable the acquiring company to raise the necessary finance.

You may be interested to learn that the private equity class is now worth in excess of £1.4 trillion and that buyout funds represent some 63% of that figure. As might be expected, the level of risk involved in such funds is largely dependent on the individual status of the companies being acquired and the sector in which they operate. Investment fund managers tend to make acquisitions when opportunities are good, debt is cheap and their bargaining power is at its highest. You should take care when deciding on which investment firm to use and question the level of expertise of its team; inexperienced fund managers may be tempted to make riskier investments in the hope of establishing a reputation for themselves.

With that in mind, you should take some time to seek out established and reputable private equity investment firms, such as Charterhouse Capital Partners, which has been in business under a variety of names for over 80 years and specialises in investing in UK and European buyouts. The firm has completed transactions valued at around £68bn.

In addition to investing in a buyout fund, you might also want to take the opportunity to purchase stock in the companies being acquired. It is often the case that their shares fall as soon as an LBO is made public. This is the perfect time to buy cheap, assuming you are confident that the company has the wherewithal to pay down the debt, at which time the share value can be expected to bounce back.

From all the data available, it seems clear that investing in buyouts is low but not entirely risk-free. Unless you put your cash into government bonds, which are virtually 100% safe, an element of risk will always be present. However, when you look at a survey covering the years 1995 to 2007 comparing European equity capital and LBO funds, it was found that LBO funds outperformed equity capital funds by between 6% and 16%. The survey reported a similar result in the US. The overall level of risk therefore appears low, whilst the potential levels of returns make buyout-investing look quite attractive.

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