Highly leveraged buyouts: A dangerous capital game?

At the beginning of the new year, "Little Swallow" Zhao Wei kept flooding the screen. Zhao Wei spent 60 million of her own money to acquire Wanjia Culture with a leverage of 3 billion and 50 times. This sparked heated discussions in the market and became the focus of news in the entertainment and financial circles. Even the Shanghai Stock Exchange sent a letter of inquiry. This is not the first time that highly leveraged buyouts have been exposed to the public eye. It has attracted widespread attention since the "Baowan Debate". People suddenly realized the powerful power of capital and also saw the power of leveraged buyouts.

Are there any problems with leveraged buyouts?

Leveraged buyout first appeared in the 1960s, became popular in the 1980s, and quickly became an important way to acquire American companies. A leveraged buyout uses the assets and future cash flows of the target company as collateral and guarantees to finance the acquisition, and ultimately achieves the acquisition of the target company. In the leveraged buyout financing structure, equity financing only accounts for 10%-20%, and debt financing accounts for 80%-90%. High liabilities are based on the assets and future cash flows of the target company as mortgages and guarantees for financing. In other words, a leveraged buyout is using other people's money to buy other people's businesses. As a result, leveraged buyouts are often called "barbarians at the door."

Although Wall Street uses "barbarians" to refer to leveraged buyouts, especially hostile takeovers, leveraged buyouts are only an acquisition model in the capital market and have no negative connotations. They even play an important role in corporate governance.

Leveraged buyouts can improve corporate governance in capital markets. For example, if a listed company has a low governance level and poor management, it seriously damages the company's interests, causing the company's performance to decline, its stock price to fall, and its market value to shrink. However, the company's equity is dispersed, or the management itself is appointed by the major shareholders, while the majority of small and medium-sized shareholders are unable to cope with the management's negligence. At this time, if the leveraged buyout seizes the opportunity, obtains control of the company, fires incompetent management, and improves the company's governance level, it can further increase the company's market value.

Leveraged buyouts can form effective supervision and restraint on the company's major shareholders and management. In order to avoid being kicked out by "barbarians", major shareholders cannot reduce their holdings at will, and company management cannot allow the stock price to fall below the issue price or even fall below the net assets (there are many stocks with ultra-low price-to-earnings ratios in my country's stock market, and there are also stocks that fall below the price-to-book ratio). In a situation where "barbarians" may knock on the door at any time, the company's major shareholders cannot reduce their holdings at will. The management will also work hard to increase the market value, thereby improving the company's operating status and improving the company's governance level. Therefore, leveraged buyout has become an effective external governance mechanism in the capital market.

Leveraged buyouts should not be done "wildly"

However, if you lack a skilled levelWithout balancing techniques and necessary firewalls, leveraged buyouts may evolve into dangerous capital games, causing staggering losses to the market. Leveraged buyouts often borrow a higher proportion of leveraged funds. If the company is in a procyclical state, everyone is happy. However, if the company's development is in a countercyclical state, the "barbarians" may kill the goose and take the eggs in order to repay the debt. In order to save money, the acquirer may lay off a large number of employees, causing great harm to the majority of employees. In a leveraged buyout, the acquirer often uses the assets and future cash flows of the target company as collateral and guarantees for financing. After the acquisition is completed, some of the target company's properties may even be sold to pay for acquisition financing, causing great harm to the interests of creditors. For example, after the U.S. food and tobacco giant RJR Group was acquired by KKR Group in 1989, its assets were quickly sold by KKR Group to obtain cash flow to repay the huge leverage funds. The performance of RJR Group, which was originally on par with Philip Morris Group, plummeted a few years later.

Although leveraged buyout started relatively late in my country, it has been surging in recent years, and "leveraged major shareholders" have become a scene in the capital market. Partial leveraged buyouts have become an important driver of "storytelling" for listed companies, and have evolved into a tool for speculative capital to make big profits with small profits. Many people have taken the concept of "anyone can do whatever is not prohibited by law" to the extreme in the capital market, adopting many high-risk practices, even to the point where "anyone can do whatever is not prohibited by law". For example, a major shareholder of a listed company pledged equity more than 30 times within three years, with a pledge ratio of nearly 90%. At present, cash acquisitions do not require approval from the China Securities Regulatory Commission. As a result, more and more listed companies are adopting cash acquisitions, but the source and financing method of acquisition funds have not been disclosed. Such acquisitions that magnify leverage through capital loans and asset management plans are "riskier". If not handled properly, they will leave a mess in the capital market and cause greater trauma to creditors, small and medium-sized shareholders and employees.

It is recommended to improve the legal regulations in the field of leveraged buyouts as soon as possible

In order to prevent problems before they occur, the author believes that, first of all, my country should establish and improve laws and regulations in the field of leveraged buyouts as soon as possible to promote the capital market to become more transparent. Looking back at the "Baoneng Controversy", it is not difficult to see that laws and regulations such as the "Company Law", "Securities Law" and "Measures for the Administration of Acquisitions of Listed Companies" did not play an effective regulatory role. Baoneng bypassed supervision through various financial products, and solvency supervision and capital supervision became the "Maginot Line of Defense". In this regard, Wu Xiaoling, deputy chairman of the Financial and Economic Committee of the National People's Congress, also said that under existing regulations, Baoneng's capital organization does not violate regulations, but this method of capital organization contains many risks. In view of this, the author believes that we cannot just rely on calling on "barbarians" to "be good-faith financial investors and not hostile acquirers", but we must speed up the pace of legal construction and establish a fair, just and effective merger and acquisition order for the capital market.