Leveraged Buyout (LBO) I

Leveraged Buyouts, that's buyouts financed by debt became the rage during late 70s and in the 80s. Much of this, was due to “The King of Junk Bond”, Michael Milken.



Milken, in the 70s had theorized that junk bonds (kind of bonds that were issued by distressed companies with low credit quality) often traded at excessive discounts. He thought those bonds offered high enough interest rates to more than compensate investors for the risk of default. By floating a low credit quality bonds to the market, the borrowers used the money for various purposes, such as internal expansion, fund a war for acquisitions or simply to pay off prior debts. For instance, Ronald Perelman, an ambitious deal maker managed to buy his first business, a jewelry distributor, with precisely $ 1.9 million in borrowed funds. After meeting with Milken, Perelman could borrow not millions but billions to launch a bid for the cosmetic giant, Revlon. People might wonder where’s the money come from? The lure, was the high interest rate – 12%, 14% or more, something that junk-bond issuers promised. While it might give people who buy this kind of junk-bonds a potential high return, people forget that the promise to pay such high return rate relied on the companies that were on the verge of bankruptcy. When the promise could not kept, this kind of investment inevitably doomed to fail.