By Peter Maxwell and Štěpán Koníř
MBI, MBO and BIMBO…No, this is not a fairy tale about the big-eared elephant and his siblings. In fact, these terms refer to a class of acquisitions with an active role of management; management buy-in (MBI), management buyout (MBO) and buy-in management buyout (BIMBO). While much has been said about MBOs, in which the company’s current management purchases control over the target (often with financial assistance of private equity investors and debt issuers), less is known about its riskier cousin, the MBI. An MBI occurs when a management team external to the target firm buys it out and institutes themselves as the controlling managers of said business. A BIMBO is a mashup of the two, conducted by a consortium of internal and external managers who take over the target’s ownership.
What are MBIs exactly?
Something of an umbrella term, an MBI can occur when a management team identifies a target and receives private equity backing. The distinction between this scenario and a private debt fund is important; private debt generates returns through loan interest, whereas private equity funds do this through increasing company value. Conversely, an MBI can also occur when a fund identifies a takeover opportunity and builds a replacement management team for the task, which may be referred to by the more unconventional leveraged buy-in (LBI) term (see our article on LBO Value Creation).
When do MBIs occur?
Whilst an MBI sounds like a simple proposition, it requires extensive experience, analysis and financing. The targets for MBIs are undervalued businesses with ineffective management where the buy-in team’s industry expertise can unlock the company’s potential. These businesses will generally be well established, cash generating and holding substantial non-core assets, allowing the Buy-In Manager (BIM) to create revenues immediately. Management teams may look to buy into a company if their current owner is reluctant to sell, and therefore it is common for them to scope out SME owners lacking a secondary management team to effectively run the business in their absence. Owners in this scenario who are open to divestment are provided with a “soft-landing” exit strategy that ensures continuity of business operations. Regarding the threat in switch in a business cycle and high market valuations, owners are open nowadays to MBI propositions like never before. Furthermore, with the niche specialization, management teams may also target non-core subsidiaries unaligned with current ownerships’ overall strategy.
Not All Plain Sailing
An MBI is less straightforward for a management team than an MBO, namely due to the information asymmetry caused by their solely external view of the target firm. It is such that enhanced detailed due diligence (and therefore enhanced cost) is required to avoid a market of lemons – 74% of sellers found the increased time for PE diligence to be a challenge. Previous industry expertise is therefore essential, and a management team without this will see their funding attempts tainted by a perceived lack of creditworthiness.
A second problem is in winning the bid itself. The sales process is typically open to several external parties, consequently creating additional demand providing upward pressure on sale value. Indeed, 38% of sellers also said that the involvement of a private equity buyer increased the purchase price. However, a competent management team with favorable terms on debt and significant profit-enhancing power can certainly secure the purchase, particularly when the current owner seeks a quick sale.
A third obstacle is the learning curve involved for new management. Maximizing volumes and margins by learning and improving current operating systems and renegotiating supplier/distributor contracts, all with potentially sceptical employees, can prove difficult.
The Art of the (Financing of the) Deal
The higher risks associated with MBIs over MBOs influence acquisition financing options, although they do share fundamental traits. Management should pursue capital from the cheapest source first before considering more expensive options. For larger transactions, securities in the form of bonds, senior debt and mezzanine debt may be attainable, particularly with low funding costs in the current economic environment. However, there are other methods available, with the immediate source of financing coming from the management team itself. Whilst typically minimal in an MBO, a high level of self-financing in MBIs contributes significantly to instilling confidence in financial backers that the management team is committed to and believes in the project. Deal financing from the seller is less common compared to MBOs, as the close relationship does not exist with incoming management, and the takeover will be more hostile in nature.
Consequently, private equity firms most frequently fund these acquisitions, so long as significant returns of around 25% are possible. However, management must be aware of the potential conflicts of interest present; a private equity firm will typically desire to realize short-term returns and exit after four years on average, whilst the management team may have longer-term goals. To enforce their position, the private equity firm will impose warranties and numerous operational terms on management in relation to the company. Nonetheless, it is not only the additional capital that PE firms provide external management teams with but also their executive experience and negotiation skills, which could ensure a smoother deal process and ultimately lead the deal to the fruition.
Divesting from an MBI
A crucial aspect of any deal is how to realize these returns with 84% of companies wishing to divest within two years. Depending on the structure of the MBI, the management team may be able to refinance their debt, allowing the company to provide capital gains returns to the private equity fund. If the private backers have some amount of company holdings, they may wish to use an IPO, a strategic sale, or a “secondary sale” to other private investors.
Prominent Deals & Trends
With debt yields at historical minimums and PE funds stocked with capital, both with little sign of change on horizon, flawless conditions for undertaking MBIs exist. On the other hand, the tense political situation and legal environment instability suggest an adverse development in deals activity.
Yet whereas general political threats such as Brexit can cool deal-flow, MBI and BIMBO activity is on the rise counter-intuitively due to British transactions. Although the market expresses concern regarding this political event, the prime incentive for managers to pursue a deal nowadays is a prepared amendment in British tax system urged by the Labour party, which would revoke non-taxable income from partial ownership of managed companies. Such a legal act would have a substantial impact on the global MBI market, which has historically been dominated by the UK with 57% (resp. 67%) share of total MBI deals (prominent MBI deals above $100m).
In general, larger scale MBI deals are naturally rare, given the MBI’s tiny share of total deals volume, and the fact that the average value of MBI transaction tends to be significantly lower than an average MBO.
Despite this fact, amongst the most prominent examples of MBI belong the following:
- AA plc, UK’s leading motoring company, $2.4bn management buy-in from 2014. External management team acquired the company from CVC and Permira consortium, securing over $1.2bn equity financing from Blackrock, Cornerstone Partners and other institutional investors. Subsequently after the acquisition, the company was listed at London Stock Exchange. Debt financing provided by Barclays.
- Bass Lease Company, UK’s 1400 pubs operator, $900m management buy-in from 1997. A divisional spin-off of Bass plc, external management activity backed by BT Capital Partners Europe. Despite its 22-year vintage, it is still one of the biggest MBI ever conducted.
- Tachihi Enterprise Co, Japan’s real estate rental services provider, all-cash friendly $600m public takeover from 2012. Levale KK, a private equity fund fully owned by director of Tachihi. Director of Tachihi acquired the company through his private equity fund Levale KK, bringing into Tachihi’s management his co-partner from Levale KK, a prominent example of BIMBO. Debt financing provided by Mizuno Bank.
Zephyr database, authors’ calculations
Do the Returns Justify the Means?
Despite the favorable financing conditions and many areas in which MBIs can create additional value, targeted returns for private backers are not guaranteed so long as earnings manipulation, undertaken by incumbent management, serves as a main profitability driver in such a deal structure. In such case, neither the deal’s auspicious financing structure nor the ceteris paribus operating performance enhancement are powerful enough to offset this event. Being so important, superior returns for public-to-private MBI are anticipated, as public companies fall under frequent scrutiny unlike private ones. Intuitively, the premium paid in MBO is lower on average by 11% than in MBI/IBO (institutional buyout) transactions. A possible explanation is that MBI teams approach takeovers with more aggressive business plans, including considerable wage cuts and headcount reductions, and are subsequently willing to pay higher premiums. Another crucial aspect of MBI transactions is the timing feature; management teams, being industry experts, are able to benefit on industry cycles and purchase targets for significantly lower prices than an average (PE) investor, thus realizing superior returns from deals. Finally, it is noteworthy to mention that as with any transaction, MBIs can untie additional value by revaluation of the target’s fixed assets and increased D&A expenses.
Editor: Eric Peghini
Authors: Štěpán Koníř, Peter Maxwell