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The $70 Billion Deal 🤑

The $70 Billion Deal 🤑
By Making smalltalk • Issue #28 • View online

Private Equity & Leveraged Buyouts (LBOs). Image may be subject to copyright.
Private Equity & Leveraged Buyouts (LBOs). Image may be subject to copyright.
Two days ago on 11th November, Private Equity (PE) firm KKR & Co. announced a proposal to acquire the US pharmaceutical group Walgreens in a deal valued at $70 billion.
Kohlberg Kravis Roberts & Co., popularly known as KKR & Co., is one of the world’s largest, oldest, and most reputed PE firms. In fact, its 3 founders are often considered as the fathers of the Private Equity industry.
The trio literally started the trend of what is known as “leveraged buyouts”, which PE firms today specialise in. In the late 1960s and early 70s, these guys made a string of such profitable investments while at Bear Stearns (the now infamous investment bank which went bankrupt in the 2008 financial crisis), before starting their own firm.
Leveraged Buyouts involve taking ownership of a company (i.e. buying it out) primarily using debt (i.e. leverage). After the buyout, PE firms focus on improving profitability & margins by cutting costs & improving efficiency - with the primary objective of re-selling (or exiting) the company at a higher price.
The debt helps in improving the return on investment (RoI), but also adds to the interest burden (i.e. expenses) of the firm. To learn more about how Private Equity firms function, check out this blogpost I’d written earlier.
Coming back to KKR’s recent announcement:
The proposed $70 billion leveraged buyout will be the largest private equity deal, ever.
That’s about ₹5 lakh crores. In case you don’t feel the magnitude of the size of this deal, allow me to put it in perspective with some stats:
  • The corporate tax cut announced few months ago by the Finance Minister was worth about ₹1.5 lakh crores
  • Only 3 listed companies in India are valued more than this deal - Reliance (₹9 lakh crores), TCS (₹8 lakh crores), and HDFC Bank (₹7 lakh crores)
  • $70 billion is about 2.6% of India’s GDP of $2,726 billion (as of 2018 end)
Notably, KKR has been involved in all the private equity deals which were the largest-ever at the time. Here are the top-5 largest private deals, of which 4 involved KKR:
The RJR Nabisco deal of 1989 is actually legendary in the investment circles, ultimately becoming a symbol corporate greed on which a best-selling book was written & even a movie was made. Called Barbarians at the Gate, it dramatises the events leading up to the buyout - check out the trailer here.
So why does this matter?
Reading this news yesterday instantly reminded me of the words of my professor who taught me Private Equity & Asset Management at the University of Oxford.
Back in 2014, he had explained to us that when the number & value of private equity deals start increasing, it’s invariably because large investors now have more money to spend.
Dry powder” is the term used to describe money that PE firms have already raised, but not yet spent. Aggregated across all PE firms globally, this is currently at a record high of $2.5 trillion - that’s trillion.
Like most things in finance & economics, private equity spending also has its own cycle - and when PE spending increases like this, it sends a signal regarding the health of the broader financial system.
Since such deals are financed primarily via issuance of bonds & taking loans from banks, they signal that bondholders are looking for higher yields, which such deals tend to offer.
The search for higher yields brings with it additional risks, and is a function of the broader market sentiment. Basically, in such an environment, equity/bond investors are willing to take on more risks, which often cause bubbles that ultimately burst.
Interestingly, 8 of the top 10 largest-ever PE deals were done during 2006-2007, just some time before the global financial crisis officially erupted in 2008.
Please note that none of this is yet grounded in academic research - but this deal is a signal to me that it’s time to look at the larger macro picture & analyse what (if any) possible cracks might be appearing in the global financial markets.
And this signal will become even stronger, in my humble opinion, if news of more such deals follow.
Happy investing!
-Vikas Bardia, CFA
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12:37 PM - 12 Nov 2019
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