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Vulture Funds and LBOs

With everyday news of start-ups shuttering, news channels closing down and small and big enterprises alike, running out of business, we thought it apt to throw some light on Vulture Funds and LBOs.

Let us start with the basics.

A Vulture-Fund is an investment fund that is always on a lookout for distressed businesses. And when they find one, they swoop in to buy securities in it at highly discounted prices. These discounted prices are supposed to justify their high-risk business.

But why do people invest in a high-risk business?

For high-returns! These investments are often in government debt of distressed countries.

Argentina, for example, paid $6.5 billion to the six vulture funds that had invested in the country’s debt. Sounds good, right? It was not. It took these vultures 15 years of negotiations to get that money. (We did a story on this as well, read it here)

One tool of investment for these vulture-funds is an LBO or a Leveraged Buyout. Now a leveraged buyout is a very interesting tool. There are two parties in the game, the acquirer or the investor and the company which is getting acquired.

Under an LBO the acquirer can leverage the company’s (the one that is getting acquired) assets to take out a loan and then acquire that company.

It is like I took a loan with your car as collateral, then bought your car with the loan money.

Sounds weird right? But, why would anyone agree to this?

One, because in an LBO, the acquirer also puts some of its assets as collateral (Usually the value of assets of the acquirer as collateral are much lower than that of the acquired company)

Second, because often a sinking company does not have any other choice but to opt for an LBO.

Now LBOs have received more than their fair share of bad publicity. Usually, these big Vulture funds who invest in high-risk equity are big corporates whose main motive is to profit off these dying companies. So they strip a company of its assets, lay-off employees and when the company goes bankrupt, the vultures fly away.

Media houses have done many stories on how these vulture-finds and LBOs are killing off America’s local newspapers. Alden Global Capital is one such criticised group. Alden is known to strip off the company of its assets, employees and even charge exorbitant management fees for their personal gains. Now when the newspaper company is without its most important assets i.e Journalists, they don’t make a profit and go bankrupt. The Vulture swoops in again, sells off the remaining assets and because their investment is now worth nothing, they don’t even have to pay back the loan!

All this has made Vulture Funds and LBOs something corporates are scared of. 

But there is another side to the LBO story.

This is the story of Blackstone’s and Hilton Hotel Deal: One of the Best and Most Profitable LBOs ever

When Hilton was bought in 2008, just before the Great Recession, market watchers thought it would be a disastrous deal. But Hilton needed funding to implement its aggressive expansion strategies and Blackstone with its expertise seemed like a good ally.

The deal looked risky because it was of almost 78% debt but it was one of the most well-structured operations. Hilton and Blackstone together changed the face of the company. Since Blackstone became involved with Hilton, the company has doubled the number of hotel rooms in its portfolio to 900,000, and there are currently 350,000 more rooms on the way. 

A key turning point for this deal was when the company went public in 2013, famously transforming the Hilton deal into the most profitable private equity deal ever.

When Blackstone finally exited Hilton in 2018 they had made $14 Billion in 11 years from the deal.

This was an example to elaborate that companies can, via an LBO, partake in deals which would’ve been outside their financial spectrums making it an amazing financing option if executed carefully.

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