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February 19, 2007 Buy and Hold vs. Fix and Flip
The phenomenon of RLBOs (or Reverse Leverage Buyouts) has met with intense
public scrutiny of late. The public's attention became fixated on a few
landmark cases such as Refco, which was bought through private equity for
$500 million and subsequently taken public a year later for more than double the price. Not
long thereafter Refco collapsed, its current market cap is $50MM, and the
inevitable lawsuits ensued. Overall, the recent controversy regarding
RLBOs has focused on the use of leverage to provide large divided payouts
to select shareholders (private-equity firms), who then push the
overleveraged firms too quickly into public markets. Detractors cry unjust
enrichment to the detriment of shareholders. So the logical question to
ask is: do RLBOs create or destroy value? As with most questions, the
answer depends.
A recent study, "The Performance of Reverse Leverage Buyouts", by Cao and
Lerner reviewed the post-IPO performance of 496 corporations that were
initiated by private equity firms between 1980 and 2002. The study
specifically focused attention on RLBOs.
The study demonstrates that RLBO firms generally outperform both the
overall market and shares issued in other IPOs that were not backed by
private equity. Bigger IPOs backed by private equity did better than
smaller ones. In many cases, it appears that private-equity firms generally
have a vested interest in maximizing long-term value, and asset stripping
rarely proves prudent. Even after private-equity firms sell - at least in
subsequent IPOs - they often retain significant holdings for years to come.
However, this study is only a partial refutation of the criticism leveled
at RLBOs. Cao/Lerner also assert that firms that were held for less than a
year by private equity performed poorly, indicating that 'fix and flip'
appears to destroy value while 'buy and hold' creates value.
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