Leverage Buyout Proposal of CSL Limited - Case Study Example

Leveraged Buyout: CSL Case Study Name University Course Tutor Date Leveraged Buyout: CSL Case Study Business Overview CSL Limited refers to an international biotechnology company which specializes in research, development, manufacturing, and marketing of products for treatment and prevention of serious medical conditions in humans. The product areas of CSL Limited are inclusive of vaccines, blood plasma derivatives, cell cultures reagents, and antivenom. Commonwealth Serum Laboratories is an Australian government agency which was founded in the tear 1916 with a focus on the manufacture of vaccines(CSL, 2015).CSL was privatized in the year 1994 after which it doubled its size following the purchase of ZLB Bioplasma, a Swiss company. Another expansion of the company was recorded in the year 2004; this was a plasma oversupply period which saw CSL purchase Aventis Behring which is a German medical company. At the time, CLS became the second Australian public company to have a share price of more than $100 per share. Success in business saw the company receive the Minister’s Award for Outstanding Equal Employment Opportunities Initiative in the year 2011. The month of October, 2014 saw Novartis announce its intention of selling its influenza vaccine business; this sale would be approved to CSL for $275 million(CSL, 2015). Currently, CSL has its headquarters in Melbourne, Victoria and boasts of $5 billion revenue. The company enjoys an immense deal of success in the market illustrated by a net income of $1.2 billion in the year 2013. Reasons making CSL to be an attractive target CSL Limited has the proposal that human plasma has the capability of saving lives. Over the years, the biopharmaceutical company has been operating via two principal subsidiaries: CSL is characteristic of developing plasma-derived and recombinant products with the purpose of treating infections, autoimmune diseases, and bleeding disorders(CSL, 2015). The other main subsidiary is CSL Biotherapies which plays the role of manufacturing influenza vaccines. CSL is a pharmaceutical giant with a Biotherapy Immunohematology unit that is characteristic of manufacturing in-vitro diagnostic products with an aim of testing blood for transfusion and detecting venoms from form snakes. The company’s operations are enhanced via marketing and distribution of vaccines and drugs from other companies under license. It is worth noting that Commonwealth Serum Laboratories has been marketing and distributing products from other companies based in New Zealand and Australia with examples being Crucell’s Vivotif Oral (typhoid) and Merck's GARDISIL for the treatment of cervical cancer(CSL, 2015). The company boasts of revenues from three segments. Firstly, the pharmaceutical giant has been making huge revenues from plasma products made and marketed in the US and Germany. The other sources of revenues for the company are products developed by CSL Biotherapies and intellectual products that have been licensed to third parties. Despite the presence of CSL’s manufacturing, distribution operations, sales, research and development across the globe, it has four principal geographic areas of operations which are Germany, Australia, US, and Switzerland, with the US offering the largest market. This has the implication that CSL has already established base in markets that are dominated by wealthy populations and attractive economic policies (Cumming,Donald & Michael, 2007). Ideally, the success of any business draws significant influence from both internal and external factors. In the case of CSL, external factors are inclusive of the purchasing power of customers and government policies. The governments of regions in which the company operates ought to have economic policies that favor investment. CSL has been operating one of the global most outsized manufacturing facilities with respect to the production of influenza vaccines. The company has also come up with an innovative way of producing Panvax which is a pandemic H1N1 swine flu vaccine (Cumming, Donald & Michael, 2010). The achievement of sales is subject to supply contracts with the US, Singapore, Australia, and Canada. The company has also exhibited significant effort in enhancing its reputation signified by the donation of a part of the H1N1 swine flu vaccine to the World Health Organization. It is also worth noting that the company has established strong research and development operations which it still continues to maintain (Diamond, 1984). Indeed, CSL has outstanding partnerships with academic institutions and other companies especially in North America, Australia, Asia, and Europe. The company has also exhibited the capability of manufacturing complex R&D biopharmaceuticals; it also oversees its products’ safety profiles. Ideally, analysis indicates that CSL is an attractive target for acquisition. Over the past decades, the company has demonstrated steady growth with negligible effect from business cycles (Diamond, 1993). The past couple of years have seen an immense deal of companies make losses as a result of such unfriendly trends as the 2008 global financial crisis. CSL has been able to withstand such conditions with no significant effects on business. Inconsistent growth is always associated with unacceptable risks in leveraged buyouts; this has the implication that CSL is an attractive target since the company’s growthhas been consistent over the years. It is worth noting that successful LBOs ought to be characteristic of moderate growth and low business risk. CSL has been relatively insensitive in terms of market-wide fluctuations. The pharmaceutical market has been characteristic of robust growth with analysts forecasting steady growth over the next couple of years. This has the implication that acquisition of such reputable companies as CSL Limited is likely to have the consequence of success (Fang, Victoria & Josh, 2012). CSL is characteristic of low capital expenditures. The business operations of CSL do not require much capital investment. It has been established that, the company has been committing only about 10% of its revenues to investment. Ideally, investment in business is always associated with significant risk from a number of factors. The higher the amount invested, the higher the risk. Investment in business faces the risk of making losses as a result of a number of factors: market fluctuations, competition, unfavorable economic conditions, and poor management decisions, among others. In the case of CSL limited, the risk faced as a result of these factors will be minimal as a result of low capital expenditures (Park, 2000). CSL is also a right acquisition target as a result of its low debt level. In the situation of LBO, the emergent management takes advantage of firm’s assets debt capacity, thus looking for low debt in the target company. A review of CSL limited reveals that the company has a pre-LBO ratio of long-term debt to assets of less than 30%. This has the implication that the company has outstanding opportunity for the expansion of debt; the situation makes it even more favorable after the combination of low debt and low systematic risk of the company (Shivdasani, A & Yihui, 2011). Analysts have reported that, in most cases, LBO target firms demonstrate higher debt levels as compared to non-target counterparts. 2013 2012 2011 2010 2009 Revenue 4,874.61 4,503.69 4,436.71 3,815.52 3,718.71 Cost of Goods Sold 2,354.79 2,330.17 2,255.54 1,870.89 1,930.57 Gross profit 2,519.82 2,173.52 2,181.17 1,944.63 1,788.14 Gross Profit Margin 51.69% 48.26% 49.16% 50.97% 48.08% Net income after taxation 1,197.68 998.22 996.57 901.6 921.9 Table 1: the company’s financial performance for 5 years From the table above, it is evident that the company has been gradually increasing its profits over the years. This has the implication that acquisition of the company would be a viable project. Companies have a tendency of investigation the financial performance of target companies prior to LBO’s; this is normally done to avoid cases in which companies are sold as a result of accumulation of debts and losses. Therefore, basing on the recent financial performance of CSL, the proposal of acquisition of the company is recommended as CSL is an attractive target. Financing Structure Notably, in a LBO, the existing debt of the target company is normally refinanced followed by replacement with new debt, with an objective of financing the transaction. This has the implication that an array of debt trenches is used to finance LBOs; this could be inclusive of a number of capital trenches (Smith, 1990). The financing of the acquisition of CSL limited could entail revolving Credit facility. Also known as revolver, this is a type of senior bank debt acting like a company’s credit card. Studies indicate that a revolver has the primary role of assisting to fund the working capital needs of a company. The company will be expected to “draw down” the revolving credit facility up to the limit of credit when cash need arises. The repayment of revolvers is normally done in the events of availability of excess cash. The revolver has the capability of providing companies with flexibility when it comes to their capital needs; this enables companies to access cash without the need for additional equity or debt funding (Higson &Rudiger, 2012). Notably, revolvers are associated with two costs: undrawn commitment fee and the interest rate charged on the drawn balance of the revolver. Ideally, the interest rate (normally charged on the revolver) is LIBOR alongside a premium that is dependent on the borrowing company’s credit features. The undrawn commitment fee has the role of compensating the bank as result of its commitment to lend up to the limit of the revolver. The financing of the acquisition of CSL Limited could also make use of bank debt. Ideally, this is a lower cost-of-capital security as compared to subordinated debt; however, bank debts are associated with more limitations and onerous covenants. This form of financing will call for full amortization over a period of 5 to 8 years. It is worth noting that covenants have the capability of restricting the flexibility of a company to make further acquisitions, pay equity holders, and raise additional debt. In addition, in the use of a bank debt, the purchasing company will have to meet financial maintenance covenants; these are quarterly tests of performance secured by the borrower’s assets. The target’s existing bank debt ought to be refinanced with new bank debt as a result of change-of-control covenants (Holthausen& David, 1996). The financing of the LBO, involving CSL Limited, could also be financed using high-yield debt which is normally unsecured. The naming of this form of debt comes from its high rates of interest with the capability of compensating the investors for the risk of such high debts. This form of debt has the potential of increasing levels of leverage beyond that proposed by other senior investors and banks. The refinancing of high-yield debts is done when the borrower has the capability of raising new debt in a cheap manner. There are two avenues of raising high-yield debt: private institutional market and the public bond. Companies are capable of retaining greater operating and financial flexibility with this form of debt via incurrence contrary to maintenance, covenants, alongside debt repayment upon its maturity (Ivashina, 2009). Notably, there are options for early repayment of this form of debt’ however, they call for repayment at a premium to face value. There is every expectation of business expansion after the acquisition. The company will be expected to enter new markets and diversify its product line. This will translate to a bigger capital base and increased revenues. With a current price per share of over $100, the share price of the LBO is estimated at $150. Sensitivity Analysis The sensitivity analysis aims at predicting the success of the LBO. This could be measured using the outcome of each deal-whether it exits via sale to financial or IPO, goes bankrupt, or to a strategic buyer. (Jensen, 1986)The LBO, involving CSL, is more likely to be successful it makes use of more bank debt and tighter covenants. It is also likely to be successful if it has the sponsorship of highly reputable PE firms and experience no changes of CEOs. The success of the acquisition will also draw an immense deal of influence from market forces. Ideally, with more companies being highly modernized and going global, the pharmaceutical market is becoming highly competitive. This has the implication that the purchasing company ought to gain edge over its main competitors to ensure that the deal remains viable. It is worth noting that the acquisition will most likely be financed by debts implying that the purchasing company ought to maximize its revenues in order to repay the debt. One of the primary means of ensuring that revenues are maximized is to employ strategies that enable the company to beat its competitors. The sensitivity of the LBO deal, involving CSL Limited is also influenced by the current market position of the company. In this case, the deal is likely to be favored by the current market position of CSL Limited considering that it is a reputable market and among the market leaders especially in Australia and New Zealand. The sensitivity of the LBO deal is also influenced by its time of completion-Studies indicate that deals that are completed when interest rates are low tend to be unsuccessful. This is a consequence of LBO buyers’ market timing behavior; they have a tendency of overinvesting in deals that are unprofitable as a result of favorable conditions of the credit market. Investors would be more willing to borrow when interest rates are low (Lichtenberg & Donald, 1990). However, in such times they will end up creating huge debts for businesses that end up being not profitable. Therefore, for the case of the acquisition of CSL Limited it is advisable to complete the deal when interest rates are at their historical level. This sensitivity analysis reveals that the acquisition is likely to succeed. Indeed, CSL Limited has established itself as a high quality company with consistency in the delivery of strong dividend growth and earnings for its shareholders. As supported by a strong financial performance over the last five years, it is proposed that, for the acquisition of CSL limited is $8 billion. Risks The recent years have seen a growth in the market share of CSL fueled by competitor difficulties and exploitation of the strengths of its portfolio. However, the company still faces strong competition from other companies which could be considered significant risk to the LBO deal. Octapharma and Baxter International are both reputable companies which have the capability of exhibiting dominance in the pharmaceutical industry. The return of Baxter into the European market poses great risk to the second half sales, market share, and margin of CSL. The LBO is also facing threat from price discounting from Octapharma; it is worth noting that this company is in attempts of winning back the market share it enjoyed up to the year 2010. Earnings of the purchasing company could also be significantly affected by regulatory change to contracts or government reimbursements (Lopez-de-Silanes et al, 2011). The deal is also facing the risk of a scare over safety and quality of the products-indeed, this has been identified as the primary unforeseeable risk to intrinsic value. The core business line of CSL is the sale of hemoglobin; from the year 2014, the sale of this product has shown a trend of decline posing yet another risk to the acquisition. The decline of sales of the main product line could have the implication that the purchasing company will not be in a position to make enough returns to make repayment of the debt used for the acquisition. This risk can, however, be alleviated via the entry into emerging markets which have been identified to be more robust(Lopez-de-Silanes et al, 2011). Exit Strategies There could be a case in which the investors intend to quit from the business as a result of difficult conditions. Entrepreneurs have the tendency of living for the struggle of establishing the business but fail to factor in the possibility exiting. One of the exit strategies that can be used in the LBO deal, involving CSL, is the selling to a friendly buyer strategy (Miller, 2012). This is an ideal method since it involves investors who know each other and can thus preserve every one’s interest. Other exit strategies that can be used are the IPO and the Liquidate. The liquidate strategy involves selling all assets of the business in order to be able to repay any existing debts. The IPO strategy entails the sale of the stock owned by the entrepreneurs and has been established to be ideal because of the capability of raising almost as much cash as the value of the stock. References CSL, 2015, About CSL [online]. Available at: [Accessed 15 October 2015] Cumming, Ds J., Donald S. & Michael W. , 2007, Private equity, leveraged buyouts, and governance, Journal of Corporate Finance 13, 439-460. Demiroglu, C& Christopher M. , 2010, The role of private equity group reputation in LBO financing, Journal of Financial Economics 96, 306-330. Diamond, D 1984, Financial intermediation and delegated monitoring, Review of Economic Studies 51, 393-414. Diamond, D, 1993, Seniority and maturity of bank loan contract, Journal of Financial Economics 33, 341-368. Fang, L, Victoria I & Josh L., 2012, Combining banking with private equity investing, Working paper. Holthausen, W & David F. , 1996, The financial performance of reverse leveraged buyouts, Journal of Financial Economics 42, 293-332. Ivashina, V & Anna K, 2009, The private equity advantage: Leveraged buyoutfirms and relationship banking, Review of Financial Studies 24, 2462-2498. Jensen, Michael C., 1986, Agency costs of free cash flow, corporate finance and takeover, American Economic Review 76, 323-329. Lichtenberg, F & Donald S, 1990, The effects of leveraged buyouts on productivity and related aspects of firm behavior, Journal of Financial Economics 27, 165-194. Lopez-de-Silanes, Florencio, Ludovic Phalippou, and Oliver Gottschalg, 2011, Giants at the gate: On the cross-section of private equity investment returns, Working paper. Miller, M, 2012, A syndicated loan primer: A guide to the U.S. loan markets, Standard & Poor’s Credit Research, September. Park, C, 2000, Monitoring and structure of debt contracts, Journal of Finance 55, 2157-2195. Rajan, R, and Andrew W, 1995, Covenants and collateral as incentives tomonitor, Journal of Finance 50, 1113-1144. Shivdasani, A & Yihui W, 2011, Did structured credit fuel the LBO boom?, Journalof Finance 66, 1291-1328. Smith, Abbie J., 1990, Corporate ownership structure and performance: The case of management buyouts, Journal of Financial Economics 27, 143-164. Higson, Chris, and Rudiger Stucke, 2012, The performance of private equity, Working Paper, London Business School. Read More