Deal Structuring of Private Equity: Its Application in the LBO of Hospital Systems

• Main Authors: Tzu-Wen Wei, 魏資文
• Other Authors: 江炯聰
• Format: Others
• Language: en_US
• Published: 2011
• Online Access: http://ndltd.ncl.edu.tw/handle/52091147984473113366

博士 === 國立臺灣大學 === 商學研究所 === 100 === Private equity (PE) has received much attention since the mid-1980s and plays an important role in the present economic recovery after the subprime crisis. Most researchers have focused on the trend of the PE industry and partial value creation analyses, and there has been a lack of a comprehensive framework of deal structuring and in-depth empirical studies. To bridge the gap, this article uses an induction approach for literature and case study methods to answer the following question: How do buyout firms structure a deal through what mechanisms for each counter party at three major stages from acquisition to holding and to divestment? First, this research uses principles of platform to analyze characteristics and operation models of private equity. It is found that a private equity company creates a transaction platform. A PE company attracts users including target companies, lending loans, other institutional investors, and consulting firms to join this platform and form network effects. Based on the concepts of platform strategy suggested by Evans and Schamelensee (2007), a PE firm has to perform three key activities, including value creation, deal design, and covenant design, to complete a deal successfully. In terms of value creation, this study compares suggestions from Loos (2006) and Berg and Gottschalg (2005) and interviews with executives at international leading PE firms. From the perspectives of case study and practical operation, this author develops an integrative analytical framework based on the investment, holding, and divestment stages. Regarding deal design, this study reviews studies of Brunner (2004) and Levin (2006) and compares pros and cons for both buyers and sellers in terms of issues of taxes and liabilities. As for taxes, buyers will consider tax shields mainly and sellers will emphasis on reduction of income taxes. This study concludes that the reverse triangular merger is the best choice for buyout transactions from the perspectives of both sides. The case studies also confirm this conclusion. As for covenant design, this research discusses agreements among PE firms, the target company and its management teams, and lending banks. The contracts include purchase agreements with term sheets, management and employee agreements, and loan agreements. The presence of covenants in financial contracts is motivated by their ability to mitigate agency problems (Dewatripont & Tirole, 1994). Jasper (1982) suggested that loan lenders were most concerned about borrowers’ earning power, cash flow generation, and business risks. This study summarizes Jasper’s suggestions as the analytical basis for case study. The second part of this study applies the comprehensive framework developed above to perform case studies in an innovative way. PE activities include venture capital, leveraged buyout, management buyout and merger and acquisition. Among them, the leveraged buyout seizes growing market and is deemed as good at perform financial engineering and value creation skills in particular. Jensen (1989) suggested that the leveraged buyout organization would eventually become the dominant corporate organizational form. This study focuses on cases of leveraged buyout. This research investigates the world’s largest buyout deal as of 2006—the acquisition of the Hospital Corporation of America (HCA) as the main case and address the unique deal structuring mechanisms in the hospital industry. The auxiliary cases are IASIS and Vanguard, which are also first-tier hospital chains in the United States. This research analyzes and compares these three cases and has several findings. It is found that PE firms apply financial engineering mainly to optimize leverage at the acquisition stage, enhance operating effectiveness to maximize EBITDA at the holding stage, and increase market valuation through their professional networks at the divestment stage. It is worth noting that PE firms increase leverage dramatically at the first stage and deleverage quickly at the second stage. In designing incentive programs for the management team, PE firms put special emphasis on cash generation. The results also show that PE firms utilize more value-creation vehicles from the entrepreneurship than agency costs perspective. Finally, this study explores business models of the medical industry in Taiwan and cases of financial innovation in the world wide. This study bases on several different academic angles (i.e., platform, finance, accounting, general management, law, strategy) and utilizes public information to perform a rigorous case analysis. This research has several managerial implications. Through the study of “Deal Structuring of Private Equity: Its Application in the LBO of Hospital Systems,” this author hopes to assist people of the medical industry in Taiwan to understand international financial strategies and mechanisms of value creation and lead Taiwan’s medical industry to the international together.