Post-LBO Development doc

Richard K. Lenz
Post-LBO Development
GABLER RESEARCH
Entrepreneurial and Financial Studies
Herausgeber:

Professor Dr. Dr. Ann-Kristin Achleitner
und Professor Dr. Christoph Kaserer
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This series presents research results from the fields of entrepreneurial and corpor-
ate finance. Its focus lies on innovative research topics at the interface of science
and practice.
Richard K. Lenz
Post-LBO Development
Analysis of Changes in Strategy,
Operations, and Performance
after the Exit from Leveraged Buyouts
in Germany
With a foreword by Prof. Dr. Christoph Kaserer
RESEARCH
Bibliographic information published by the Deutsche Nationalbibliothek
The Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliograe;
detailed bibliographic data are available in the Internet at .
Dissertation Technische Universität München, 2009
Die Reihe erschien von 2003 bis 2007 im Verlag Wissenschaft & Praxis Dr. Brauner.
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Foreword
Private Equity and leveraged buyouts have become common in Europe, including in
particular Germany. They are a catalyst for corporate restructuring and growth. Over
time, financial investors have started to exit their investments. The development of
some former LBOs raises the question whether the financial investors traded long-
term growth against short-term cash flow and expropriated value. Financial
investors are further accused of reducing employment, cutting salaries, offshoring
production, and leaving companies financially instable.
Researchers have questioned the sustainability of performance improvement and
tested changes in performance indicators. The findings confirm that the financial
performance of former LBOs declines. The decline occurs with a time lag, but
research fails to explain in detail its determinants of this decline. In particular, the

decline seems to be caused by increase strategy diversification, the recurrence of
inefficiencies and reduced management focus on efficiency. These observations are
limited to companies that exit through a public offering, not through a trade sale.
This study seeks to enhance completeness and precision of research into the post-exit
period. Given the secrecy of the industry, no empirical data has been gathered that in
detail analyses how the way the LBOs are supervised and managed changes at the
exit. Research on the subsequent changes in strategy and operations is sparse and
limited to those companies pursuing a public offering. A greater understanding of
the source of performance development requires further plowing through major
corporate activities.
In an unprecedented breadth and depth, this thesis sheds light on LBOs and their
post-exit development and overcomes the limitations of former studies. The author
provides an unforeseen review of causal relationships between changes and inter-
dependencies of corporate governance, management objectives, strategy, operational
setup and resulting financial performance. The empirical research is based on three
case studies consolidating external and internal information as well as interviews
with both managers, former financial investors and post-exit investors. The author
makes several important contributions to theory development and tests hypotheses
from both agency theory, strategic management, corporate entrepreneurship,
operations and last but not least financial performance.
In summary, the presented thesis provides an excellent insight into the buyout and
general corporate governance research. In spite of the limitations of a case study and
the holistic research approach, the thesis remains highly relevant to researchers and
Foreword
VI
practitioners, and should be seen as a highly valuable contribution to the ongoing
discussion and research in the field.
Prof. Dr. Christoph Kaserer
Acknowledgements
When I started to consider wirting a doctoral thesis about private equity and former

LBOs, I was rightly warned of the thorny territory I was intending to enter. At the
end, it was to the support and encouragement of various people to whom I express
my sincerest gratitude that made me finalize this academic journey as an enjoyable
and fruitful experience.
Firstly, I would like to thank my academic supervisors Professor Christoph Kaserer
and Professor Ann-Kristin Achleitner of the Technical University Munich, Germany,
for their academic guidance and encouraging support. Professor Kaserer was very
supportive throughout the development of my dissertation and provided me with
the necessary theoretical groundwork, motivation and patience with respect to my
parallel professional obligations. Professor Achleitner encouraged with the case
studies and her genuine insights into the Private Equity industry.
Secondly, I am indebted to my former colleagues Dr. Jürgen Meffert, Dr. Holger
Klein and Fabienne Serfaty at McKinsey & Company with whom I enjoyed a highly
inspiring time. The questionnaire of the growth initiative for German medium-sized
companies was, so to say, the initiating spark for starting my thesis. Jürgen Meffert
was an invaluable support as thought leader throughout my thesis and provided my
with the freedom to invest sufficient time and resources. Holger Klein relentlessly
pushed me with writing while sharing his thoughts and experiences. I am further
heavily indebted to Fabienne Serfaty. Without her support in finding the right case
studies and her permanent encouragements in the office I would have not been able
to finalize this thesis. I also owe greatest thanks to Professor Herbert Henzler for his
unrivalled support in providing access to various interview partners. Finally, thanks
must go to Dr. Berthold Fürst at Deutsche Bank, M&A, Germany, for his support in
providing me with the freedom to finalize my thesis.
The thesis would have not taken place without the time commitments of the
interviewees at the case study companies that provided me with various information
and insightful comments to the data gathering. I would in particular want to thank
Sven Kassner and Heinz-Georg Stiller (Wincor Nixdorf), Curd-Hasso von Flemming
and Horst Einzelmüller(Techem), Steffi Brobowski, Egon Kircher and Albert Beer
(Trevira). I am further indebted to several Limtied Partners and supervisory board

members who provided with invaluable insights on the way they managed the
companies and who commented on my research findings. Special thanks go to Silke
Scheiber (KKR), Dr. Alexander Dibelius (Goldman Sachs), Stefan Zuschke (BC
Partners) and Dr. Axel Wieandt (Deutsche Bank).
Acknowledgements
VIII
Furthermore, I owe thanks to various colleagues from the CEFS and McKinsey that
supported me with invaluable insights. Dr. Annabell Geidner and Dr. Oliver
Klöckner shared with me their knowledge and experience for the theoretical
groundwork and reseach approach. Dr. Achim Berg shared his collected material on
Private Equity and LBO, and was a stimulus from his own theoretical groundwork. I
also owe thanks to Dr. Nils Hoffmann for continued discussions.
Finally, I carry inexpressible gratitude for the support and help of my family and
friends. My father was my biggest inspiration, being surprised but grateful by my
late desire to write a doctoral thesis. In the last months, he remembered me
continuously of finalizing the thesis and thereby set me the final spurs. I especially
would like to thank Josef Arweck, Dr. Andreas Franz, Dr. Daniel Hildebrand,
Matthias Hommer and Dr. Marc Tenbücken, not only for their great friendship but in
particular for their inspiration and contribution to make the intense research very
social and enjoyable. Last but not least, I want to thank Miss Sarah Wild, that entered
half-way of the thesis my life and walked along all the ups and downs of this path,
patient, never urging, cheering and making the time working worth living.
Dipl. Ing. (Univ.) Dipl. Kfm. Richard Lenz
Table of Contents
1 Introduction and Overview 1
1.1 Relevance of Thesis 1
1.2 Research Objectives 3
1.3 Research Approach 7
1.4 Structure of Analysis 9
2 Definition and Context 11

2.1 Buyouts: a Definition 11
2.2 Characteristics of Buyouts 14
2.2.1 Industry-Specific Characteristics 15
2.2.2 Company-Specific Characteristics 18
2.2.3 Longevity of Buyouts and their Exit 20
2.3 Institutional Governance Framework 25
2.3.1 Buyout Investors 26
2.3.2 Stock Market 28
2.3.3 Strategic Owner 31
3 Related Theory to the Buyout Cycle 32
3.1 Introduction 33
3.2 Agency Theory 36
3.2.1 Agency Costs of Equity and Debt 38
3.2.2 Agency Costs of Free Cash Flow 40
3.2.3 Agency Costs during the Buyout 41
3.2.4 Agency Costs in the Post-Exit Period 44
3.3 Resource-Based View 48
3.3.1 Overview Resource Base 49
3.3.2 Categories of Resources and Capabilities 51
3.4 Corporate Governance-Related Perspective 54
3.4.1 Stakeholders in General and their Claims 55
3.4.2 Large Investors 56
3.5 Active Ownership and the Governed Corporation 60
Foreword V
Acknowledgements VII
Table of Contents IX
Index of Figures XV
Index of Tables XVII
Index of Abbreviations XXI
A Introduction and Founding Theory 1

Table of Contents
X
1 Introduction to the Basic Model 65
2 Post-Exit Changes in the Governance Structure and
Managerial Objectives 68
2.1 Changes in Governance Structure at the Exit 69
2.1.1 Debt Leverage over the Buyout Cycle 69
2.1.2 Ownership Structure and Performance 79
2.1.3 Owner Identity and Activity Level of Investors 86
2.1.4 Change of Management Shareholdings 94
2.1.5 Concluding Remarks 98
2.2 Changes in Motives and Potential Wealth Transfer 99
2.2.1 Buyout Investors 101
2.2.2 Post-Exit Shareholders 103
2.2.3 Management 104
2.2.4 Employees 106
2.2.5 Debt Holders 107
2.3 Changes in Management Objectives at the Exit 108
2.3.1 Emphasis on Efficiency by Management 109
2.3.2 Emphasis on Corporate Entrepreneurship by Management 111
3 Post-Exit Changes in Efficiency-Focused Management Activities 114
3.1 Introductory Remarks 114
3.2 Changes in Operations and Manufacturing 115
3.2.1 Operational Productivity and Employment 116
3.2.2 Asset Productivity and Capital Expenditure 124
3.2.3 Outsourcing, Offshoring and Partnering 129
3.2.4 Working Capital Management 133
3.3 Changes in Administration and Organization 136
3.3.1 Overhead Productivity 137
3.3.2 Hierarchical Complexity and Decision-Making 141

3.3.3 Efficiency of Management Control Systems 145
4 Post-Exit Changes in Entrepreneurial Growth Focused-
Management Activities
150
4.1 Introductory Remarks 150
4.2 Changes in Strategy 156
4.2.1 Strategic Positioning 157
4.2.2 Diversification and Scope 171
4.3 Changes in Innovation 178
4.3.1 R&D Spending and Efficiency 179
4.3.2 R&D Focus and Cooperation 189
B Model building and Hypotheses Development 65
Table of Contents

XI
4.4 Change in Market Development 191
4.5 Change in Human Resource Management 198
4.5.1 Human Resources 199
4.5.2 Top Management Resources 203
4.5.2.1 Quality and Composition of Team 203
4.5.2.2 Incentive System and Compensation 209
5 Performance Development during the Buyout Cycle 215
5.1 Introductory Remarks 215
5.2 Performance Development during Buyout Restructuring 215
5.3 Post-Exit Performance Development 227
5.3.1 Exit Market Development in Germany 227
5.3.2 Determining Concerns for the Choice of Exit Channel 231
5.3.3 Costs and Benefits 235
5.3.4 Performance Development of a LBO exiting via Going-Public 237
5.3.4.1 General Empirical Evidence related to a Going-Public 237

5.3.4.2 Changes in Corporate Governance and Performance
at Going-Public
243
5.3.4.3 Performance of LBOs Going Public 246
5.3.5 Performance Development of a Buyout Exiting via Trade Sale 251
5.3.5.1 General Empirical Evidence related to a Trade Sale 251
5.3.5.2 Changes in Corporate Governance and Performance
after a Trade Sale
255
1 Research Methodology 259
1.1 Identification of Case Studies 259
1.2 Measures for Analyses 261
1.2.1 Measures for Corporate Governance 261
1.2.2 Measures for Management Objectives 262
1.2.3 Measures for Value Creation Levers 263
1.2.4 Measures for Performance Development 267
1.3 Data Collection 269
2 Case Study: Wincor Nixdorf 271
2.1 Case Description 271
2.1.1 Company Development before the Buyout 271
2.1.2 Company Development during the Buyout Period 273
2.1.2.1 Efficiency-Focused Management Activities 273
2.1.2.2 Entrepreneurial Growth-Focused Management Activities 275
2.1.3 Company Development After The Exit 277
2.1.3.1 Market And Competitive Environment 277
C Empirical Part 259
Table of Contents
XII
2.1.3.2 Efficiency-Focused Management Activities 278
2.1.3.3 Entrepreneurial Growth Focused-Management Activities 285

2.2 Case Analysis 297
2.2.1 Changes in Governance over the Buyout Cycle and in the
Post-Exit Period
297
2.2.1.1 Debt Leverage 297
2.2.1.2 Ownership Concentration 299
2.2.1.3 Activity Level of Investors 301
2.2.1.4 Managerial Shareholdings 305
2.2.2 Changes in Management Objectives 308
2.2.3 Changes in Efficiency-Focused Management Activities 310
2.2.4 Changes in Entrepreneurship-Focused Management Activities 314
2.2.5 Changes in Performance Development 318
3 Case Study: Techem 324
3.1 Case Description 324
3.1.1 Company Development before the Buyout 324
3.1.2 Company Development during Buyout 325
3.1.2.1 Efficiency-Focused Management Activities 325
3.1.2.2 Entrepreneurial Growth-Focused Management Activities 327
3.1.3 Company Development after the Exit 330
3.1.3.1 Market and Competitive Environment 330
3.1.3.2 Efficiency-Focused Management Activities 331
3.1.3.3 Entrepreneurial Growth Focused-Management Activities 336
3.2 Case Analysis 351
3.2.1 Changes in Governance over the Buyout Cycle and in the
Post-Exit Period
351
3.2.1.1 Debt Leverage 351
3.2.1.2 Ownership Concentration 353
3.2.1.3 Activity Level of Investors 357
3.2.1.4 Managerial Shareholdings 359

3.2.2 Changes in Management Objectives 362
3.2.3 Changes in Efficiency-Focused Management Activities 364
3.2.4 Changes in Entrepreneurship-Focused Management Activities 367
3.2.5 Changes in Performance Development 372
4 Case Study: Trevira 379
4.1 Case Description 379
4.1.1 Company Development before the Buyout 379
4.1.2 Company Development during the Buyout Period 381
4.1.2.1 Efficiency-Focused Management Activities 381
Table of Contents

XIII
4.1.2.2 Entrepreneurial Growth-Focused Management Activities
383
4.1.3 Company Development after the Exit
386
4.1.3.1 Market and Competitive Environment
388
4.1.3.2 Efficiency-Focused Management Activities
388
4.1.3.3 Entrepreneurial Growth Focused-Management Activities
395
4.2 Case Analysis
401
4.2.1 Changes in Governance over the Buyout Cycle and in the
Post-Exit Period
401
4.2.1.1 Debt Leverage 402
4.2.1.2 Ownership Concentration 403
4.2.1.3 Activity Level of Investors 405

4.2.1.4 Managerial Shareholdings 407
4.2.2 Changes in Management Objectives 410
4.2.3 Changes in Efficiency-Focused Management Activities 411
4.2.4 Changes in Entrepreneurship-Focused Management Activities 416
4.2.5 Changes in Performance Development 421
5 Comparative Case Study Analysis 427
5.1 Changes in Governance Structure 427
5.1.1 Debt Leverage 427
5.1.2 Ownership Concentration 428
5.1.3 Activity Level of Investors 429
5.1.4 Managerial Shareholdings 431
5.2 Changes in Management Objectives 433
5.3 Changes in Efficiency-Focused Management 436
5.4 Changes in Entrepreneurial Growth-Focused Management 445
5.5 Changes in Performance Development 458
5.5.1 During the LBO 458
5.5.2
Post-LBO 459
5.5.2.1 Revenue Growth 459
5.5.2.2 Margin Development 460
5.5.2.3 Cash Flow from Operations 463
5.5.2.4 Cash Flow from Investments and Resulting Free Cash Flow 466
5.6 Discussion 467
5.7 Closing Remarks 472
1 Research Synthesis and Conclusion 475
2 Contributions to Research and to Practice 482
2.1 Contributions to Agency Theory 482
2.2 Contributions to Corporate Governance Theory 484
D Synthesis and Outlook 475
Table of Contents

XIV
2.3 Contributions to Operations Management, Strategy, and
Corporate Entrepreneurship Research 487
2.4 Contributions to Finance Research 489
2.5 Applications of Findings to Post-Ext Shareholders and Investors 493
3 Limitations of Study and Areas of Future Research 497
1 Interview Partners 501
2 Key Financials of Case Studies 502
E Appendix 501
F References 505
Index of Figures
Figure 1: Structure of analysis 10
Figure 2: Product life cycle with investment need and cash flow generation
(illustrative) 17
Figure 3: Institutional governance framework (illustrative, author) 25
Figure 4: Basic model – impact of governance on management's objectives, on the
applied levers on strategy and operations, and corporate performance 65
Figure 5: Changes in management objectives
109
Figure 6: Overview of hypotheses for efficiency-related management activities 115
Figure 7: Overview of hypotheses for entrepreneurial growth-related activities 151
Figure 8: Constituents of entrepreneurial orientation 154
Figure 9: Strategic fit between a target and a bidder business 167
Figure 10: Development of exit volume of German Private Equity 229
Figure 11: Number of exits and share of exit volume for buyout in Germany 230
Figure 12: Changes in post-exit performance 251
Figure 13: Derivation target sample group by Initiative Europe 260
Figure 14: Post-exit corporate strategy objectives in 2004 (Wincor Nixdorf) 286
Figure 15: Post-exit corporate strategy objectives in 2007 (Wincor Nixdorf) 287
Figure 16: Development of share price since IPO (Wincor Nixdorf) 321

Figure 17: List of substantial acquisitions and divestments in the post-exit period
(Techem) 342
Figure 18: Product evolution (Techem) 344
Figure 19: Topics of supervisory board meetings (Techem) 355
Figure 20: Development share price (Techem) 375
Figure 21: Trevira marketing concept (Trevira) 396
Figure 22: Change in legal structure of Trevira and its subsidiaries (Trevira) 409
Figure 23: LBO performance adjusted to industry average 461
Figure 24: Post-LBO performance adjusted to industry average 464
Figure 25: Post-LBO performance adjusted to buyout average 465

Index of Tables
Table 1: Criteria for the LBO suitability (author) 15
Table 2: Constituents of governance (author) 61
Table 3: Managed versus the governed corporation (according to Pound) 63
Table 4: Change in debt leverage and structure at the entry into the buyout 72
Table 5: Change in debt structure ownership from pre- to post-exit 74
Table 6: Overview change in equity ownership concentration and
management shareholdings from pre- to post-buyout
84
Table 7: Surveys on the impact of buyouts on manufacturing and operations 117
Table 8: Surveys on the impact of buyouts on administration and organization 138
Table 9: The Impact on R&D Intensity during the Buyout and in the Post-Exit
Period 184
Table 10: Performance studies for restructuring during buyout based on data

from financial statements and surveys 219
Table 11: O
verview of performance studies for restructuring during buyout
based on data from capital markets 220

Table 12: Impact of changes in governance structure o
n
performance development 225
Table 13: O
verview of costs and benefits of a going-public for a LBO (author) 236
Table 14: Overview of costs and benefits of a trade sale for a LBO (author) 237
Table 15: Overview of long-term performance studies for going-public, buyout
and non-buyout (excerpts) 239
Table 16: Cross-sectio
nal regression analysis of changes (industry-adjusted) in
company performance 249
Table 17: O
verview of (long-term) performance studies related to trade sales in
Germany 255
Table 18: Measures for the corporate governance constituents 262
Table 19: Measures for levers of value creation 266
Table 20: Overview of performance indicators 268
Table 21: Change in employee mix (Wincor Nixdorf) 279
Table 22: Changes in operations-related cost positions (Wincor Nixdorf) 279
Table 23: Changes in operational productivity (Wincor Nixdorf) 280
Table 24: Changes in asset base and asset productivity (Wincor Nixdorf) 281
Table 25: Changes in working capital (Wincor Nixdorf) 283
Table 26: Product portfolio at exit from buyout (Wincor Nixdorf) 288
Table 27: Changes in R&D input, output and efficiency (Wincor Nixdorf) 290
Index of Tables
XVIII
Table 28: Market growth by regions during and after the buyout
(Wincor Nixdorf) 293
Table 29: Changes in composition of top-management board (Wincor-Nixdorf) 296
Table 30: Changes in debt leverage over the buyout cycle (Wincor Nixdorf) 299

Table 31: Changes of ownership in the post-exit period (Wincor Nixdorf) 301
Table 32: Membership structure of the supervisory board (Wincor Nixdorf) 303
Table 33: Topics of supervisory board meetings (Wincor Nixdorf) 304
Table 34: Synthesis of changes in governance (Wincor Nixdorf) 307
Table 35: Synthesis of changes in management objectives (Wincor Nixdorf) 309
Table 36: Synthesis of changes in efficiency-focused activities (Wincor Nixdorf) 313
Table 37: Synthesis of changes in entrepreneurial growth-focused activities
(Wincor
Nixdorf) 317
Table 38: Change in overall performance, stand-alone and industry adjusted
(Wincor Nixdorf) 320
Table 39: Change in performance (Wincor Nixdorf) 323
Table 40: Changes in operational productivity (Techem) 335
Table 41: Changes in asset productivity (Techem) 335

Table 42: Post-exit corporate strategy objectives (Techem) 338
Table 43: Changes in R&D input, output and efficiency (Techem) 343
Table 44: Changes in working capital (Techem) 347
Table 45: Changes in sales productivity (Techem) 347
Table 46: Changes in the management board (Techem) 350
Table 47: Changes in compensation scheme (Techem) 350
Table 48: Change in debt leverage over the buyout cycle (Techem) 355
Table 49: Changes in ownership structure (Techem) 356
Table 50: Membership structure of the supervisory board 357
Table 51: Synthesis of changes in governance (Techem) 361
Table 52: Synthesis of changes in management objectives (Techem) 363
Table 53: Synthesis of changes in operations (Techem) 365
Table 54: Synthesis of changes in entrepreneurial growth-focused activities
(Techem)
370

Table 55: Synthesis of changes in entr
epreneurial growth-focused activities
(Techem, continued)
371
Table 56: Change in overall performance, stand-alone and industry-adjusted
(Techem) 374
Table 57: Change in performance (Techem) 376
Table 58: Changes in operational productivity (Trevira) 390
Table 59: Changes in asset base and asset productivity (Trevira) 391
Table 60: Change in material costs as part of total sales (Trevira) 392
Index of Tables

XIX
Table 61: Changes in working capital (Trevira) 393
Table 62: Market growth by regions during and after the buyout (Trevira) 399
Table 63: Change in sales by business segment during and after the buyout
(Trevira) 399

Table 64: Changes in composition of top-management board (Trevira) 401
Table 65: Changes in debt leverage over the buyout cycle on holding level
(Trevira) 403

Table 66: Change of ownership in the post-exit period on holding level (Trevira) 404
Table 67: Membership structure of the supervisory board (Trevira) 406
Table 68: Synthesis of changes in governance (Trevira 408
Table 69: Synthesis of changes in management objectives (Trevira) 412
Table 70: Synthesis of changes in efficiency-focused management activities
(Trevira)
414

Table 71: Synthesis of changes in efficiency-focused management activities
(Trevira, co
ntinued) 415
Table 72: Changes in entrepreneurial growth-focused management activities
(Trevira) 419
Table 73: Change in overall performance, stand-alone and industry adjusted
(Trevira) 423

Table 74: Change in performance development (Trevira) 424
Table 75: Review of hypotheses for change in corporate governance constituents
(H1 to H4) 432
Table 76: Review of hypotheses for change in management object
ives
(H5 to H12) 435
Table 77: Review of hypotheses for change in efficiency-focussed management
(H13 to H20) 442

Table 78: Review of hypotheses for change in entrepreneurial growth-focussed
management (H20 to 27) 451
Table 79: Review of hypotheses for change in company performance (H29)
471
Table 80: Development of dividend quote in Germany (last ten years) 495
Table 81: Development of capital structure and indebtedness in Germany 496
Table 82: Adaptation of buyout constituents of corporate governance to the
post-exit period (author) 497
Table 83: List of interview partners 501
Table 84: Profit & loss statement Wincor Nixdorf 502
Table 85: Profit & loss statement Techem 503
Table 86: Profit & loss statement Trevir 504

Index of Abbreviations
AG Aktiengesellschaft
AktG Aktiengesetz
ATM Automated teller systems
BCG Boston Consulting Group
BVCA British venture capital association
BVK Bundesverband deutscher Kapitalbeteiligungsgesellschaften
(German association of private equity firms)
CAGR Compound annual growth rate
CAPM Capital asset pricing model
CAR Cumulative abnormal return
CEO Chief executive officer
CFO Chief financial officer
CMBOR Centre for management buyout research
DAX Deutscher Aktienindex
DB Deutsche Bank
DBI Deutsche Bank Investor
DCF Discounted cash flow
EBIT Earning before interest and taxes
EBITDA Earning before interest, taxes, depreciation and amortization
EBO Employee buyout
EPOS Electronic point of sale system
et al. Et alii, et aliae, et alia (Latin), and others
etc. et cetera (Latin): and other things, and so forth
et seqq. Et sequentia (Latin): and the others following
EUR Euro
EVA Economic value added
EVCA European venture capital and private equity association
e.g. Exemplum gratii (Latin): for instance, to exemplify
FAZ Frankfurter Allgemeine Zeitung

FTD Financial Times Deutschland
GEX German Entrepreneurial Index
GDP Gross domestic product
GmbH Gesellschaft mit beschränkter Haftung
HLT Highly leveraged transaction
IAS International accounting standard
IBO Institutional buyout
Index of Abbreviations
XXII
IPO Initial going-public
IRR Internal rate of return
KGaA Kommanditgesellchaft auf Aktien
KKR Kohlberg, Kravis & Roberts
KonTraG Gesetz zur Kontrolle und Transparenz im Unternehmensbereich

LBO Leveraged buyout
LMBO Leveraged management buyout
MBI Management buyin
MBO Management buyout
MDAX Mid cap DAX
M&A Mergers and acquisitions
NOPBT Net operating profit before taxes
NOPLAT Net operating profit less adjusted taxes
NPV Net present value
PE Private equity
R&D Research and development
RBV Resource-based view
ROE Return on equity
ROIC Return on invested capital
S&P Standard and Poors

SEC Securities and exchange committee
SIC Standard industry code
SG&A Selling, general and administrative expenses
SDAX Small cap DAX
SME Small and medium-sized enterprises
TFP Total factor productivity
UK United Kingdom
USA United States of America
USD United States Dollar
US-GAAP United States generally accepted accounting principles
VC Venture capital
WACC Weighted average cost of capital


A Introduction and Founding Theory
1 Introduction and Overview
1.1 Relevance of Thesis
Leveraged buyouts (LBOs) have become common in Europe, including in particular
Germany. They are a catalyst for corporate restructuring and growth, and typically
involve equity from professional managed partnerships. Some EUR 21.6 billion was
invested in German LBOs by 2006
1
, thereof the five largest transactions accounted for
EUR 12.5 billion.
The LBOs involve significant changes in the way a company is managed. Interest
alignment of management with the investors is increased by granting co-ownership.
The company’s capital structure is optimized by raising debt and ownership itself is
concentrated in the hands of investors who actively monitor company performance.
Research into a significant number of LBOs in various regions and sectors, also in
Germany

2
, shows that these changes lead to a significantly enhanced performance of
LBOs.
Once companies have repaid a considerable part of the acquisition debt, which
typically is imposed on the company, investors consider exiting their investment.
Investors’ preferred exit strategy is the return of the company to public trading,
depending on circumstance, through an initial or secondary public offering.
Investors opt for a trade sale to a strategic buyer if equity markets suffer illiquidity
and investor sentiment is low. The exit volume in Germany has increased from EUR
0.7 Billion in 1998 to EUR 10.3 Billion in 2006
3
.
Exits from LBOs again prompt changes in the governance of the company. Managers
usually cash out on their investment and reduce their stake, primary offerings
decrease debt leverage, and the buyout investor’s remaining equity is distributed to
either institutional investors or a strategic buyer.
A few former German LBOs raise the question whether the buyout investors traded
to their advantage long-term growth against short-term cash flow and expropriated


1

See CMBOR 2006

2

A detailed overview of the existing research on LBO performance is provided in chapter B5.2. The most
known surveys are Kaplan 1989a, Smith 1990b, and Muscarella and Vetsuypens 1990 (all US) and
Luippold 1991, Wegner 2003, and Kitzmann 2005 (all Germany).
3

See the discussion on the development of LBO exit volume in chapter B5.3.1 and in CMBOR 2006.
A Introduction and Founding Theory

2
value
4
. German politicians who likened private equity and hedge funds investors to
“locusts who feasted on German firms for profit before spitting them out”
5
fuelled
this discussion. They accused the buyout investors of reducing employment, cutting
salaries, offshoring production, and leaving companies financially instable
6
.
Existing research confirms that the accounting performance of former LBOs declines.
The research shows that the decline occurs with a time lag of three to four years
when these companies underperform against their industry average. The time lapse
indicates that the inefficiencies are not the manager’s intent, but the result of various
small decisions not taken that would have been in the best interest of the company.
Slack resources are re-introduced and sub-optimal investments made. Change in
how the company is managed is largely a function of changes in governance at the
exit. Bruton et al. in a survey on the very changes note that:
"Nonetheless, agency theory predicts that there would be a reintroduction of inefficiencies and
a loss of previously experienced performance gains. […]. As manager ownership declines,
growth goals once again become important because they are more consistent with the
manager/agent’s personal utility. Increased diversification and firm size lead to greater
compensation for the manager. "
7

German companies include a large number of attractive LBO candidates given their
strong market position and stable cash flows that result of operations in mature
markets and proven products. They offer considerable growth potential from
increasing internationalization and entry into new market related to their core
business. Given their low capital base, given the fact that they are often family-
owned and their lack of management focus, these companies benefit from takeovers
by large corporations that serve as catalysts for growth and restructuring
8
. The locust
analogy nonetheless fueled resistance of German companies to buyout investors.
Family-owned companies were already standoffish towards private equity investors
because of lack of experience and different cultural backgrounds
9
.
LBO research until now has not looked at former German LBOs. It is primarily based
on a relatively small sample of US and UK-originated and floated LBOs, most of


4

See the case of the secondary LBO of Friedrich Grohe AG, “Investoren – schmeißen Sie die raus”, Der
Spiegel, November 28 2005, “Grohe dreht auf “, Sueddeutsche Zeitung, May 25 2007
5

See “Locusts in Lederhosen – business in Germany”, Economist October 20 2007
6

See „Die Zeche zahlt der Wirt“, Der Spiegel May 2 2005, „Die deutsche Lektion“, Financial Times
Deutschland, May 13 2005
7

See Bruton, Keels et al. 2002, pp. 713 and 714
8

See Achleitner 2008,p.88
9

See Achleitner and Poech 2005
1 Introduction and Overview

3
which were studied in the 1980s and 1990s
10
. Researchers have also not reviewed
performance development of trade sales in the post-exit phase because little data is
publicly available. Most importantly, researchers admit to not having attributed a
cause-and-effect relationship to post-exit performance decline.
1.2 Research Objectives
This thesis seeks to achieve the following objectives and furnish answers for
subsequent questions:
Objective 1:
How does corporate governance of a former LBO change after the exit?
As part of detailed empirical work on the new ‘leveraged buyout’ phenomenon,
researchers have won a detailed understanding of how corporate governance
changes at the entry into a buyout. Several studies collected detailed analysis of
changes in the debt
11
and equity structure
12
. The studies also reviewed changes in

management compensation schemes as well as the constituents of German LBOs
13
.
Studies on exits from buyouts focused on companies with a public offering. Analysis
therefore depended on those aspects of corporate governance that could be measured
with publicly available data such as changes in debt leverage
14
and ownership
structure
15
. Understandably, the activity level of governance in terms of intensity and
quality of monitoring fell beyond the scope of empirical studies and constitutes a
research gap. The public unavailability of information on exits through trade sales
means that the database is limited to exits through public offerings. Commenting on
the financial performance of reverse LBOs, Holthausen and Larcker said:
"While the accounting performance and valuation implications of leveraged buyouts have
been studied in numerous academic articles, the performance of reverse leveraged buyouts
[…] is a largely unanswered question. Examination of reverse LBOS can provide additional

10

A detailed overview of studies on the performance of LBOs can be found in chapter B5.3.
11

See DeAngelo, DeAngelo et al. 1984, DeAngelo 1986, Marais, Schipper et al. 1989, Kaplan 1989a,
Muscarella and Vetsuypens 1990, Kaplan and Stein 1990, Kaplan 1991, Cotter and Peck 2001, Wu 1997
12

See Maupin, Bidwell et al. 1984, DeAngelo and DeAngelo 1987, Kaplan 1989a, Kaplan and Stein 1990,
Singh 1990, Kaplan 1991, Phan and Hill 1995, Wu 1997, Cotter and Peck 2001, Bruton, Keels et al. 2002,

Peck 2004
13

See Luippold 1991, Forst 1992, Gräper 1993, Vest 1995, Jakoby 2000, Wegner 2003
14

See Muscarella and Vetsuypens 1990, Mian and Rosenfeld 1993, Holthausen and Larcker 1996, Jalilvand
and Switzer 2002
15

See Muscarella and Vetsuypens 1990,Mian and Rosenfeld 1993, Holthausen and Larcker 1996, Bruton,
Keels et al. 2002, Peck 2004
A Introduction and Founding Theory

4
evidence about the extent to which leverage and concentration of ownership provide desirable
incentives within organizations”16.
Because observation of public offerings is to some degree incomplete and for trade
sale non-existent, analysis will have to start with understanding changes in the
constituents of the governance. How will debt leverage change? Will the company
benefit from any sale proceeds? Will the ownership structure remain concentrated?
What effort will new shareholders put in monitoring management? To what degree,
will management get equity stakes? How is the LBO governance in Germany
different to other countries?
Objective 2:
How do changes in corporate governance affect management objectives?
Adjustments in the company’s governance structure will most likely lead to changes
in management’s goals and objectives. These changes will lead to modifications in
the company’s strategy and operations. Management objectives, even though they
only offer limited insight into actual changes in strategy and operations, summarize

the overall re-direction and serve as a proxy indicator.
High debt may focus management on maximizing productivity of operations and
increasing available cash flow. It may also diminish focus on growth as long as
current operations do not produce sufficient profit. Research into LBOs has tracked
management objectives and measured considerable change at the entry into a
buyout
17
.
Laxer governance after the exit may involve a change of objectives, with little focus
on efficiency and entrepreneurship. An open shareholder structure with reduced
monitoring and low management stakes may re-motivate managers to build up slack
resources and pursue non-value-creating growth. Initial first empirical evidence of
an LBO exit indicates the recurrence of inefficiencies and reduced management focus
on efficiency
18
.
Again, these observations are limited to companies that exit through a public
offering, not through a trade sale. This study seeks to enhance completeness and
precision of research into the post-exit period. How will management view the
importance of continuing operational improvement activities? Will it take unpopular
measures even if they lack power as owners after selling their shares in the exit? Will


16

See Holthausen and Larcker 1996, p. 294
17

See Easterwood 1989, Phan and Hill 1995, Zahra 1995, Bruining and Wright 2005
18

See Bruton, Keels et al. 2002