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•Five Greatest Environments for Producing Money Makers 125

Idea 69 – Take-overs and junk bonds

Take-overs could, of course, be in the section on winning in the stock market. It is
usual for the shareholders of the company being taken over that they receive a pre-
mium on the share price once it becomes known that there is a predator, friendly or
hostile, about. But there is a large body of opinion that believes that this effect is
counteracted by the negative impact of the shareholders of the bidding company.

So the money makers in this environment seem to be the wheelers and dealers
who make take-overs happen and who deal with the assets and debts of the com-
pany after the take-over.

Let’s take as an example an American-style leveraged buyout (LBO) and see
how the idea of companies being ‘in play’ has produced markets where a lot of
money can be made and lost.

The LBO uses a target company’s assets and earnings to finance the take-over.
The buyer simply pledges the assets of the target company as security for lenders,
who will only lend the money if the bid is successful. As soon as the purchase has
been completed the debt is secured on the company’s own assets. There are many
examples, but one of the most famous was the bid for RJR Nabisco in 1989.

The result of all this is that the new company has the millstone of debt round its
neck from day one. So, corporate raiders will sell off parts of the new company or its
assets to try to get this more under control. This is called ‘rationalisation’ and is
frequently attended by its close cousin ‘downsizing’.

Leveraging is, whatever the junk bond salespeople tell us, dangerous. If the
profits of the business do not grow to expectation or if interest rates take a turn up
the way, trouble can ensue. The huge debts from the buyout may be the downfall of
the company bought out.

LBOs are not so popular in the UK, although they too have a close cousin in the
management buyout.

Normal company bonds are a well-accepted form of capital and carry a sensible
degree of risk. In the leveraged situation the amount of debt involved makes the