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Federated Department Stores Leveraged Buyout Debacle
Federated Department Stores was a company running a collection of relatively high end retailers. The company had lots of stores but did not have a mass marketing strategy. The hostile Leveraged Buyouts of Federated Department Stores became the target of a hostile leveraged buyout by Robert Campeau, a Canadian financier. Robert Campeau believed he could realize a major gain in value for the corporation with a change in management. He acquired Federated at a price that was nearly double its pre-acquisition market value. This was risky enough, but he amplified the risk by using debt to cover about 97 percent of the acquisition costs. This was a leverage ratio (debt/equity) of about 32 to 1. Leverage ratios in excess of 9 to 1 have a notably higher rate of failure. The safe levels of the leverage ratio depend upon the nature of the business, the stability of the rate of return on capital. American banks typically operate with leverage ratios of 15 to 1 but this is acceptable because of the predictability and stability of their earnings. Manufacturing corporations in the U.S. operate with leverage ratios which are typically in the range of 0.5 to 1 or 1 to 1.
Robert Campeau acquired Federated in 1989. In 1990 Federated filed for bankruptcy. While financially the LBO of Federated was a failure Campeau was able to bring about some adjustments before the collapse that improved the performance of the company. The improvements were just not enough and not soon enough to cope with the financial burden of high interest payments to cover the high acquisition price.
Companies can learn from the experiences from Federated to use the “right” mix of debt and equity to aid financing decisions and mitigate the risk of bankruptcy. All things considered such as rs, rw, rb, and Tc, Companies should consider the target ratios such as weight for equity, S/(S + B), and the weight for debt, B/(S + B) to produce projects with a positive NPVWACC and to increase the valuation of the company to maximizing wealth.
Cite this as:
YouSigma. (2008). "Federated Department Stores Leveraged Buyout Debacle." From http://www.yousigma.com.
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