The headlines about the possible bankruptcy of the largest leveraged buyout to date, Energy Future Holdings Corporation, brings up the question of how to compete against LBOs.
LBOs are taken private in a buyout largely financed by debt, which raises their debt to equity ratio to levels significantly higher than average. The concept is that the companies are bloated and once cuts are made the slimmed-down organization will generate the cash flow to pay off the debt and eventually go public again. As debt is less flexible than equity, LBOs do go bankrupt at a significantly higher rate than other firms. The demands of the debt payments leave little flexibility for adverse events such a downturn in the economy. Or in Energy Future’s case, a drop in natural gas prices on which its electricity prices are based per regulated formula.
So how do you compete against a highly leveraged rival?
1. Increase your spending on marketing; the rival has fewer resources.
2. Emphasize your stability. While most LBOs survive the changes, most businesses are aware of the very public LBO failures. 3. LBOs nearly always cut staff significantly to operate “lean and mean.” Plus they often send manufacturing overseas is possible. So hire the best people, whether working or laid off; they would rather work for a more stable organization. 4. Pick up any assets being divested inexpensively. LBOs are often consolidating operations or selling “non-core” assets.
How else can you compete against an LBO competitor?