Microsoft-Dell: What Is A Leveraged Buyout?


Dell CEO Michael Dell is reportedly leading a $20-billion leveraged buyout attempt for the company he founded in 1984, raising a few questions: Just how would such a deal work? What would an investment by Microsoft mean? And exactly what is a leveraged buyout anyway?

The last one is the easiest. A leveraged buyout is when the acquisition of a company, either by another business, internal managers or other parties, is financed almost entirely with borrowed money. That debt generally takes the form of either bonds or loans.

Leveraged buyouts, in fact, are often completed with a high debt/equity ratio -- as much as 90 percent debt to 10 percent equity, according to a definition on the financial website Investopedia. Often the acquired company's assets are used as collateral for the loans. If an acquired company is "over-leveraged," its cash flow can't keep up with the interest payments on the debt and the business could go bankrupt.

[Related: Channel Gung-Ho Over Microsoft's Dell Investment]

Dell has reportedly been in discussions with a handful of banks and private equity firms to finance the buyout bid.

Reports surfaced Monday that Microsoft is a possible "mezzanine" or preferred financing partner in the deal, contributing as much as $3 billion to the near-$20 billion it may require to take Dell private.

Mezzanine capital usually refers to preferred equity that is structured either as a loan or preferred stock if the debt isn't repaid within a certain period of time. Mezzanine financing can be risky for the lender because it is often provided quickly with little chance for due diligence on the part of the lender, or with little or no collateral from the borrower, according to Investopedia. That means the interest rates on the financing -- the interest rates on the loan -- can be as high as 20 to 30 percent.

Mezzanine financing would not provide Microsoft with an equity stake in Dell unless the computer maker fails to repay the loan. So why would Microsoft get involved? Dell is a major OEM partner, and Microsoft may want to do whatever it takes to stay close to the company.

Another reason could simply be that Microsoft recognizes a good investment opportunity when it sees one. The software giant is sitting on more than $5 billion in cash and cash equivalents and $61.6 billion in short-term investments, as of Sept. 30, 2013, the end of the company's fiscal 2013 first quarter. A return of 20 percent or more on some of that cash would be very attractive indeed.

PUBLISHED JAN. 22, 2013