Case study

The EMAS Leveraged Buy-Out

by Professor Ian H. Giddy
New York University


1. Situation of Company Pre-LBO

EMAS (which originally stood for Malaysia Armed Service Enterprise) was started to provide the Malaysia Armed Forces with consumer goods at affordable prices. EMAS has a well-known brand name in Malaysia, a reputation for giving value for money, and a low default rate (about 0.8% of Sales in 1998, and 1.1% in 1999) on its customer-financing business. HP financing rates are: 8% on PCs, 12% on other goods. 

           EMAS was profitable, and had come through the economic crisis well -- it had made profits every year despite the poor retail market conditions in Malaysia during the late 1990s. It had five retail outlets and a warehouse in Klang, Malaysia, prior to its LBO. Its biggest market is the lower and middle-income families who live in the Klang Valley area. 

            EMAS was wholly owned by a State Company, which decided to divest the enterprise because it was not considered a core business.However, the State Company was aware of EMAS's initial public offering (IPO) potential, and so negotiated to have an option to re-invest in EMAS, prior to its IPO, at a discount to its IPO price. 

2.The LBO Investors

            The Investors are a group of financial investors of good reputation, and who have a track record in hotel development and investment. Some of them are based in the US where they had migrated from Malaysia and Indonesia over 10 years ago. They do not have any retail experience.The Investors had been looking for a well-managed and profitable company with listing potential to buy into. EMAS fit those requirements.
For the LBO, the Investors acquired a Malaysia-incorporated shell company ("Hope"), which was used to buy over the assets, liabilities, business undertakings and the "EMAS" trademark leaving the post-acquisition EMAS as a cash shell with the vendor. The acquisition was financed partly by equity and bank loans to Hope. Hope is also intended to be the IPO listing vehicle.

3. Financing the LBO

            Hope was incorporated in mid-1999 to buy EMAS’s existing assets, liabilities and business at 10.5 times prospective PER i.e. equivalent to 2 times book value, subject to a minimum of RM52m and a maximum of RM63m. The RM52 million was paid at the date of sale, while the remainder if any would depend on Hope’s earnings performance in the first two years. The vendors have an option to subscribe up to 20% of Hope’s issued shares prior to IPO at an 8% discount from the IPO price.
                The leveraged buyout was financed primarily by bank borrowings (RM42m senior debt at Libor + 2%) provided by a prominent Malaysian bank) and partly by equity (RM10.25m).

4. Changes Following the LBO

           Post-LBO changes have been minimised. The Investors rely on EMAS's operational management, and had acquired EMAS's business on the condition that EMAS's management would remain in place. Hence, there has been no change in operational management.
To retain and motivate them, key management staff are provided with share ownership opportunities under the LBO arrangements. The Investors intend to extend share ownership opportunities to all staff so as to inculcate a dynamic and team culture.

The US-based Investors have also mentioned that there were some retail ideas that they could introduce to Hope, and one of their ideas was to introduce an extended 3-year warranty to their goods.

Hope has also started a web site to retail its goods electronically. However, the   investment into e-commerce has not swung into full gear yet. The company intends to expand into geographical areas where they are currently under-represented, starting from the Klang Valley to the rest of peninsular Malaysia. Since the LBO, the 6th retail outlet has been opened, and the launch of another outlet is planned. The emphasis is on brick-and-mortar expansion initially to achieve greater economies of scale.
           For this expansion, the company needs approximately RM6 million. The Investors are not willing to provide additional capital themselves; instead they aim to raise funds through an IPO. Although the company’s financials may not yet be strong enough to meet the requirements of the Kuala Lumpur Stock Exchange, such as having positive net tangible assets, the Investors have stated their intention to launch the IPO before the end of the year. They aim to issue at a price of approximately 15 times earnings and to retain at least 51% of the shares. They would like to get the interest costs down in order to improve earnings and hence get a better price for the shares. Some of the proceeds of the IPO will be used to reduce Hope’s senior debt to more acceptable levels. 
  • How much debt should this kind of company have?
  • What will it take to ready the company for a public offering? 
  • How will the debt be brought down level if the IPO is delayed or cancelled? 
  • How is LBO debt usually repaid or refinanced? 
    The company may require additional funding prior to its IPO. The Investors have been considering a convertible note, or finding an equity investor – a financial investor, a venture capital fund or a strategic partner – to take up to 20% of the post-IPO equity value. What form of funding, and at what terms, would you recommend?
Prepared by Ian H. Giddy with the assistance of Lynn Goh.

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