We’re From Private Equity and We Aim to Underwhelm You

(Bloomberg Opinion) -- Europe's latest bid by a leveraged-buyout firm puts investors in a tricky spot. The 3.4 billion-euro ($3.8 billion) offer for German lighting group Osram Licht AG values the company's shares at less than what they were trading at as recently as March. Nevertheless, it would require real guts to turn down what Bain Capital and Carlyle Group LP are dangling.

Osram was already in a weak state when news about the potential bid emerged in November, pushing the stock as high as 41 euros. A profit warning in March – the company's sixth in little more than a year – dragged the shares down to 25 euros, and they would doubtless have sunk even lower had the takeover talks not been rumbling on. The 35 euros-a-share offer is some 39% above that low point, and 22% above the average price over the past three months.

At 3.8 billion euros including net debt, the mooted valuation is a generous nine times estimated Ebitda for 2020. Signify NV, a Dutch rival that was formerly part of Royal Philips NV, trades at just six times that metric.

These dynamics should focus the minds of Osram's supervisory and management boards as they weigh the offer. The share price would suffer badly if this deal failed. Moreover, the company would need a very convincing strategic plan to justify turning it down. Its current team will struggle to make the case for staying independent after presiding over the sharp decline in the stock since the start of 2018.

Osram has some funky technology and the rise of autonomous vehicles could be its savior. But, for now, it has become uncompetitive in markets that have themselves deteriorated. Ebitda this year is forecast to fall by 50%. Turning the company around will require greater focus, necessitating asset sales and job cuts to reduce costs. The financial performance has to get worse before it gets better – whoever is in charge.

In turn, that need for restructuring makes this a particularly risky buyout. A declining business in a cyclical industry is difficult to load up with debt. Financing for the transaction is thus likely to be mainly equity-based – hence the need for two buyout firms on what is otherwise a relatively small deal.

To make a mid-teens internal rate of return over five years requires doubling the equity value of an investment. With little benefit from leverage, that would mean having to grow the enterprise value by almost the same proportion.

It's hard to see what the business will look like in 2025. Bain will probably make its return by breaking up the company and selling it in chunks at varying profit multiples rather than offloading it in one jumbo exit.

The math might just work. Analysts reckon Osram in its current form could make about 760 million euros of Ebitda in 2023. If Bain can do a bit better than that and sell at a blended multiple similar to the one at which it is buying, it should be able to double its money and earn its return.

Could Osram do the same thing as a public company? Quite possibly. But maybe not with the current management – or shareholders.

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

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