LBO Flashcards
***What are the 3 LBO levers to drive value creation during holding period?
1) EBITDA growth
- increasing cash flow by increasing revenues, reducing costs, or making accretive acquisitions
- Impacts (1) EXIT equity value and (2) FCF
2) Raising / paying down debt
- ability to pay down debt using consistent cash flows and reducing capital expenditures
- (1) increases EXIT equity value and (2) enhances returns for PE investor
3) Multiple expansion
- purchase multiple vs exit multiple
- typically purchase price / EBITDA
- increases EXIT equity value
e. g., tech investments tend to have a lot of multiple expansion over time –> since entry multiples are so high to begin with, LBO models have sometimes outrageous assumptions on growth/add-on acquisitions, exit multiple etc.
Enterprise value formula
EV = equity value + debt / debt-like instruments - cash / cash equivalents
= Equity Value + [Debt + Preferred Stock + Convertible Debt + Minority Interest + Capitalized Leases - Equity Investments in JVs] - Cash
> capital lease operates similarly to debt (represents a future financial obligation)
In other words, Purchase Equity Value = Purchase EV - Net Debt
Fully diluted shares outstanding (FDSO)
Equals common shares + net shares from anything that can convert to stock
e. g., restricted stock units, warrants, options
- RSUs are similar to shares (can be converted to stock, given to management)
> calculate FDSO using treasury stock method (minimizes dilution to the company by assuming that the company uses proceeds from exercise to buy back shares)
Treasury stock method
Used to compute the minimum dilution to the company
FOR EACH option tranche or warrant type:
1) Proceeds = exercise price per option * # of options outstanding that are IN the MONEY
2) # of shares created (might be 1:1)
3) # of shares purchased = proceeds / acquisition share price
4) Net shares = # of shares created - # of shares purchased
Rule of 72
Used to approximate HOW LONG it will take for an investment to DOUBLE if growing at a fixed compound growth rate (MoM = 2x)
Or
Used to approximate IRR, given how long it takes an investment to DOUBLE (MoM = 2x)
Formula: 72 / # of time periods = IRR (already in percentage)
e.g., If an investment takes 5 years to double, IRR is 72/5 = ~14 percent
RECALL: IRR is the SAME THING as the investment’s CAGR = annual return of an investment
Rule 114
Used to approximate HOW LONG it will take for an investment to TRIPLE if growing at a fixed compound growth rate (MoM = 3x)
Or
Used to approximate IRR given how long it takes an investment to TRIPLE (MoM = 3x)
Formula: 114 / # of time periods = IRR
Rule of 144
Double the rule of 72
Used to approximate HOW LONG it will take for an investment to QUADRUPLE if growing at a fixed compound growth rate (MoM = 4x)
Or
Used to approximate IRR given how long it takes an investment to QUADRUPLE (MoM = 4x)
Formula: 144 / # of time periods = IRR
What is the benefit of amortization of fees (e.g., OID, debt or equity financing fees)?
Amortization increases expenses (e.g., interest), which reduces future tax burden
- BUT NOT ALLOWED TO AMORTIZE ONE-TIME EXPENSES like legal fees
- Can only amortize items with a FINITE LIFE e.g., capitalized financing fees, intangible assets other than goodwill
How to calculate A/R, inventory and A/P?
Use days metrics
A/R = Revenue * (Days AR / 365) Inventory = COGS * (Days Inventory / 365) A/P = COGS * (Days AP / 365)
How do you calculate prepaid expenses or accured liabilities?
Typically a % of revenue
How do you calculate PPE?
Ending PPE = Starting PPE + CapEx - D&A
What are the two most common return metrics?
1) Internal rate of return (IRR)
- an investment’s CAGR
- annual return on an investment
- Most PE firms target ~20% IRR (vs stock market, 8-10% p.a. returns) –> higher in private markets because of risk associated with using debt
2) Multiple OF Money (MoM)
- “cash return”, expressed as a multiple
= Total proceeds / Total investments
= (Exit equity investment + dividends) / Initial equity investment
(Remember: Firm is buying Equity VALUE, but not paying 100% of it with cash, and there’s TRANSACTION fees, so might not equal equity INVESTMENT)
> If you buy 100% of the business, you get 100% of the ending equity value too
Otherwise, if management rolls over equity, you get % ownership * ending equity value
Relationship between MoM and IRR:
(1 + IRR)^t = MoM
IRR = (MoM)^(1/t) - 1
**What are the key LBO steps?
1) List out and calculate key transaction assumptions
- Tax rate, interest rate, initial leverage (Initial debt is a multiple of leverageable EBITDA), entry EBITDA, holding period
- EV and equity value (if public company, start with equity value; if private company, start with EV)
- Purchase price of company
2) List out Sources and Uses of capital
- Key sources: Debt (Bank Debt, Senior Notes, Bonds), Equity investment - Common Stock, Preferred Stock, Options
- Key uses: Purchase equity, Refinance debt (assume net debt = debt on B/S - cash on B/s), Cash Sent to B/S, Original Issue Discount (debt fee, amortized), Underwriting Fees (amortized), Transaction Expenses (one-time, not amortized)
- Total Sources = Total Uses (equity contribution might be a plug)
**Purchase equity value + refinance net debt = Purchase Enterprise Value (check)
3) Forecast financials to calculate Total FCF available to pay down debt (3-statement model)
- Year 0 figures are useful for determining initial debt
- Start calculating Year 1, and typically one year following exit year (forward looking multiple for entry and exit EBITDA)
- Leave interest expense in IS alone (circular reference, depends on AVERAGE DEBT in that year)
4) Lay out Debt Schedule (average debt balance each year, interest rate, total cash interest expense)
- In paper LBO, we use simple assumption that FCF is used to paydown debt UPON EXIT (so we have constant annual interest expense, and need to use cumulative levered FCF)
5) Closing Balance Sheet adjustments
6) Calculate Total FCF available to paydown, then calculate returns (MoM and IRR)
Why do you subtract cash from EV calculation?
Because “buying cash” is REDUNDANT, so we care about NET DEBT (debt - cash)
> all available cash will be used in transaction
What does Minority Interest mean?
Minority Interest or Non-controlling interest refers to the % of a subsidiary that the parent company does NOT own
e.g., parent company owns 51% of subsidiary; the remaining 49% would go into the minority interest line
Why do we include in EV calculation?
- to ensure apples to apples comparison
- net income figures include 100% of the parent, but balance sheet includes only 51% of line items
What is an Original Issue Discount (OID)?
- OID is used to sweeten the deal of debt
- occurs when debt is issued BELOW PAR (so issuer receives par less discount)
- considered a type of Debt Fee that can be amortized (non-cash)
- shows up right after interest expense on the I/S
What are underwriting fees?
Fees charged by investment banks for assistance in debt or equity financing
- typically charged as a % of debt
- can be amortized over time
- treated like interest expense, but considered non-cash
- Shows up right after cash interest expense on I/S (e.g., “Amortization of Financing Fees”)
> together, they are Interest Expense (financing fees are associated with raising of debt, so properties are more similar to interest vs intangibles) - Must add back to calculate Levered FCF (right after Plus D&A)
What is an attach rate? How does it differ from a take rate?
Attach rate (%) is similar to penetration, typically for the sale of secondary product/service as a result of a primary sale
e.g., attach rate of e-payment processing = # people who integrate e-payments with CMS vendor / total # of people with CMS
Take rate (%) is a pricing term, typically for NET bps
What are the core components of a revenue build / subscriber build?
1) YoY growth (represent NET growth)
2) Gross adds (new customers), typically % of beginning of period customers
3) Attribution / churned customers, typically % of beginning of period customers
How do you calculate free cash flow for LBO analysis? Do you use Unlevered Free Cash Flow or Levered Free Cash Flow?
Total FCF available for debt paydown = Net Income + D&A - Capex - Increases in NWC
= (EBITDA - net interest expense - cash taxes) - Capex - Increases in NWC (assuming no principal repayments yet)
= Free Cash Flow to Equity (FCFE)
= Levered Free Cash Flow (need to deduct any mandatory repayments)
(Different from Unlevered Free Cash Flow, which is used in DCFs to value a company)
UFCF = EBIT*(1 - T) + D&A - Capex - Increase in NWC
> LFCF takes out after-tax interest
What are cash taxes?
Taxes calculated AFTER you deduct both interest, PIK interest, D&A (both of these expenses are TAX DEDUCTIBLE)
List all the relevant working capital accounts?
Current assets:
- Accounts receivable
- Inventory
- Prepaid expenses
Current liabilities:
- Accounts payable
- Accrued liabilities
What is the order in which debt tranches need to be paid?
Order of seniority:
1) Revolver (revolving line of credit; this is analogous to your credit card)
> drawn down when the company needs more cash than it is generating (Negative FCF = borrowing from revolver)
> it is NOT a source of capital (just used if needed)
2) Term Loan A, B etc. (Bank Debt)
3) (Senior) Bones / Notes
What does the debt schedule do in LBO?
For every debt instrument, what do you need you calculate? (rows in excel)
Debt schedule is used to determine
1) AMOUNT OF DEBT (beginning, ending balance, average balance)
2) Interest rate
3) Cash interest expense
4) Debt paydown
> there are structural restrictions on how much debt can be paid down each year (mandatory payments, voluntary payments in certain order - limited by amount of FCF available and need to maintain minimum cash balance)
> For Revolver: pay attention to maximum capacity vs available capacity
> Cash Flow Sweep assumption - we want to use ALL AVAILBLE FCF to pay down debt
———————————————————–
For every debt instrument, determine:
Beginning balance \+ PIK Interest \+ Recap Debt / Additional Allocation \+ (Revolver only: Optional borrowing) - Mandatory repayment - Voluntary repayment = Ending balance
Interest rate (some mix of floor % + Libor) > if there's no floor, use 0%
Interest expense (interest rate * average debt balance)
What is PIK interest?
What is the IRR for the PIK debt investor?
Refers to “Payment in Kind” interest, or NON-CASH interest that accrues to the balance of debt
Basically you are paying interest WITH additional debt (vs cash)
> don’t paydown balance until the end
PIK interest (in any year) = % * beginning debt balance
Features
- typically carry higher interest rate due to higher risk of default
- popular among companies that cannot afford cash payouts (e.g., growth companies, earlier stage companies)
- is subject to compounding
- for the investor (recipient of PIK interest), it is considered taxable income (lender has increasing taxes)
FORMAT in debt schedule: Cash available for PIK debt paydown Beginning balance Plus: PIK Interest (instead of optional borrowing / (repayment)) Ending balance
** Cash available for senior notes paydown etc. should NOT increase by PIK interest each year (because it is NON-CASH, so just set equal to last cash flow)
IRR should approximately equal PIK interest rate (not exact because of compounding)
What does Recap Debt mean?
Refers to the option in certain debt tranches to RAISE ADDITIONAL DEBT
Debt schedule excel logic:
Available capacity (revolver)
Optional borrowing/(repayment) (revolver)
Repayment
Interest rate
Revolver specific line items: Available capacity (to borrow) = Maximum capacity - Beginning balance
Optional borrowing/(repayment)
> borrow more IF FCF available is less than beginning balance of revolver, up to available capacity
> FCF can be positive (repay) or negative (borrow)
= MIN( Available capacity, -MIN(FCF, beg. balance))
+ = borrow
- = repayment
Other debt:
Repayment (inside formula for revolver)
= -MIN(FCF, beg. balance)
Interest rate = MAX(LIBOR, Interest rate Floor) + XX bps
> typically expressed as “L + XX” (e.g., L + 400 to represent 4%)
What must you remember when using the =XIRR formula?
Must convert dates into Custom Date format
Make sure range of cash flows matches range of timing
First cash flow must be negative (investment)
=XIRR formula is helpful when investor is receiving multiple cash inflows (e.g., annual dividends)
What are the pros and cons of paying out an annual dividend?
Pros:
- Can de-risk the investment because you receive $ earlier
- increases IRR
Cons:
- Opportunity cost - better use of cash via investing in NPV positive projects
- Will typically decrease MoM slightly because of dividend fees and interest paid on any new debt
Returns table memorization
- 0x MoM =
- 0x MoM =
2.0x MoM (Rule of 72)
= 40% over 2 years (72/2 = ~40)
= 25% over 3 years (72/3 = 25)
= 15% over 5 years (72/5 = ~15)
3.0x MoM (Rule of 114)
= 20% over 6 years (114/6 = ~20)
Paper LBO sections
Assumptions
- Interest rate
- D&A expense as % of revenue
- Tax rate
Entry
- Entry EBITDA
- Entry multiple
- Entry (Purchase Enterprise Value)
- Initial leverage
- Initial Net debt
- Initial cash
- Initial equity value
Financial forecast Net income Plus: D&A Less: CapEx and Cap. Software costs Less: (Increase) / Decrease in NWC Cash flow Cumulative cash flow for debt paydown
Exit
- Exit EBITDA
- Exit multiple
- Exit EV
- Ending net debt
- Cash to B/S
- Ending equity value
When to use EV vs equity value in LBO calculations?
EV is used when talking about MULTIPLES
Equity value (investment) is used when calculating RETURNS (MoM or IRR)
What does it mean when “management has been awarded options” in the form of % of equity?
It means that investors will need a higher equity value AND valuation (EV) in order to generate the same return
Implied total equity value = Required equity value to investor / (1 - mgmt. ownership %)
Assume that management is awarded options UPON EXIT (does not affect entry equity value)
How do you calculate Prepaid Expenses and Accrued Liabilities?
% of metric
Prepaid Expenses = % of revenue
Accrued Liabilities = % of revenue
Closing balance sheet adjustments - which key balance sheet accounts are affected by M&A and will have an adjusted Pro Forma balance sheet?
Concept: Closing Balance sheet is done BEFORE we track balance sheet account balances over time
> Pro Forma = Immediately after the transaction (still year 0)
Assets: Dr +, Cr -
> Cash (Cr- cash balance to use cash to buy business, Dr+ minimum cash)
> no change to PPE yet
> Goodwill (cr- existing goodwill, dr+ pro forma goodwill)
> Intangible assets (dr+ write up of intangible assets)
**all working capital accounts and PPE will be the same (not impacted by purchase)
Liabilities: Dr -, Cr +
> Existing debt (Dr- to wipe out)
> New debt instruments (Cr+ to add in balance from sources)
> ** Capitalized financing fees (** Dr- balance)
> Deferred tax liability (*Cr + balance)
Equity:
> Shareholder equity (Dr- wipes out old equity account, - debt transaction expenses; Cr+ purchase equity INVESTMENT)
** anything that is AMORTIZED needs to be on the Balance Sheet (recall the OID just becomes a financing fee)
Is purchase price supposed to be equity or enterprise value?
Enterprise value (true cost of the business)
But for returns analysis, PE firms care about equity value (equity investment)
In some cases, you will see Purchased Equity or Purchase Price of Equity
What is “Step-up of equity”?
Refers to how much we are WRITING UP (above book value of equity) the entire business
> also referred to as “Allocable Purchase Premium”
Step-up of Equity = Purchase price of Equity - Book Value of Equity + Existing goodwill
Where:
> Purchase price of Equity = Purchase EV - Debt + Cash
> Book Value of Equity = Fair Value of Assets - Fair Value of Liabilities
> need to add existing goodwill, otherwise double counting
Step-up of equity is then ALLOCATED to goodwill, intangible assets write up, and deferred tax liability
> affects taxes paid in the future (i.e., increases amortization)
3 components:
Step-up of Equity = Goodwill portion + Intangible assets other than goodwill portion - deferred tax liability portion
What happens when you write up intangible assets other than goodwill?
Value of these intangible assets increases
The increase in value then is AMORTIZED overtime (shows up on IS as amortization, use annual amortized amount of write-up)
Total write-up of intangible assets = % of step-up of equity * step-up of equity
What is “deferred tax liability”?
DTL is created when we WRITE UP the value of intangible assets during M&A, which causes amortization expense to increase.
> GAAP taxes become lower than cash taxes - paid lower taxes than what is really owed
> But, higher amortization of intangibles are NOT deductible for cash tax purposes
> Creates a temporary difference due to timing = future cash taxes will exceed future book taxes, so we need to make things cash neutral by unwinding DTL
> We will need to PAY ADDITIONAL taxes to the government in the future
> So DTL affects TAX CASH FLOW CONTRIBUTION
DTL ($) = (Total write-up of intangible assets or PPE * tax rate %)
Annual DTL unwind = (increase in expenses * tax rate) / Life
Concurrently, we UNWIND DTL on the cash flow statement by DEDUCTING annual DTL (to make things cash neutral)
> shows up under Cash Flow from Operations (also a part of FCF calculation)
> On the IS, we paid less taxes = more cash
> On CF statement, we unwind annual DTL by increasing cash spent (outflow) = we pay for those taxes
“Less: Unwind of Deferred Tax Liability”
> Overall effect is neutral
DTL shows up on Balance Sheet under Liabilities, same with Capitalized Financing Fees
How do you calculate pro forma goodwill?
Pro forma Goodwill = Step-up Equity - Write-up of intangible assets - PPE Write-up + deferred tax liability (dr)
(First wipe out starting goodwill)
> Step-up Equity already takes into account the existing goodwill balance
What is the assumption for new debt instruments?
Typically a flat $ amount, or multiple of EBITDA (Leverageable EBITDA, typically historical)
What are capitalized financing fees?
Contra liability account with a DEBIT balance (negative balance on liabilities side)
Represents the FEES PAID TO ALL ADVISORS who help RAISE DEBT; gets amortized (annual amortized financing fee) and has a finite life
= $ debt raised * Fee % (dr)
Contrast capitalized financing fees with one-time “transaction” expenses (like legal, accounting consulting)
Pro forma cash
= Starting cash balance - starting cash (because we use it all, cr) + minimum cash balance needed on B/S (dr)
Pro forma intangible assets
= Starting intangible assets + write up as a % of step-up equity (dr)
Pro forma debt
Existing debt = Existing debt - existing debt (wipe out)
New debt (revolver, bank debt, PIK debt etc) = add in new debt (cr)
Pro forma DTL
Shows up on liability side of balance sheet with cr balance
How is leverage used to enhance returns?
Higher level of debt provides benefit of GREATER TAX SAVINGS realized due to DEDUCTIBILITY of a higher amount of interest expense (incremental interest tax savings)
Enhanced returns (higher IRR and MoM)
> FCF will be lower in situations where there is higher level of debt due to INCREMENTAL INTEREST EXPENSE associated with additional debt taken on (so less cash available for debt repayment)
Does purchase equity value need to equal equity investment (sources)?
No, especially for full Model Test
Purchase equity value is calculated in your entry valuation (model assumptions)
> Uses
Equity investment is on the Sources side, often a plug (MAX difference between Total Sources and Debt, 0)
o Initial equity value is calculated based on EV, initial debt and cash, while equity investment takes into account NEW debt raised
o PE firm is buying the initial equity value, but is not paying for 100% of it with cash (due to debt raised)
o Therefore, equity value DOES NOT NECESSARILY EQUAL equity investment
o Also, equity investment DOES NOT NECESSARILY EQUAL Equity value – debt because we have to pay for transaction FEES!
o Also, in returns analysis, if management has rollover equity, then Value to PE firm equals ending equity value * % ownership
What checks should you have in your model?
1) Does Total cumulative FCF = Change in Net Debt? (debt paydown)
> abs(SUM of FCF Available for Debt Paydown) = abs(Net Debt Ending Balance - Net Debt Beginning Balance)
> Make sure to adjust for PIK interest in each year because PIK interest is another driver that increases debt balance each year
> abs(SUM of FCF) = abs(Net Debt - Ending Balance) + abs(SUM of PIK interest)
2) Does balance sheet balance (Sources = Uses, Assets = L + E)
> Closing Balance sheet (A = L + E, also for each section Pre-txn + Debits + Credits = Pro Forma)
LBO Section: Financial forecast
Revenue
% growth
EBITDA
% margin
Less: D&A (% of revenue) EBIT Less: Interest expense (circ reference) Less: Amortization of financing fees (calculated in Debt schedule) EBT Less: Taxes (max formula) Net Income
Plus: D&A
Plus: Amortization of financing fees
Less: Capex (% of revenue)
Less: Increase in NWC (% of revenue)
Free cash flow (before debt paydown)
Less: Optional borrowing / (repayment) > SUM relevant lines in debt schedule
Cash Flow (Represents change in cash balance)
Operation Assumptions:
D&A as % revenue
Capex as % revenue
Increase in NWC as % revenue
LBO Section: Entry valuation
Within Transaction Drivers > Model Assumptions
Entry valuation: Entry EBITDA Entry Multiple Purchase Enterprise Value Less: Initial Debt Plus: Initial Cash Purchase Equity Value
Goal:
> Calculate Purchase Enterprise Value and Purchase Equity Value
LBO Section: Transaction
Within Transaction Drivers > Model Assumptions
Transaction: Exit Multiple Tax Rate Cash to B/S Transaction Expenses Rollover equity (if any) Implied ownership (if any)
Goal:
> Layout key assumptions related to model
> Depreciation, Capex assumptions show up within Financial Forecast section (Operating Assumptions)
> Interest rate assumption show up within Debt sub section
LBO Section: Debt
Within Transaction Drivers > Model Assumptions
Debt: Total Leverage (sum of below, multiple) Bank Debt (assumption) Senior Notes (assumption) etc. (But not revolver)
*To the right of the above, keep track of assumptions:
Floor, Rate, Fee (%), Fee ($)
Revolver Capacity (assumption) Leverageable EBITDA (Financial Forecast)
LBO Section: Sources and Uses
Within Transaction Drivers
Sources:
Bank Debt
Senior Notes
etc. (But not revolver)
Equity Investment (plug, use max formula)
Uses:
Purchase Equity Value (link)
Refinancing Net Debt (Initial Debt - Cash)
Cash to B/S (assumption)
Underwriting Fees (Sum of financing fees related to debt)
Transaction Expenses (assumption)
Check that Sources = Use
LBO Section: Debt schedule
Libor curve (for each year, put the Libor curve %)
Cash available for revolver paydown (link to FCF calculated)
Revolver:
Beginning balance (initial balance hardcoded to be $0)
Optional borrowing / (repayment) (formula)
Ending balance
Interest rate (Floor, Rate)
Interest expense (% * debt balance, likely using avg)
Maximum Capacity (link to assumptions) Available Capacity (Max - beg balance)
[If applicable] Cash available for PIK debt paydown: Beginning balance (link to Sources) Plus: PIK interest Ending balance Interest rate (Floor, Rate) Interest expense (% * beginning PIK debt balance)
Cash available for Bank Loan / Senior Notes etc.:
Bank Loan/Senior notes etc.: Beginning balance (link to Sources) (Repayment) (inside formula, using adj. FCF) Ending balance Interest rate Interest expense
Interest Calculation: Revolver PIK interest Bank Debt Senior Notes etc. Total interest expense Amortization of financing fees (Amount, Years, then straight division constant amount each year) Total interest expense + amortization
LBO: Circular reference modelling
We need to build in a circular reference (circ) toggle so that we can control the model
> Every line that has circularity needs a toggle
If Circ toggle is turned on, then we allow the circular reference to calculate cash interest expense / cash interest income
If Circl toggle is turned off, then we set cash interest expense to 0
Why?
> circular reference is created because FCF depends on cash interest expense, but cash interest expense depends on FCF
Formula:
=IF(circ cell = 0, 0, -cash interest cell)
***NEED To make sure that you turn on circularity in excel (“Enable Iterative Calculation to 100”) - ALT F T F
LBO: Balance sheet (Abridged version, no closing balance sheet)
Simple setup: Calculate Net Debt in each year, as well as multiples
> Helpful for calculating EV, Equity Value, and returns in each year
> Need to include Year 0
Assets:
Cash (Year 0 balance should equal Cash to B/S = NEW structure; Then every subsequent year = Previous Cash Balance + Cash Flow After All Debt Paydown)
Liabilities: Revolver (Ending balance, including Year 0) Bank Debt Senior Notes etc. Total Debt % of Initial Debt Total Net Debt
Total Debt / EBITDA (multiple)
Total Net Debt / EBITDA (multiple)
LBO: Returns analysis
***
Exit (for each year, calculate Ending EV and Ending Equity Value):
Ending EBITDA (*Might need to link NFY’s EBITDA!!)
Exit Multiple
Ending Enterprise Value
Less: Debt (Link to total ending debt balance from balance sheet in each year)
Plus: Cash (Link to Cash balance)
Ending Equity Value
> if PE firm does not own 100%, then multiply by % ownership to get “Value to PE firm”
Returns analysis: Year 1 Exit Value Year 2 Exit Value Year 3 Exit Value etc.
IRR
MoM
> Convert years to Time format type
Initial investment outlay is negative (link to Equity Investment in Sources)
Link to ending equity value calculated above
Format IRR and MoM rows with light grey and box outline
THEN PUT SUMMARY OF ACTUAL RETURNS (IRR and MoM in the Transaction Drivers section)
LBO: Closing B/S adjustments
xx
Minimum cash to B/S - how do you ensure that you don’t fall below this threshold?
When we model the revolver, whenever FCF is negative, recolver is there to allow us to draw money, so we never fall below the min. cash number
If we do, then we know the model is busted (aka. we exceeded the maximum capacity for the revolver)
Non-cash line items to add back to NI
- D&A
- Original Issue Discount (first deducted after cash interest)
- Amortization of financing fees (first deducted after cash interest)
- Amortization of Intangible Writeup (first deducted after D&A)
- PIK Interest (tax deductible)
**We also have to DEDUCT “unwind of deferred tax liability) before capex
What is rollever equity?
PE firm allows existing management to “roll” their existing stake or convert existing shares into new shares, representing a certain ownership % and value
e.g., allowing management to roll equity worth 40% of the business and $875M
Terminology: Multiple expansion vs ___
Multiple contraction (e.g., from 12x entry multiple to 10x)
Assume that you buy and sell the common equity of a company at the same entry and exit multiple. Assume that the EBITDA of the company grows at 10% annually, but that the company never generates any net cash flow. Do you think this is likely to be a profitable investment? If so, under what circumstances would this be an unprofitable investment?
Recall drivers of LBO returns:
xx
Mandatory amortization on debt - what does this mean?
Same thing as “Mandatory Repayment”
If the LBO test requires it, it will be a constant amount equal to “% of original debt balance”
What does “Drawn on Close” mean?
Refers to the amount of DEBT that is drawn / borrowed when the transaction closes
So for Revolver, typically won’t have a balance drawn, but still have maximum capacity
For other loans like term loans, amount drawn = beginning debt balance
Dealing with dividends
xxx
What is cash interest income?
Cash on balance sheet gains interest
Typically equal to % average cash balance
So need to do some calcs under Cash Interest Expense section:
Beginning Balance (first year will be min. cash to B/S)
Net Cash Flow
Ending Balance
Cash Interest Income
What is a “fixed LIBOR swap”?
Means that we force the LIBOR interest rate to always be a fixed amount (for hedging purposes)
Difference between LTM EBITDA and NTM EBITDA? If you have one, how do you estimate the other?
Difference is a period of 12 months
LTM EBITDA * (1 + EBITDA growth rate) = NTM EBITDA
Also: NTM EBITDA Multiple * (1 + EBITDA growth rate) = LTM EBITDA Multiple
(because LTM EBITDA Multiple = TEV/LTM EBITDA and TEV cancels out)
Running list of things to look out for when making LBO (qualitatively)
1) EBITDA margin (current % and growth)
2) Leverage: how quickly does the company pay down debt (could be a signal that they could borrow more)
