LBO Flashcards
What is an LBO
LBO model estimates implied returns from the buyout of a company in which a significant portion of purchase price is funded with debt capital
After a buyout, the firm operates the company and uses the FCF to pay down debt each year
What are the 5 data points to determine in an LBO model
Entry valuation, so pre LBO entry equity and enterprise value
Default risk through credit ratios
FCF, cumulative debt paydown and net debt in exit years
Exit valuation EV MV
And LBO return metrics, IRR and MoM
What are the 5 steps of an LBO
- Entry valuation, estimate implied purchase price
- Compute capital required and sources of funding
- Financial forecast, project post LBO financials and debt schedule
- Exit valuation and returns, approximate the exit equity valuation and IRR MoM
- Sensitivity analysis, assess the impact of the key LBO return drivers
LBO Entry valuation
To calculate enterprise value, entry multiple is multiplied by either the last 12 months (LTM) EBITDA
Entry Valuation = Purchase EBITDA x Entry Multiple
Make assumptions about purchase price, debt to equity ratio, interest rate on debt. Might also assume something about the operations and their respective growth (revenue or mar)
Required capital and schedule
Lower the required upfront equity contribution, the higher the returns.
Compute sources (how we fund) and uses (amount of capital required) to show how you finance the transaction and what you use the capital for. This also shows how much investor equity is required.
Adjust companys balance sheet respectively.
Financial forecast and debt schedule
For LBO model a complete 3 statement model is required to properly impact the income statement and cash flow statement. This is projecting BS, IS, CFS.
The debt schedule is going to track revolver drawdown (pay down), mandatory amortiyation, optional prepayments and computation of interest expense
Determine the amount of debt paid down in each period based on available cash flow.
LBO exit valuation and return schedule (IRR and MOIC)
Exit EV/EBIDTA, conservative assumption is to set the exit multiple equal to purchase multiple and get EV.
Remaining net debt on BS at presumed exit date can be deducted for exit equity value
Sensitivity analysis
We must consider different cases, base, upside and downside. How different assumptions may impact implied returns for the LBO model.
Why leverage when buying a company
This boosts return. Any debt is not your money .
Other capital is also available to purchase other companies.
What impacts LBO the most
Purchase and exit multiples have biggest impact on return of the model
Then leverage amount
Operational characteristics (revenue growth, EBIDTA margins)
How do you pick a multiple
The same way you do it anywhere else: you look at what comparable companies are trading at, and what multiples similar LBO transactions have had. As always, you also show a range of purchase and exit multiples using sensitivity tables.
What is an ideal candidate for an LBO
Stable and predctable cash flows,
opportunity for expense reduction to boost margins,
strong management team,
base of assets to use as collateral
How to you use an LBO to value a companu
You use it by set a target IRR and then back solve the excel to determine what purchase price the PE firm could pay to achieve that IRR
Why do we sometimes sat LBO sets floor valuation
A PE firm will always pay less for a firm than a strategic acquirer would, based on interest
Real life LBO
A mortgage on your house
Downpayment is your investor equity
Mortgage is the debt
Mortgage interest payments is debt interest
Mortgage repazments is debt principal repazments
Selling the house if youtr exit
How is BS adjusted in an LBO
You need to add new debt, basically wipe out SHE and replace by however much equity the PE firm is contributing
Cahs is adjusted for any cash used to finance the transaction
Goodwill and other intangibles are used as a plug to balance the BS
Why are goodwill and other intangible assets created in an LBO
They represent the premium paid to the fair maket value of the company and act as a plug to ensure BS balances.
Why does a strategic acquirer pay in cash and a PE firm w leverage
These are different scenarios
The PE firm doesnt intend on holding the company in the LR but wants to exit so its less concerned with the expense of cash vs debt and more concerned about useing leverage to boost returns by reducing the amount of capital iit has to contribute upfront
In an LBO debt is owne by the company so they assume much of the risk, the strategic advisor buys thed ebt
Do you need to project all 3 financial statements
No, you can estimate changes in NWC and therefore BS is not strictly required
You do however need IS to tack how debt balances change and CFS to show how much cash is available to service debt
How to determine how much debt and what tranches can be raised
Ideally using comparable LBOs
What are reasonable coverage ratios
Reasonable coverage ratios will indicate how much debt a company can take on and on what terms
Coverage atios are cmpany and inudrty dependent. Check comparable LBO transactions and make debt comps showing types, tranches, and terms of debt for similarly sized companies and in the industry
Rules
Never lever more than 50x EBIDTA, rarely exceed 5 10 x EBITDA
Bank vs high yield debt
High yield debt tends to have higher interest rates, hence the name. These are usually fixed (bank is LIBOR) and they have incurrence covenants
Bank vs high yield debt
High yield debt tends to have higher interest rates, hence the name. These are usually fixed (bank is LIBOR) and they have incurrence covenants preventing the company from doing somethign like selling an asset while bank debt has maintenance covenants requiring minimum financial performance like debt to ebidta ratio levels.
Why use bank debt
If you want low cost option
Also use bank debts if you plan for selling off or expanding or capital expenditures and you dont want to be restricted bz incurrence covenants
Why use high yield
If the company wants to refinance at some points and are not too sensitive to itnerest payments
Also if you want to expand or sell assets
Why LBO a risky industry like tech
If they have stable cash flows or if you specialize in
Consolidation, turnarounds or divestitures
How to boost return in LBO
Lower purchasing price
Raise exit multiple
Increase leverage
Increase growth rate (organic or inorganic through Acquisition)
Increase margin (by reducing expenses)
Hard to implement
LBO tax shield
Interest paid on debt is tax deductible so you save money on taxes and terefore increase CF as a result of having debt from the LBO
CF is still lower than if you didnt have debt since interest expense still reduces net income over what it would a debt free company
What is dividend recapitalisation
In a dividend recap, the company takes on new debt solely to repay a special dividend out to the PE firm that bought it
This boosts returns as more leverage is higher returns. PE firm also recovers some of its equity investment.
