LBO Flashcards
Walk me thru LBO
- make transaction assumptions based on the purchase price
- develop a sources & uses table to determine different types of debt use, mgmt rollover, and sponsor equity
- project financial statements, determine how FCF can pay the debt
- project how much target can be sold for, subtract remaining debt
- make exit assumptions to calculate MOIC and IRR
What are the two types of returns on an LBO? What do they mean, which one’s better?
MOIC: exit equity value/ entrance equity value
IRR: effective compound rate
IRR is time dependent, whereas MOIC isn’t
How can PEs recognize returns from an LBO?
- IPO
- Sale to strategic
- Dividend recap
Raise new debt, use the cash to issue divs
Why do PEs use leverage?
Leverage amplifies returns
The interest expense and debt repayment are fixed
If the company does well, MOIC will be high
If it does poorly, the high debt payments will make things worse
Characteristics of a good LBO candidate
- attractive purchase price
- stable cash flow
- low capex
- be in a fast growing industry
- hard assets to collateralize debt against
What are some ways that a PE firm can reduce entrance equity?
- negotiate for a lower price
- increase leverage
- management rollover
3 drivers of return in an LBO
- multiple expansion
selling when the market is doing well - leverage
- organic ebitda growth
cut costs with diversitures and layoffs
organically increase revenue
How do you pick purchase and exit multiples in an LBO?
Just like in a DCF. Look for comps and precedents, do sensitivity tables
How does a LBO floor valuation method work?
- assume an exit multiple and an exit ebitda
- use the desired IRR to calculate entry equity
- add debt and subtract cash to find entrance EV
How is the balance sheet adjusted in an LBO model?
- new debt is added on to liabilities
- SE is wiped out, replaced by however much equity the sponsor is contributing
- cash is adjusted according to however has been spent
Why are goodwill and other intangibles created in an LBO?
Goodwill represents a premium to the FMV
but usually they’re just used to make the BS balance
Why do sponsors prefer to use debt in an LBO?
- leverage
- they don’t actually own the debt, the holding company does.
With a strategic, the buyer owns the debt
How do you determine the amount of debt that can be raised?
Look at comparable LBOs (same industry, size) and find reference points for the amount and tranches of debt
What are some leverage and coverage ratios?
Leverage ratios: can’t legally go above 6x EBITDA
Interest rate coverage ratio: EBIT/interest expense
Debt to equity: D/E
Debt to EBITDA
What’s the difference between bank debt and HY debt?
HY debt: fixed interest rates, have incurrent covenants, bullet maturity
Bank: LIBOR/FFR + spread, maintenance covenants, usually amortized
What’s a dividend recap?
The company takes on new debt to pay a dividend to the PE firm to boost returns.
When the company has good cash flow or when it’s hard to exit
What is LBO circularity?
interest expense depends on debt balances
cash available for debt repayment depends on interest expenses
lower debt repayment -> higher interest payment -> less cash -> less debt repayment
use Excel circular calculation to find the stable values
What’s the rule of 72?
years to double = 72/ int rate
Give me 4 sources and uses of funds
sources:
1. sponsor equity
2. mgmt rollover
3. debt
4. excess cash
uses:
1. buying out the owners
2. refinancing debt
3. transaction fees
4. putting cash on the balance sheet
