LBO

Question 1

Walk me through a basic LBO model.

Answer 1

1. Make assumptions about Purchase Price, Debt/Equity ratio, Interest Rate on Debt and other variables; consider revenue growth or margin assumptions if you can.
2. Create S&U section which determines how company is financed and how much investor cash is required.
3. Adjust company’s B/S for new debt and equity, as well as adding Goodwill & Other Intangibles to Assets to make it balance.
4. Project the company’s I/S, B/S and CF/S; determine how much debt is repaid each year, based on available CF and required interest payments.

Question 2

Why would you use leverage when buying a company?

Answer 2

To increase your returns:

1. Increases returns on your invested capital
2. Frees up capital for other investments

Question 3

What variables impact an LBO model the most?

Answer 3

1. Purchase and exit multiples
2. Leverage used
3. Operational stuff - revenue growth, EBITDA margins

Question 4

How do you pick purchase multiples and exit multiples in an LBO model?

Answer 4

Look at public company comps and LBO comps, then show a sensitivity range for these multiples.

May set purchase and exit multiples based on a target IRR, but this is just for valuation purposes

Question 5

What’s an ideal LBO candidate?

Answer 5

Businesses with:

• Stable and predictable cash flows
• Low-risk profiles
• Low reinvestment needs (capex, etc.)
• Opportunity to cut costs

Also nice to have:

• Strong management
• Assets to collateralize

Question 6

How do you use an LBO model to value a company, and why do we sometimes say that it sets the “floor valuation” for the company?

Answer 6

By setting a targeted IRR, then back-solving in Excel to determine what purchase price the sponsor could pay to achieve that IRR.

Floor b/c sponsors pay less than strategics.

Question 7

Give an example of a real-life LBO.

Answer 7

Taking out a mortgage to buy a house:

1. Down payment = investor equity
2. Mortgage = LBO debt
3. Mortgage Interest = LBO debt interest
4. Mortgage Repayments = principal repayments/amort
5. Selling the House = selling / IPO’ing company

Question 8

Can you explain how the B/S is adjusted in an LBO model?

Answer 8

1. L + E = add new debt, wipe out S/E and replace with new investment
2. Assets = cash is adjusted for any used to finance deal, then plug Goodwill to balance B/S

Question 9

Why are Goodwill & Other Intangibles created in an LBO?

Answer 9

Like an other acqs., to plug premium to FMV paid.

Question 10

If strategics like to pay in cash, why would sponsors want to use debt?

Answer 10

1. Not a long-term holder - doesn’t care about net interest expense effects of cash/debt. Wants to juice returns.
2. In an LBO, target assumes the debt risk but not the sponsor, whereas a strategic acquirer would assume.