LBO additional notes Flashcards
(16 cards)
Walk me through an LBO model
- Make some assumptions on the deal, purchase price, debt-to-equity ratio, and interest rate.
- Define the sources and uses capital for the deal. Where is the money coming from and where is it going.
- Adjust the company balance sheet to account for Goodwill, additional debt, and any changes in equity
- Project out the company’s 3 financial statements over time.
- Project the exits / exit multiples
Why use leverage to buy a company?
Leverage amplifies the return or losses. The debt levels need to be supported by the cash levels. It preserves your cash balance to go out and do other deals.
What variables impact an LBO model the most?
The purchase and exit multiples are very important. Leverage – the more leverage amplifies the results of the deal. Operational factors – revenue growth, margin growth.
How to choose LBO purchase and exit multiples?
We look at the market, it will tell you what it’s willing to accept. We look at comparable companies and precedent transactions.
What are ideal LBO candidates?
- Stable cash flows (signifies a low-risk business)
- Opportunity to cut expenses (increase margins – higher multiple when you exit the deal)
- Business does not need much capital expenditure investments
- Great management team
- Group of assets that can be used as collateral for new debt.
Give an example of a real-life LBO (analogy)
Buying a home is very similar to an LBO, we put up some equity and the bank underwrites the remaining debt. You can sell the house when the value goes up, pay off the loan and keep the additional gain on selling the house.
Explain how the balance sheet is adjusted in an LBO model
Assets – Cash increases, goodwill and other intangibles will increase if PE firm pays over book value.
Liabilities – Debt increases (the leverage)
Shareholders equity adjusts for how much is put into the deal.
Debt vs Cash when Acquired by PE vs Strategic
PE firms – the entire business model is buying and selling companies
Strategics – regular businesses incorporating this business into their operations
Depends on the holding period of the business. PE hold companies shorter so they are not concerned about Debt. They want to make sure the cash flow covers the debt payments.
Strategic companies will own a company indefinitely, they will use less debt.
Do you need to project all three statements in an LBO model?
We technically don’t need to project all statements. We need the income statement and the CFS. A balance sheet is not needed, just need to keep track of debt.
How many tranches of debt in an LBO?
Tranche – specific debt contract
Look at comparable companies to determine the tranches. Tranches are all about the structure of the debt.
What are reasonable leverage ratios?
5 – 10x EBITDA is generally very high
The ratio is unique to the company, industry, and market conditions
Bank Debt vs. High-yield debt
Bank debt will typically have lower interest rates, that are also floating. Maintenance covenants – bank protects themselves legally.
High yield – interest rates are fixed. An incurrence covenant exists.
Why do an LBO in a risky Industry?
Riskiness is balanced out by the expertise of the PE firm and the desire to be in that industry. Some PE firms focus on turnarounds. The firm is helping the company that is struggling, or on the verge of bankruptcy. PE firms might focus on divestitures, you are selling a part of a company.
Five ways to increase LBO returns
- Lower the purchase price of the deal
- Increase the sales price of the exit
- Use more leverage
- Have a higher growth rate
- Higher margins
What is a dividend recapitalization?
PE firm performs an LBO. It then uses the company to borrow money and then pay itself a dividend. It increases the leverage on the company.
How would a dividend recap impact the financial statements?
No change in the cash flow statement, borrowed money comes in and then gets paid out.
