LBO Model Flashcards
1
Q
- Walk me through a LBO model
A
- LBO: an acquisition where a significant portion of the purchase price is financed through debt, and the remaining equity comes from the investor or private equity firm.
1. Make assumptions about: - purchase price
- debt/equity ratio
- interest rate on debt
- operational assumptions
2. Create sources & use section: - sources: how you finance the transaction
- uses: how the capital is used
- investor equity: The amount of money the investor or private equity firm contributes.
3. Adjust for the new Debt and Equity figures; add goodwill and other intangibles on the asset side
4. Project out the company’s B/S, I/S, and C/F; calculates how much debt is paid off each year based on available cash flow
5. Calculate: make assumptions about the exit of the company (usually using EBITDA multiple); the return on the investment is calculated based on the equity investors receive when they exit.
2
Q
- Why would you use leverage when buying a company?
A
To boost your return, and have more capitals to purchase other companies
3
Q
- What variables impact an LBO model the most?
A
- Purchase multiple & exit multiple
- Amount of levered debt
- Operational characteristics (EBITDA margins and Revenue Growth)
4
Q
- How do you pick purchase multiples and exit multiples in an LBO model?
A
- Look at comparable companies and precedent transactions; show range using sensitivity tables
- sometimes set the purchase and exit multiples based on IRR (internal rate of return) you are trying to achieve (higher IRR = low purchase & high exit multiples)
5
Q
- What is an “ideal” candidate for an LBO?
A
- Stable and predictable cash flows
- low-risk businesses
- not much need for long-term investments and CAPEX
- opportunity to cut expense & boost margins
- strong management team
6
Q
- 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?
A
Valuing a company with a LBO model: setting a targeted IRR and back-calculating the maximum purchase price that would achieve that return. The resulting purchase price is the “floor valuation” because PE firms almost always pay less than strategic acquires do.
7
Q
- Give an example of a “real-life” LBO.
A
Taking a mortgage to buy a house.
- Downpayment = Investor Equity in an LBO
- Mortgage = debt in LBO
- Mortgage interest payment = Debt Interest in an LBO
- Mortgage Repayments: Debt Principal Repayments in an LBO
- Selling the House: Selling the Company / Taking It Public in an LBO
8
Q
- Can you explain how the Balance Sheet is adjusted in an LBO model?
A
- Liabilities & Equity side is adjusted
- new debt is added on
- S/E is wiped out and replaced with investor equity - Asset:
- Cash is adjusted for the amount that is used to finance the transaction
- Goodwill and Other Intangibles are the “plug” to make up for the difference
9
Q
- Why are Goodwill & Other Intangibles created in an LBO?
A
THe premium to its fair market value; in LBO, act as a plug to make up for the difference between assets side and liabilities & s/e side
10
Q
- We saw that a strategic acquirer will usually prefer to pay for another company in cash – if that’s the case, why would a PE firm want to use debt in an LBO?
A
- If the PE wants to hold the firm in short term: reduces the amount of equity they need to contribute, thereby amplifying their returns
- The debt is placed on the target company’s balance sheet, limiting the PE firm’s risk.
11
Q
- Do you need to project all 3 statements in an LBO model? Are there any “shortcuts?
A
12
Q
- How would you determine how much debt can be raised in an LBO and how many tranches there would be?
A
Look at comparable LBOs, companies similar in:
- size
- industry
13
Q
- Let’s say we’re analyzing how much debt a company can take on, and what the terms of the debt should be. What are reasonable leverage and coverage ratios?
A
- look at the “debt” comps to figure out the types, tranches, and terms of debt comparable peer companies have used
- general rules: never lever a company at 50x EBITDA; usually 5-10x EBITDA
14
Q
What is the difference between bank debt and high-yield debt?
A
- high-yield debt: higher interest rates
- high-yield debt: usually fixed interest rates
- high-yield debt: incurrence covenants; bank debt: maintenance covenants. Incurrence covenants prevent you from doing something (e.g., selling assets; buying a factor), whereas maintenance covenants require you to maintain a minimum financial performance
- “You can’t issue more debt if your DEBT/EBITDA is over 6x
- “Your Debt/EBITDA ratio must always stay below 5x.”
- bank debt: usually amortized (principal paid off over time); high-yield debt: entire principal is due at the end
15
Q
- Why might you use bank debt rather than high-yield debt in an LBO?
A
- PE firm is concerned about meeting interest payment
- If they want major expansion/CAPEX and don’t want to be restricted by incurrence covenants
