Lecture 4 Flashcards
LBO
3 leverages than LBO uses
1) Financial Leverage
2) Tax Leverage
3) Managerial Leverage
Managerial Leverage
“Carrot and stick”, Carrot: mgmt. package (lot of money)
Stick: high leverage (bankrupcy risk)
Acquisition debt located?
HoldCo, PE fund can operate “debt pushdown” into OpCo; debt that foes to OpCO is most senior (will be repaid first and is closest to operating assets)
Shareholders loan in LBO
Loan guranteed by shareholders; bears interest which
1) tax deductible, will be repaid before equity
2) incentivie for mgmt. (reudces their IRR if performance is not good) reduces return provided to mgmt. vs PE
HoldCo seperate from OpCo
Legal entitiy that will bear acquisition debt of the LBO, usually you benefit from tax integration and have additional expenses: mgmt. fees at HoldCo, interest on SHL
Condition for leverage to be positive for ROE? What is the downside?
CoD post tax < ROCE –> higher ROE means higher risk (i.e. higher volatility of CF as your fixed costs increase because of higher interest expenses and debt principal reimbursement)
2 (dis-)advantages of financial leverage
Advantages: 1) boosts return since value gains not shared eqully (IRR), 2) reduces taxes;
Disadvantage: 1) higher default risk, 2) higher volatility
Condition to benefit from tax consolidation (in France)
Subsidiary has to be owned by a min. of 95% by the parent
Why debt pushdown can be considered as an abuse?
Push down too much debt; OpCo bears the risk of acquisition debt (financial assistance rule) and you put in jeopardy all stakeholder of OpCo (especially problem if you have NCI at OpCo level)
Financial assistance rule can also apply if acquisition debt located at OpCo is sseking to get gurantees from the Operating assets of OpCo
5 key levers to create Shareholders value in LBOs?
- Deleveraging
- Enhance top line (vc)
- Operational Improvement (vc)
- tax advantages
- multiple expansion
inside these drivers the key driver is IMHO “mgmt. discipline”, incentives and coaching
Affect on purchase price
1 factor: availability of financing and therefore the level of ND/EBITDA reachable
- EV
- Assessment of Business Plan
- IRR
- cash generation capacity
Good LBO candidate
1) stable CF (mature)
2) good management
3) Top Line growth
4) Operational Improvements
5) Investment requirements
6) Exit
7) Purchase Price
8) suitable for buy and build strategy
LP vs. GP; how is return split?
Limited partners invest their money in a PE fund. Risk is limited to their investment and get return depending on selling price vs. purchase price
General Partners are managing the PE fund. Responsible for investing the money of the LPs. Paid through a mgmt. fee (flat) and a carried interest which is a return on the money they invest in the fund
“Classical” hurdle rate
IRR 15-25% (or. 2-2.5x Money Multiple)
Money Multiple
exit equity / entry equity (does not take into account the time value of money)
Used by PE when IRR is not good enough because of long holding period
Mgmt fees, carried interest
Mgmt. fees: 2%
Carried interest: 20% pf capital gain provided by the overall hurdle rate above 8%
Equity as % of EV
Before 2007 35%; post 2007 c.40.50% (banks became more cautious)
Current EBITDA multiples on LBO deals
c. 10x since post crisis level of 7.7x-8.9x (highest level before the crisis at 9.7x)
Leverage on LBOs
Current 5x; post crisis level 3.9-4.2x compared to 4.9-5,9x pre-crisis level)
LBO financing tranching
- Senior Debt / HYB (3-5x)
- 2nd Lien loans or unsecured notes (0.5-1.5x)
- Structurally Subordinated Debt w/ HYB and MezC. (0.5-1.5x)
Capex line? Vendor loan?
Capex line is undrawn facility made available to company under LBO that the company can draw in case they need cash for Capex
Vendor loan granted by selling shareholder. Usually PIK and junior (same level as SHL)
RCF (pricing, seniority, maturity and reimbursement)
Revolving Credit Facility: undrawn facility granted to a company (w/ max drawing amount) that can use for temporary cash needs (e.g. WC swings). Fee on the amount of RCF undrawn and available + interest on amount undrawn + usually an extra fee if company draw the FDC at more than 33%and 66%
- seniority pari passu with senior debt
- Pricing: E/L + 275-350bps
- Amortization: none
- Maturity: 3-7y
Term Loan (pricing, seniority, maturity and other significant elements)
- Seniorty: senior
- Pricing: TLA: E/L + 300-375bps, TLB/TLC: 300-450bps + margin ratchet
- Amortization: linear w/ 2y grace period (only for TLA)
- Maturity: TLA 6.5y, TLB 7y, TLC slightly longer
- Other: covenant lite (79%), TLA very rate
- In case more junior debt, TLA lenders will asked to be repaid before the junior debt holders in case the company decided to do volunatary repayments of debt
Second Line note (pricing, seniority, maturity and reimbursement profile, nb of turn of EBITDA)
- Pricing: 7.5% - 9.0%
- Seniority: second ranking once revolver and TL are repaid
- Maturity: 8y
- Reimbursement: no amortization
- Nb of turn of EBITDA: 0.5x- 1.5x
High Yield (pricing, seniority, maturity and reimbursement profile, nb of turn of EBITDA)
- Pricing: E/L + 5-9%
- Seniority: can be SSN or SubN
- Maturity: 7-8y
- Reimbursement: no amortization
- Nb of turn of EBITDA: 0.5x- 5x
Mezzanine (pricing, seniority, maturity and reimbursement profile, nb of turn of EBITDA)
- Pricing: E/L + 11% - 13%
- Seniority: Senior to SubN, junior to rest
- Maturity: 8-9y
- Reimbursement: bullet
- Nb of turn of EBITDA: 0.5x - 1.5x
HoldCo loan (pricing, seniority, maturity and reimbursement profile, nb of turn of EBITDA
- Pricing: 8.5%- 10.0%
- Seniority: Subordinated to any senior/junior debt located at OpCo
- Maturity: longest
- Reimbursement: bullet
- Nb of turn of EBITDA: 0.5x - 1.5x
PIK toggle characteristics: possibility to switch from PIK to cash payment at the company’s direction
Principle of Unitranche? Main advantage?
blend senior and mezzanine into a single tranche
Adv.: One set of investors (Simpler & faster)
4 main exit possible from an LBO
1) Secondary LBO
2) IPO (less than 100%, no controll)
3) Trade sale (control premium, realized syn.)
4) Leverage Recapitalization (secondary LBO with same shareholders)
