Lecture 5 Deal-level Value Creation Flashcards
What are the three categories of value drivers in PE transactions
- Operative and strategic
- Corporate governance
- Financial
Which aspects pertain to operative and strategic value drivers?
- operative support/ restructuring
- strategic orientation
Which aspects pertain to corporate governance value drivers?
- reduction of agency costs
- mentoring
Which aspects pertain to financial value drivers?
- financial arbitrage
- financial engineering (no value creation but shift; e.g. tax deductibility of debt)
Value transfer hypothesis
No creation of value within a buyout transaction but rather a value transfer in favor of the private equity company
employees, state, debt providers are negative affected
-> no clear empirical support
Value creation hypothesis
There is a creation of value within a buyout transaction due to improvement within the portfolio company.
e.g., reduction of agency cost, disciplining function of debt, and better monitoring
-> majority of studies confirm this hypothesis as transactions increase profitability and productivity (often value is increased by a mixture of value transfer and value creation)
What can total value creation be decomposed into?
- EBITDA growth
- Free cash flow (FCF) effect
- Mulitple effect
How can EBITDA growth be measured?
- EBITDA at entry compared to EBITDA at exit
Which of the value creation factors are operational?
EBITDA growth and FCF effect. The multiple effect is not operational
What is the free cash flow effect?
- cash flows generated during the holding period
- free cash flow is used for paying down debt or paying dividends (rather reinvestments)
- illustrates the de-leverage effect
Leverage effect
The return expectations of the owners of a levered company consist of two components (a) operative risk (b) financial risk.
If the company is financed only by equity, then only the operative risk remains.
higher gearing keeping all other variables constant, increase the return on equity but also the default risk
By which means can EBITDA grow?
Either by sales growth or EBITDA margin increase (cost reduction). Sales and EBITDA can also be increased through acquisitions
How is the contribution of EBITDA growth in the value creation model being calculated?
By multiplying the change in EBITDA between entry and exit with the EBITDA multiple at entry.
What is the FCF effect influenced by?
- EBITDA growth
- working capital effects
- investments
- tax and interest payments
Is de-leveraging a value driver in PE?
No The generation of the required CF to do so is the actual value driver.
