leverage buyouts Flashcards
what is leverage buyouts?
A leveraged buyout (LBO) is the acquisition of a company in which the buyer puts up only a small amount of money and borrows the rest.
The appeal of an LBO
- Tax advantages associated with debt financing,
- Freedom from the scrutiny of being a public company or a captive division of a larger parent,免于审查
- The ability for founders to take advantage of a liquidity event without ceding operational influence
- The opportunity for managers to become owners of a significant percentage of a firm’s equity.
What Companies Make Good LBO Targets? the criteria of good LBO target
in financial:
1. historical profitability and the ability to maintain above average profit margins.
2.strong and predictable cash flow to service the financing cost to the acquisition.
3. readily separable assets or business which could be available for sales.
in business :
1. a strong management team
2. good reputation and strong market position.
3. low cost producer within an industry, create the competitive advantage
4. potential of real growth in the future
5. not subject to long term cyclical swing in profitability
6. products are not subject to rapid technological change.
Risk of LBO
LBO risks are high because payback depends entirely on the company’s future performance.
Type of LBO
1.Taking a public company private,
The first situation arises when an investor (or investment group) buys all of the outstanding stock of a publicly traded company and thus turns the company into a privately-held enterprise (“taking private” in reverse of “going public”). These deals may be friendly or hostile.
2.Financing spin-offs and
Public or private companies often wish to sell off elements of their business to get cash.
3.Private property transfers.
The last situation concerns cases where a privately held operation is bought by an investor group. Such cases often arise when a small businesses owner, having reached retirement age, wishes to divest him-or herself of the company and either cannot find a corporate buyer or does not wish to sell to a company.
valuation multiples of LBO
EBITDA is a measure of a company’s operating performance. Essentially, it’s a way to evaluate a company’s performance without having to factor in financing decisions, accounting decisions or tax environments. By minimizing the non-operating effects that are unique to each company, EBITDA allows investors to focus on operating profitability as a singular measure of performance
LBO process
- target selection 2. due diligence and deal structure 3. post acquisition management 4. exits.
LBO Model
- Determine the purchase price and the amount of debt and equity required.
- Assign percentage totals, interest rates, and repayment percentages to the debt tranches.
- Create a Sources & Uses table to track how funds are used in the deal.
- Build income statement projections based on assumptions for revenue and expenses.
- Calculate Free Cash Flow and the cash available for debt repayment.
- Complete the Debt Schedule and determine the mandatory and optional repayments.
- Link the Debt Schedule to the cash flow statement and income
- Calculate investor returns and create sensitivity tables.
there are two types of debt used in LBOs
bank debt (also known as senior secured notes, secured debt, etc.) and high-yield debt (unsecured notes, “senior notes,” unsecured debt, and so on).
The key differences:
High-yield debt tends to have higher interest rates than bank debt (hence the name “high-yield”).
High-yield debt interest rates are usually fixed, whereas bank debt interest rates are “floating” – they change based on LIBOR or the Fed interest rate.
High-yield debt has incurrence covenants while bank debt has maintenance covenants. Incurrence covenants prevent you from doing something (such as selling an asset, buying a factory, etc.) while maintenance covenants require you to maintain a certain financial performance (for example, the Debt / EBITDA ratio must be below 5x at all times).
Bank debt is usually amortized – the principal must be paid off over time – whereas with high-yield debt, there is a bullet payment.
bank debt (also known as senior secured notes, secured debt, etc.) and high-yield debt (unsecured notes, “senior notes,” unsecured debt, and so on).
Common Items in the Sources Column and Uses Column:
Common Items in the Sources Column: • Debt & Preferred Stock (all types) • Investor Equity • Excess Cash from Target • Non-controlling Interest Assumed • Debt Assumed
Common Items in the Uses Column: • Equity Value of Company • Advisory, Legal, Financing, and Other Fees • Refinanced Debt • Non-controlling Interest Assumed • Debt Assumed • Non-controlling Interest Purchased
how to build the income statement of LBO?
Essentially you look at historical trends for revenue growth, expenses, and other items and create future projections that make sense:
- Revenue Growth: Assume a discount to the historical growth rates, with decreasing growth into the future.
- Expense Percentages: Make everything a percentage of revenue. You can use historical averages for these percentages (better) or simply straight-line the most recent percentages
- Tax Rate: Link to the historical effective tax rates and / or what equity research analysts project for the next few years.
- Amortization of Intangibles: Pull from the schedule in the company’s most recent public filing.
- CapEx and Change in Working Capital: Make both of these percentages of revenue, and use historical averages if possible or straight-line the most recent percentages
LBO Model: Step 5 & 6
- Calculate Free Cash Flow and the cash available for debt repayment.
In a basic LBO model, we define Free Cash Flow as: Cash Flow from Operations minus Capital Expenditures. - Complete the Debt Schedule and determine the mandatory and optional repayments.
LBO Model: Step 7 & 8
Link the Debt Schedule to the cash flow statement and income
- Calculate investor returns and create sensitivity tables.
Main metric: Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments. Internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.
A PE firm can boost IRR’s by:
Reducing the Purchase Price of the target,
Increasing the Exit Multiple,
Increasing the Leverage (debt) used,
Increasing the company’s revenue growth rate (organically or via acquisitions) and
Increasing margins by reducing expenses (cutting employees, consolidating buildings, etc.).
Tax shield of LBO
This means that the interest a firm pays on debt is tax-deductible – so they save money on taxes and therefore increase their cash flow as a result of taking on debt in the LBO.
