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Investment Banking BOOK > LEVERAGED BUYOUTS > Flashcards

LEVERAGED BUYOUTS Flashcards

1
Q

What is a leveraged buyout?

A

The acquisition of a company, business or target using debt to finance a large portion of the purchase price with the remaining portion being funded through equity contribution from the financial sponsor.

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2
Q

Why are LBOs used

A

They are used to realize an acceptable return on its equity investment upon exit through a sale or IPO of the target (20%+ annual return, after around 5 years)

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3
Q

What is the debt:equity proportion for a typical LBO?

A

Debt: 60-70%
Equity: 30-40%

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4
Q

What occurs during an LBO process?

A

The FCF is used to service and repay the debt (increasing the equity portion of the capital structure). The financial performance is increased through bolt-on acquisitions and business growth to further increase returns

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5
Q

What is a CDO?

A

Collateralized Debt Obligation - asset-backed securities backed by interests in pool of assets.
CLO = c. loan obligation
CBO = c. bond obligation

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6
Q

What are the characteristics of a strong LBO candidate

A
  1. Strong Cash Flow Generation
  2. Leading and Defensible Market Positions
  3. Growth Opportunities
  4. Efficiency Enhancement Opportunities
  5. Low Capex Requirements
  6. Strong Asset Base
  7. Proven Management Team
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7
Q

Why strong cash flow generation?

A

Debt investors require a business model that demonstrates ability to support periodic interest and debt repayments over the life of the loan/security.

    • strong / niche markets
    • stable consumer demand
    • Brand name
    • Established customer base
    • Long-term sales contracts
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8
Q

Why leading defensible market position?

A

This reflects entrenched customer relationships, brand name, superior products, and favorable cost structures. Create barriers to entry and increase stability.

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9
Q

Why Growth Opportunities?

A

Profitable top-line growth helps drive returns, generating cash available for debt repayment while also increasing EBITDA and enterprise value. It enhances the speed and optionality for exit (IPO).

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10
Q

Why Efficiency Enhancements?

A

Enhancements in the form of operational efficiency generate cost savings and represent substantial value created for equity holders for exit. This can be lowering overhead costs, streamlining operations, reducing headcount, rationalizing supply chain, and implementing new management information systems

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11
Q

Why Low Capex requirements?

A

Ideal candidates would not require substantial capital investment and thus limit cash outflow (and retain cash flow capabilities).

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12
Q

Why Strong Asset Base?

A

A strong asset base can be pledged as collateral. This also tends to signify high barriers to entry because of substantial capital investment required.

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13
Q

Why proven management team?

A

Talented management is needed as the firm operates under highly levered capital structure with ambitious performance goals. There is usually an aligned incentive for management with meaningful equity stake.`

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14
Q

What does IRR measure?

A

It measures the return on sponsor’s equity during a time horizon (to produce a NPV = 0)

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15
Q

How do sponsors aim to monetize their investments?

A

Strategic Sale
Financial Sale
IPO

The main goal of the sponsor is to achieve multiple expansion upon exit.

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16
Q

How can a sponsor achieve a high multiple on exit?

A

Increase the target’s size and scale
Meaningful operational improvements
Repositioning of business toward more highly valued industry segments
Acceleration of the organic growth rate/profitability
Accurate timing of cyclical sector

17
Q

Why would a sponsor sell to a strategic?

A

1) Strongest potential bidder (due to synergies and benefit from lower cost of capital)

18
Q

Why would a sponsor IPO a target?

A

In an IPO exit, the sponsor sells a portion of its shares in the target. The sponsor will remain the largest equity stake but understands a future exit will come through follow-on offerings.

This gives the investor a liquid market for its remaining investment while also preserving any opportunity to remain with the firm long-term. And if Capital Markets are good, it could offer a compelling valuation.

19
Q

What is a Dividend Recapitalization?

A

A dividend recapitalization is where the target raises proceeds through the issuance of additional debt to pay shareholders a dividend. In doing so, the net debt of the company increases while the equity significantly decreases.

20
Q

How is the additional debt dealt with?

A

The debt may be issued as an add-on or as part of a refinancing of the existing capital structure.

21
Q

Why would you use a dividend recap?

A

It provides the equity holders a chance to retain all their stake in the company while recouping some or a lot of their initial investment.

22
Q

What are the tiers of debt?

A 
Bank Debt (First / Second Lien)
High Yield Bonds (Senior Unsecured / Subordinated)
Mezzanine Debt (Subordinated / Preferred Stock)
Equity Contribution (Common Stock)
23
Q

What is a maintenance covenant

A

A maintenance covenant requires the borrower of debt to maintain a designated credit profile through compliance with certain financial ratios

24
Q

What is a revolving credit facility?

A

A revolver is a line of credit extended by the bank that permits the borrower to draw varying amounts up to a specified limit

25
Q

What is an Asset Based Lending Facility?

A

Type of revolver secured by first priority lien (A/R and inventory) and then second lien (PP&E). Subject to borrowing base formula to limit availability based on eligible assets.

26
Q

What are term loans and what are their types?

A

A loan with a specified maturity that requires principal repayment according to a defined schedule.

Amortizing term loans (A): require substantial principal repayments throughout the lifetime

Institutional term Loans (B) : larger than TLAs and amortize at a nominal rate (1% per year) with a bullet payment (large) at maturity. Since market for TLAs is up to 7 years they are typically used in LBOs.

27
Q

What are second lien term loans?

A

A floating rate loan secured by a second priority security interest in the assets. Ranks junior to first lien and TLAs or TLBs.

28
Q

What are high yield bonds?

A

Non-investment grade debt securities that obligate issuer to make interest payments to bond-holders at defined intervals. 100% bullet payment on maturity. Typically offer a higher coupon rate to compensate for the greater risk. Fixed interest rate.

29
Q

What is Payment in Kind (PIK) interest?

A

PIK toggle for interest is a feature that allows issuers to pay interest by issuer additional notes rather than through cash payments. This allows for cash retention and , increasing the coupon slightly (0.75%).

30
Q

What is a bridge loan?

A

Interim financing to bridge between issuance of permanent capital.

31
Q

What is mezzanine debt?

A

Mezzanine debt sits at a cost below equity and above high yield bonds. It offers greater flexibility in structuring terms conducive to issuer and investor and is prevalent in middle market transactions

32
Q

What is a club deal?

A

A club deal is the teaming up of sponsors into a consortium to reduce the amount of equity contributed per sponsor.

33
Q

What is a covenant?

A

It is a provision in a credit agreement to protect against the deterioration of the borrower’s credit quality.

34
Q

What is an affirmative covenant?

A

It requires the borrower and its subsidiaries to perform certain actions such as maintaining corporate existence and books and records, regular financial reporting, maintaining assets, collateral, insurance, and paying taxes

35
Q

What are negative covenants?

A 
The limit the borrower's ability to take certain actions (exception for baskets) including limitations on:
Debt
Dividends and stock redemptions
Liens
Dispositions of assets
Investments
Mergers and consolidations
Amendments of debt
Transactions with affiliates
36
Q

What are financial covenants?

A

They require the borrower to maintain a certain credit profile through compliance with specified financial ratios or tests on a quarterly basis.

Maximum Senior Security leverage ratio
Total Leverage Ratio
Minimum interest coverage ratio
Minimum fixed charge coverage ratio
Maximum annual capital expenditures
Minimum EBITDA
37
Q

What are baskets?

A

These are exceptions to covenants that permit the borrower to take specific actions.

Investment Banking BOOK (6 decks)

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