Leveraged Buyouts and LBO Models Flashcards
key difference between a private equity firm’s acquisition of a company and a normal company’s acquisition of a company
-Private Equity Firm never plans to hold the company forever
Search is like home flipping:
- Search for undervalued companies
- Buy a company using a combination of debt and equity
- Private equity company runs the company for many years and then flips it
- Private equity then sells the investment and repays debt for hopefully a higher return
What are you concerned about in an LBO? (Measurements)
IRR exceeding internal discount rate
2 ways borrowing money helps
- Reduces up front costs
- Frees up cash to repay debts
Ideal company for an LBO
- Large enough - Smaller deals are 5-10M
- Price is right
- Stable cash flows to service debt (pre-revenue biotech or startup would be the worst possible because they can’t pay back interest.)
- Stability
Ideal LBO candidate (Income statement)
Fixed Costs, Revenue, margins, growth?
- Low fixed costs
- HIgh recurruing revenue
- High EBITDA margins
- Revenue growth not essential
Ideal LBO Candidate (Balance sheet)
High fixed assets such as PP&E for use as debt collateral
Ideal LBO Candidate (Cash Flow Statement)
- Stable cash flow needed above all
- Minimal capex spends (Mature company with lots of assets, but not spending on assets)
- Minimal working capital requirements also help, but tend to matter less.
Ideal LBO Candidate (Valuation Multiples?)
- Lower to mid-range EBITDA multiples
Ideal LBO candidate (Management Team)
- Strong CEO and CFO that have worked together for a long time and ideally are participating in the LBO by rolling over shares.
Ideal LBO Candidate (Industry / Market Features)
- High barriers to entry or “stickiness” (facebook.)
- Strong competitive advantage
- Stable, growing industry
- Little risk of technological change
- Ideally a market leader in a relatively fragmented industry
Ideal LBO Candidate (Financing Method and Debt Capacity)
Can support many tranches of deb as well as alternative debt structures depending on the companys needs.
- Relatively low % equity, perhaps around 20-30% depending on market conditions.
Ideal LBO Candidate (Credit stats and ratios)
EBITDA / Net Interest Expense > 2.0x
(EBITDA-CapEx) > Net Interest Expense > 1.5x
- Total Debt / EBITDA dependendent on industry and market but usually 5-6x and far often lower than that
Ideal LBO Candidate (Credit Rating)
Post-deal credit ratings dont take that much of hit that will cause interest rates to go up
- Credit ratings will always go down but ideally a drop from A to BB rather than AA to CCC.
Advantages of a fragmented market
PE firms can make additional acquisitions to make the companies they acquire bigger and more valuable.
Exit strategies / sources of returns
Target IRR?
- M&A exits are feasible
- Target IRR of 20-25%
- Avoid deals that are overly dependent on multiple expansion (EV / EBITDA must increase from 10x to 15x for the IRR to be above 20%
Difference in holding time between LBO and M&A deal
- LBO PE firm sells after 3-5 years
Leveraged buyouts vs M&A deals (Buyer)
- In an LBO, PE firm forms a shell company so debt is at that level.
Leveraged buyouts vs M&A deals (Purchase Price)
- Based on per share premium and valuation methodologies in both
- In LBO you consider purchase price required to achieve specific IRR
Leveraged buyouts vs M&A deals (Funding Source)
- M&A Buyers use cash, equity, debt
- LBO can only use cash and debt
Leveraged buyouts vs M&A deals (Funding statement projections)
In M&A deal, you need projections for both buyer and seller
- In LBO you project only sellers financials
Leveraged buyouts vs M&A deals (Synergies)
- Important in M&A but not in LBO
Leveraged buyouts vs M&A deals (Relevant Analysis)
EPS accretion/dilution matters a lot in M&A deals but is irrelevant in
LBOs; the same goes for Contribution Analysis. You’ll look at Returns Attribution and
LBO Valuation Analysis in LBOs, but not in M&A deals.
Leveraged buyouts vs M&A deals (Value to Society)
Most M&A and LBO deals tend to destroy value, but some M&A deals do lead to positive outcomes (e.g., Google / YouTube). Many leveraged buyouts, by
contrast, are based on “financial engineering” and don’t improve the company or add much value to the world at large.
How to calculate proceeds to PE firm at end of LBO model?
Subtract net debt
MOM Multiple vs IRR
1. Buy for 1,000 sell for 1,300 in one year
- Buy for 1,000 sell for 9,000 9 years later
- IRR = 30%, MOM = 1.3x
- IRR = 15%, MOM = 3.0x
MOM is overall increase while IRR is time dependent
When to use IRR vs MOM
in short periods (1 year), IRR is pointless, so use MOM
If holding for 5, 6, 7 years do IRR
What is a hurdle rate and what is based on?
Target IRR for PE firms before they can start earning a performance bonus.
Double your money scenario IRR questions
For “double your money” scenarios, you take 100%, divide by the # of years, and then estimate the IRR as about 75-80% of that value.
For example, if you double your money in 3 years, 100% / 3 = 33%, and 75% * 33% = 25%
Double your money in 3 years IRR
100% / 3 x 75% = 25% IRR
Double your money in 5 years IRR
100% / 5 x 75% = 15% IRR
Triple your money scenario IRR questions
200%/number of year * 65%
Triple Your Money in 5 Years IRR
200%/5 * 65% = 25% IRR
Triple Your Money in 3 Years
200%/3 = 66% x .67 = 45%
3 Yr scenarios IRR final multiple
2/3
5 Yr scenario IRR final multiple
63%
