LBO Flashcards
(55 cards)
Walk me through an LBO
- Start with summary for purpose of model and key inputs/outputs
- In a leveraged buyout mode, you assume a private equity company acquires a company using debt and cash, they own it for a few years, and then sell it after a defined period time to make a return on their investment.
- Step 1 of LBO is to make basic transaction assumptions of things like purchase price, % of cash, % of debt used.
- Step 2 is to make a sources and uses table, and work out where money for the transaction is coming from and then where it is going to.
- Step 3 is to modify balance sheet and make assumptions for goodwill and intangibles being created.
- Step 4 is to project all three statements for company and create a debt schedule for the company to show how debt changes over time and what interest they are paying,
- Step 5 is to calculrate investor returns at the end by working out how much the investor put down at the beginning, and then how much they are getting back at the end, to calculate their return on investment.
Why is debt schedule important?
- Integral to LBO; interest expense is key to examining profitability of LBO.
Most complex part of LBO?
Interest/debt schedule
In an LBO, what would happen if mandatory debt repayment is larger than cash balance + cash generated by company?
Company would have to raise additional debt, usually through a revolver (credit facility for a company)
What multiple do you use for IRR calculation?
- Most of the time you will be using EBITDA for multiple calculations
How do you calculate IRR?
- IRR is calculated based on Investor equity being the start, and then final value being the equity value when they sell the company and repay the debt. They will receive no cash flow in any of the year in between
What does IRR tell you?
- IRR tells us that the PE company gets X% return dependent on the assumptions inputted in the LBO
What is a target IRR?
- PE firms usually aim for 20-25% return if possible
How to test robustness of IRR?
- Sensitivity tables are used to test the robustness of the IRR, as the assumptions can change
What could you look at in LBO sensitivity table and how would they change the IRR?
- Can include looking at exit multiple and premium paid with initial purchase price. Can also look at % of debt used to finance the transaction. Higher multiple = higher IRR, lowwere purchase price = higher IRR, more debt = higher IRR
Is debt or cash better to buy companies with for PE firms?
- More leverage means you pay less up front with your own cash, allowing you to get a higher IRR when you sell.
What inputs have the greatest impact on IRR?
- Purchase premium, exit multiple and % debt tend to have greatest impact on IRR
- Why would PE want to do this with leverage?
Leverage boosts return, because you use less of your own money initially. Also, leverage also allows more cash and equity to purchase other companies
- Why would a PE firm want to use more debt?
Leverage boosts return, because you use less of your own money initially. Also, leverage also allows more cash and equity to purchase other companies
- Which variables impact the LBO model the most?
Exit multiple, purchase premium on each share, and then % of debt. Other ones include revenue growth and margins.
- What makes an ideal LBO candidate?
Stable cash flow, as the cash flow needs to be able to repay the debt that the firm takes on to fund the transaction. Also helps if company has low fixed costs and higher operating leverage (means they have higher margins). PE firms also like to look at valuation; look for undervalued compared to competitors, as they can go in and make changes and then increase IRR. Cyclicality can also be considered (eg semiconductors or chemicals).
- How do you adjust balance sheet in LBO?
Look at sellers book value, look at writing off goodwill, create new goodwill, create intangibles
- What are different types of debt you could use to finance LBO?
Bank debt and high yield debt usually are two main ones
- Characteristics of Bank Debt?
: Lower interest, floating rate, repay the principal over life of loan, allowed to prepay the debt, maintenance covenants (keep multiples above certain levels, ie total debt / EBITDA, EBITDA / interest etc)
- Characteristics of high yield?
: Higher interest, fixed rate, don’t repay principal over life of loan (repay at end), prepament not allowed, incurrence covenantes (more one time events, e.g CapEx, divestitures, acquisitions)
- How do you determine the %’s of debt types?
Look at previous issuances
- What is meant by tax shield in LBO?
Interest is tax deductible, so you pay less in taxes
- What is meant in cash flow sweep in LBO?
Excess cash flow is allocated to repay debt ahead of time, usually bank debt.
- What happens when you have dividend recap in LBO?
The company takes on debt, and the PE firm receives cash. This is taking on more debt and the PE firm receives cash, which boosts the returns of the transaction.
