Module 3 Flashcards
what are some driving characteristics that have shaped the high-multiple and high leverage environment we are in now?? (6)
readily available, inexpensive, and covenant lite capital options for quality assets
natural turn of PE investments from 05-07 (5 to 10 year periods)
low interest rates have led pension deficits in which further appetite for alternative investments
large institutional capital and sovereign wealth funds creating in-house management teams
bullish public equity markets are allowing certain corps to use their now higher valued shares for M&A
corps dependent on organic growth may be facing pressure to grow in a slow economic environment and may be looking to grow inorganically
what are the 4 ways in which a private equity company can work with their investee company to increase top line growth? (GRIN)
entry into new market segments
geographic expansion
revitalization of an underperforming subsidiary
implementing a market strategy to increase volume or allow for real price increase
What are the three ways in which a company can expand margin and operational improvements?
Cost cutting
Raising productivity
Improve working capital management
What are the 5 ways in which a company can executing M&A or divestment activity?
Revenue synergies for cross-selling of complimentary products
cost synergies by allowing consolidation of manufacturing facilities
acquiring a competitor and increasing market share
opportunity to acquire a new business at an attractive price and capture accretive value
divestments on non-core assets
what are four important considerations to take into account on pricing of M&A transactions ?
transformative or tuck-in?
does price include synergies or not?
how will synergies be realized?
multiples arbitrage?
how can PE firms work with their investee companies to improve working capital?
tighten up A/R collections whilst extending their A/P to improve working capital in the business
what is a tuck-in acquisition?
a small addition to an existing company, and this is driven by a small relative size to acquirer
what is the primary advantage of tuck in acquisitions?
higher probability of the success of integration in comparison to larger acquisitions
what impact on earnings and resultantly company value is usual from tuck in acquisitions?
since tuck in acquisitions are usually at smaller multiples than the acquiring co, tuck in acquisitions are usually immediately accretive to inherent value, as they then become subject to the parent multiple, with additional earnings
what are follow-on acquisitions?
when additional equity is invested into an existing investment - additional capital usually comes from PE sponsor and results in additional ownership or pro-rata participation by existing shareholders
what is the differentiator from tuck in and follow on acquisitions when evaluating a large transformative acquisition?
the size and degree of risk involved are much higher, and can either result in massive failure (AOL/Time Warner) or massive value creation (Kraft/Heinz)
what is the primary use of leverage in PE M&A transactions?
to amplify returns to equity holders
what common leverage ratio is used to earmark industry standards and appetite for financiers’ debt capacity?
debt to EBITDA ratio
What are the two primary reasons for a leverage recapitalization?
dividend or repurchase a large portion of common stock in cash or in-exchange for other securities
what are three important key points that need to be highlighted in the scenario of a dividend recap?
subject company can capture a tax benefit of having a leveraged balance sheet, properly debt-sizing the company
the post-cap capital structure may result in actually a higher valuation for the company, as equity relative to company valuation will decrease
additional leverage should amplify future returns to equity investors, subject to the company having the ability to handle the existing indebtedness
what is also important to keep in mind when evaluating if a dividend recap is appropriate? from a risk perspective
projected future returns are going to be more highly sensitive to profit margins, tax rates, cost of debt, and market valuation - over-leveraging can quickly send a company downwards if not appropriately sized (ie. lack of liquidity, financial flexibility, etc)
what is “multiple expansion”?
it is the increasing of the multiple realizable by the company, due to improved cash flows, improved outlook, lower risk, lower cost of capital, or various value creation strategies that have been successful (top line growth, cost cutting, etc)
why do PE managers sometimes look for cyclical industries in a state of “multiple depression”?
it may potentially leave future upside on industry-wide bounceback to be accretive to exit value (ie. think O&G industry and market-wide movement of multiples)
what are the larger 5 reasons for a PE manager to refinance the capital structure?
match duration of debt to expected hold
achieve lower cost of capital than existing indebtedness
reduce financial covenants
dividend recapitalization
poor performance may lead to a new amended structure with existing creditors with achievable covenant package
what are three primary questions for investors to ask in regards to a refinancing situation?
what are the sources and uses?
how is interest rate on new debt being calculated? (variable, fixed, LIBOR)
what were the refinancing costs? this is important in determining net returns
what are the three overarching types of considerations for PE managers when timing an exit?
company specific
industry specific
market specific
what are company specific timing considerations for exit?
time taken to implement certain strategies, such as a new operational platform and realizing synergies
what are industry specific timing considerations for exit?
the potential for lack of investor appetite for certain types of investments (based on industry)
what are market specific timing considerations for exit?
factors such as compressed equity value when looking to IPO, or markets depressed in a global financial crisis, resulting in a liquidity crunch
