Leveraged Buyouts (LBOs)
Leveraged Buyout Analysis
A leveraged buyout (LBO) is the acquisition of a company, division, business, or collection of assets (“target”) using debt to finance a large portion of the purchase price. The remaining portion is financed with an equity contribution by a financial sponsor (private equity party).
Historically financial sponsors sought a 20% annual return and an investment exit of 5 years. In a traditional LBO, debt has typically comprised 60% to 70% of the financing structure, with equity comprising the remaining 30% to 40%.
Companies with stable and predictive cash flows, as well as substantial assets, generally represent attractive LBO candidates due to their ability to support larger quantities of debt.
Cash flow is primary used to repay debt during to time to which the sponsor acquires the target until the exit. The debt portion of the LBO consists a broad array of loans like bank debt, high yield bonds, mezzanine debt and equity.
LBO analysis is used to check whether the deal is interesting for a financial sponsor. The LBO analysis is used to check whether the sponsor can make the needed returns (e.g. 20%) with a certain financial projection (operating scenarios), purchase price, financing structure and exit multiple after a certain number of years (e.g. 5 years).
In sell side advisory I always make the LBO model of the deal because I want to check how the deal “looks” for a financial sponsor. In other words: Is the deal interesting for private equity?
Also in buy side advisory it is interesting to make this analysis. For example it is interesting for a strategic party who wants to buy a certain target to know what competitive bidders (like private equity) are willing to pay for the target. You will never know for sure, but at least you can make an “educated guess” when you build the LBO model.
Let’s assume we want to build a model for a certain target. Here fore we need financial projections of the company, these can for example be obtained from a “Confidential Information Memorandum” (CIM) or from a “Discounted cash flow model” (DCF) if we have made the DCF analysis already.
We first need to build the historical and projected income statements (P&L’s) through EBIT. You can first start with typing in the numbers you have received from the CIM and then later on you can add multiple operating scenarios. The different scenarios can be typed in in a separate tab in excel and with the “CHOOSE function”, and a built in “toggle”, you can easily switch between operating scenarios.
So in first in stance we build the model until EBIT, because we do not know yet how the deal will be financed. So we also do not know yet the interest payments that need to be taken up in the projected income statements. This does not matter for now since we get back to this later on.
After a start of the estimated P&Ls we need to start building the projected balance sheets. The opening balance sheet is typically provided in the CIM and entered into the model. And you need to add extra line items for the new financing structure after the deal.
In order to build the balance sheet after the deal you need to add two adjustment columns in which you type in the sources (how the deal is paid) and uses (what is paid for) of the deal. And also add a column in which you give the “pro forma balance sheet”, so actually this is the opening balance sheet after the deal.
Cash flow statements
Of course does a LBO model also need cash flow statements (CFSs). We build them through the indirect method starting with net income and adding depreciation and amortisation since these are “non-cash” items. The net income is still not correct, because the right interest expenses are not yet taken up, but this does not matter since for now we are just building up the model.
In the CFSs we also need to show the year on year (YOY) changes in the balance sheet, think about the property, plant and equipment (PPE) and also the working capital line items (e.g. accounts receivable, inventories, prepaid and other current assets, accounts payable, accrued liabilities and other current liabilities).
The amounts of the above line items are forecasted in the balance sheet also through a separate “assumption tab”. Together with estimating the operating scenarios in the P&L, also estimates can be made for the line items in relation to the working capital. And with the “CHOOSE-function” in excel and a built in “toggle” you can switch between scenarios and this also effects the working capital (and the investments in working capital in the CFSs).
Also CAPEX (capital expenditures = investments in assets) need to be taken off as a “cash out” in the CFSs. They are also the result of the delta on YOY line items in the balance (e.g. PPE). And this line item PPE is estimated again in the “assumptions tab”, for example as a percentage of sales.
The financing section of the CFSs will be still left blanc, because we have not assessed yet how to finance the deal (in different financing scenarios).
When we have built the estimated P&Ls, balance sheets and CFSs it is time to enter the purchase price assumptions. To calculate the price of the shares we for example take a LTM EBITDA (last twelve months) (earnings before interest tax depreciation and amortisation) times a certain “multiple”, let’s say for example a multiple of 8. Then we have calculated the enterprise value (EV).
In order to get from EV to the price for the shares we need to deduct “net debt”, which consists out of total debt minus (excess) cash. Actually here we also need to take the “equity bridge” with “cash like” and “debt like” items into account, but I will not get into details about the “equity bridge” here.
Then in the LBO model we need to add the sources and uses. Uses is where we spend the money on for the acquisition, e.g.: equity purchase price + repayment of existing debt + call premiums (if any) + financing fees + transaction fees for the investment banker or corporate finance consultant.
These “uses” need to be financed with “sources”, for example: a revolving credit facility + certain term loans + notes/ bonds + equity + cash on hand. It is common to fill the model with multiple “financing structures” since Microsoft excel enables us to run sensitivity analyses on these different financing structures.
When we have added the sources and uses we need to connect them to the balance sheet. Most likely goodwill will be paid in a transaction. This simply means that a buyer pays more than the book value of the “net identifiable assets”. We need to make these adjustments in the balance sheet as well.
An example of taking up the sources and uses in the balance sheet is given under here. The example comes from the book: Investment Banking: Valuation, leveraged buyouts and mergers & acquisitions of Joshua Rosenbaum & Joshua Pearl (exibit 5.15 in the book).This is the main book I use in my training sessions and the participants receive a copy of this book when they register for my training sessions.
After that we can start filling the model with a debt schedule. When all the different debt components are modelled we can then also finish the: P&Ls, balance sheets and CFSs. This since we then know the interest payments for the P&Ls, paying back of principal and heights of the debt components at the end of different years for the balance sheets and CFSs.
For the interest payments we can use the forward Libor Curve from Bloomberg as a starting point. On top of that a spread is added for the different debt components.
In a discounted cash flow model we speak of a “free cash flow”, but you can also see this term back in a LBO model. In a LBO model the term “free cash flow” means: Cash available for debt repayments.
And in the LBO model it is common to build in a “cash sweep”, which means that all excess cash, after the mandatory principal repayments, will be used to pay back debt. And of course it makes sense to model in a “minimum cash amount” that should stay on the balance sheet for “working capital” purposes.
Further more the debt schedule needs to be modelled like a “waterfall”, so the cash needs to flow back to the lenders depending on the level of seniority, e.g. from the revolving credit facility to the term loans, to the notes/ bonds etc.
After that the P&Ls should be finished with the interest expenses and the balance sheets and CFSs with the principal repayments and new debt amounts at the end of the year.
Perform LBO analysis
When your model is complete we want to perform LBO analysis. First of all we need to know the credit statistics since the deal is highly leveraged. So your model needs to show insights on the main credit statistics like: EBITDA over interest, senior secured debt over EBITDA, net debt over EBITDA etc. Of course, this needs to be shown for all the years of your forecast.
We also need to know what the returns are for the investment. Here fore we need to take an exit into account. The common practice for an analyst for modelling practises is to take (in first instance when you build the model) a similar exit multiple on EBITDA as the EBITDA multiple on which you can buy the company. E.g. when you can buy the shares for 8 times EBITDA enterprise value, then also model an 8 times “EBITDA year 5” as exit enterprise value.
In most LBO models a “cash sweep” is modelled in as mentioned before. This way in most models you see an original equity contribution. This is the equity contribution the financial sponsor has put in at the date of the acquisition. Then we assume we sell the shares again at a certain EBITDA multiple at year 5. And then we need to deduct the “net debt” level at year 5 as well. What is left is the equity value after year 5.
Imagine you buy a firm with an equity contribution of 20 million euro (the rest is debt) at the date of the acquisition. And you then you sell it for 50 million share value at year 5 (enterprise value – net debt). Here you make a cash return of 2,5 (50 million/ 20 million).
This cash return is a number we always need to know. But a more elegant number is the IRR (internal rate of return). It basically is the honest yearly return the investor makes. And it stands for a “discount rate” in which the present value is exactly zero, so it shows the honest return for an investor.
At the same way as we calculate the cash return we like to calculate the IRRs of the LBO model for a range of for example 10 exit years. And then the most important IRR is the IRR with an exit after year 5 since this is an average holding period for a financial sponsor.
Personally, I am a big fan of the LBO model and always like to calculate the IRR of an acquisition since it is so honest. And you can even take up the LBO “valuation” on the football field if wanted next to “comps” and “DCF”.
An example of a football field including LBO “valuation” is given under here. The example comes from the book: Investment Banking: Valuation, leveraged buyouts and mergers & acquisitions of Joshua Rosenbaum & Joshua Pearl (exibit 5.44 in the book).This is the main book I use in my training sessions and the participants receive a copy of this book when they register.
My next blog will be on “buy-side M&A” (the M&A model) and it will discuss “accretion/ dilution” in a M&A deal. Stay tuned!
And when you are interested in being able to prepare all the main valuation models for real in excel follow my valuation training in Amsterdam/ Zuidas. More info below, and here you can also find my profile as an international trainer in Corporate Finance.
Training Business Valuation & Deal Structuring
This is a practical 6-day training in “Business Valuation & Deal Structuring” (Investment Banking M&A) and the main topics are: valuation, leveraged buyouts (LBO’s) and mergers & acquisitions (M&A’s).
The training mainly focusses on giving the participant hands on tools to build financial models in excel to determine the value of a company on 1) a stand-alone basis, 2) in a LBO situation and 3) in a buy-side M&A scenario.
In the training we will look at different valuation techniques to calculate “enterprise value” like: 1) Comparable companies analysis, 2) Precedent transaction analysis, 3) Discounted cash flow analysis (DCF), 4) LBO analysis and 5) Buy-side M&A analysis.
And we will look at different techniques to get from “enterprise value” to the “value of the shares” taking (adjusted) net debt into account.
The training is very practical in a sense that the trainer will explain the concepts first and will then apply them in class to real life companies with the participants. With all the calculations “Microsoft excel” is used to build the needed financial models.
This training is meant for analysist and associates from international investment banks. Moreover, the training is meant for analysts and consultants in: M&A, private equity, venture capital and strategy. In addition, the training is meant for accountants, tax lawyers, bankers in credit analysis, financial managers, CFO’s etc.
During the training will be focussed on international companies listed on the stock exchange. But the valuation techniques are also applicable to (non-listed) private firms.
For any more question on this training feel free to contact by email: email@example.com and/ or by phone: +31 6 8364 0527 (time zone: Amsterdam).
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1. Wednesday October 2nd2019: 10 AM – 6 PM;
2. Thursday October 3rd2019: 10 AM – 6 PM;
3. Friday October 4th2019: 10 AM – 6 PM;
4. Saturday October 5th2019: 10 AM – 6 PM;
5. Monday October 7th2019: 10 AM – 6 PM;
6. Tuesday October 8th2019: 10 AM – 6 PM.
Sunday April 7th: Not a training day.
Location: Crowne Plaza Hotel – Amsterdam South. George Gershwinlaan 101. 1082 MT Amsterdam. The hotel is located in Amsterdam South (financial district), right across train station “Amsterdam South” and about 15 minutes from “Schiphol Airport”.
Price & payment:
The price for this 6-day training is 3.900 euro excluding vat. And only 2.900 euro ex vat when you book before 31stJuly 2019 (1.000 euro early bird discount).
This price is for the 6-day training including study materials (A hardcopy of the theory + workbook of: Investment Banking: Valuation, leveraged buyouts and mergers & acquisitions of Joshua Rosenbaum & Joshua Pearl), coffee and tea all day, luxury lunch at lunchtime and a snack in the afternoon.
There is a maximum of 20 participants for the training based on first come first served. This way there is room for interaction in class.
You can register yourself by sending an email to: firstname.lastname@example.org.
You will then receive a registration form and additional details for registration. Or download the registration form and training manual at: www.kerstencf.nl/training
Trainer & Consultant: J.J.P. (Joris) Kersten, MSc BSc RAB
· 130 recommendations on his training can be found on: www.kerstencf.nl/referenties
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J.J.P. (Joris) Kersten MSc BSc RAB (1980) is owner of “Kersten Corporate Finance” in The Netherlands, under which he works as an independent consultant in Mergers & Acquisitions (M&A’s) of medium sized companies.
Joris performs business valuations, prepares pitch books, searches and selects candidate buyers and/ or sellers, organises financing for takeovers and negotiates M&A transactions in a LOI and later in a share purchase agreement (in cooperation with (tax) lawyers).
Moreover, Joris is associated to ‘AMT Training London’ for which he provides training as a trainer and assistant-trainer in Corporate Finance/ Financial Modelling at leading investment banks in New York, London and Hong Kong.
And Joris is associated to the ‘Leoron Institute Dubai’ for which he provides finance training at leading investment banks and institutions in the Arab States of the Gulf. This for example at Al Jazira Capital in Saudi Arabia and TAQA in Saudi Arabia.
In addition, Joris provides lecturing in Corporate Finance & Accounting at leading Universities like: Nyenrode University Breukelen, TIAS Business School Utrecht, the Maastricht School of Management (MSM), the Luxembourg School of Business and SP Jain School of Global Management in Sydney.
Moreover, he provides lecturing at partner Universities of MSM in: Peru, Surinam and Mongolia. And at partner Universities of SP Jain in Dubai, Mumbai and Singapore.
Joris graduated in MSc Strategic Management and BSc Business Studies, both from Tilburg University. In addition, he is (cum laude) graduated as “Registered Advisor Business Acquisitions” (RAB), a 1-year study in the legal and tax aspects of M&A’s. And Joris obtained a degree in “didactic skills” (Basic Qualification Education) in order to lecture at Universities.
Currently Joris is doing the “Executive Master of Business Valuation” to obtain his title as “Registered Valuator” (RV) given out by the “Netherlands Institute for Registered Valuators” (NIRV). This title will enable Joris to give out business valuation judgements in for example court cases.