LBO Analysis

-by edu CBA

• Consider that the concept of leveraged buyout is very similar to buying a house.

• Suppose you want to buy a big house what will you do?

• Due to rising real estate prices, definitely it is not possible to do the entire down payment.

• Then what do you do? Yes, ofcourse you go for a loan.

• And most of the times it forms a major part of the entire process. Similar is the concept in LBO analysis.

LBO Analysis Concept

If we break down it to simple terms, in an LBO, the “down payment” is called Equity (cash) and the “mortgage” is called Debt.

In Leverage Buyout, the acquisition of another company

is significantly by borrowed money (bonds or loans) to meet

the cost of acquisition.

Steps involved in LBO Analysis • In the first step of LBO analysis we need to take care of some

transaction assumptions. Analyzing the purchase price and financing of the deal are some important steps here.

• With this information, then a table of Sources and Uses can be created Uses reflects the amount of money required to effectuate the transaction. The Sources tells us from where the money is coming.

• Next we make the changes in the existing balance sheet of the company to reflect the transaction and the new capital structure. This process leads to the construction of the “Proforma” balance sheet. At this step intangible assets like the goodwill and capitalized financing fees are likely to be created.

• The third and the crucial step is to create an integrated cash flow model for the company. Here, the company’s income statement, balance sheet and cash flow statement are projected for a period of time (five years mostly). The balance sheet has to be projected based on the newly created proforma balance sheet. While projecting the debt and interest, post-transaction debt must be considered.

• Once the model is created, assumptions about the private equity firm’s exit from its investment can be made. A general assumption is that the company will be sold after five years at the same implied EBITDA multiple at which the company was purchased. There is a reason why we calculate the sale value of the company. It allows us to also calculate the value of the private equity firm’s equity stake which we can then use to analyze its internal rate of return (IRR).

Sources of funds in LBO Analysis

• Revolving credit facility

• Bank Debt

• Mezzanine debt • Subordinated or High-Yield

Notes

• Seller Notes

• Common Equity

Key characteristics of a LBO candidate

• Mature industry and the company.

• Clean balance sheet with no or low amount of outstanding debt.

• Strong management team and potential cost-cutting measures.

• Low working capital requirement and steady cash flows.

• Low future capital expenditure requirements • Feasible exit options.

• Strong competitive advantages and market position • Possibility of selling some under performing or non-core assets

Returns in LBO analysis • In Leverage buyout the financial buyers evaluate investment

opportunities by analyzing expected internal rates of return (IRRs), which measure returns on invested equity.

• Historically, financial sponsors’ hurdle rate, which is the minimum required rate, have been in excess of 30%, but may be as low as 15-20% for particular deals under adverse economic conditions.

• Sponsors also measure the success of an LBO investment using a metric called “cash on cash”.

• Typical LBO investments return range between 2x – 5x cash-on-cash. If an investment returns 2x cash on cash, the sponsor is said to have “doubled its money”.

Exit Multiples

• LBO analysis helps in determining the purchase price of the prospective Company or business.

• It helps in developing a view of the leverage and equity characteristics of the transaction.

• Calculate the minimum valuation for a company since, in the absence of strategic buyers, an LBO firm should be a willing buyer at a price that delivers an expected equity return that meets the firm’s hurdle rate.

Applications of the LBO Analysis

Knowledge is like a line With no ends…

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