LBO Training Summary

and present A Summary of Leveraged Buyout (LBO) Models

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Uses for an LBO Model  An LBO Model is an analysis used by private equity firms (financial sponsors) to evaluate an acquisition  The goal of an LBO is to acquire a company by financing the purchase with as much debt as cash flow and debt markets will support  The more debt available, the smaller an equity investment the financial sponsor has to make  The higher the leverage, the higher the expected IRR for the financial sponsor or private equity firm Copyright 2009

Uses for an LBO Model (cont’d)  The goal of an LBO model is to establish expected internal rates of return (“IRR”) for the acquisition that reflects:  Purchase price assumptions and the cash needed  Capitalization assumptions: leverage, debt tranches, equity investments  Base case financial projections for balance sheet, cash flow and income statement  Model should include sensitivity functions for a range of:  purchase prices,  capitalization structures,  operating assumptions Copyright 2009

Uses for an LBO Model (cont’d)  Private Equity Firms / Financial Sponsors usually have a required rate of return hurdle  Expected transaction IRR must meet or exceed hurdle rate  PE firms required rates of return usually range from 15% to 30% (18% - 25% typical)  The IRR analysis is strongly driven by the amount of leverage  With higher leverage, less equity, and higher IRR  Often the goal is to leverage up the Company based on cash flow and the debt markets  More leverage increases risk, as cash flows will pay interest and debt service Copyright 2009

Uses for an LBO Model (cont’d)  Leverage is largely determined by the debt markets  Until mid-2007, the debt markets were experiencing excess liquidity  Lenders were allowing higher leverage  In 2005-2007 leveraged at 4.0–6.0x recent EBITDA  Higher levels allowed higher prices yet still attain the required IRR Copyright 2009

Uses for an LBO Model (cont’d)  Leverage is comprised of some combination of:  Senior secured loans  Junior loans/bonds  Mezzanine debt, or “hybrid” securities  Lenders may require the financial sponsor to have a minimum equity investment  Minimum equity contribution is typically around 20% - 25% of total capitalization Copyright 2009

Uses for an LBO Model (cont’d)  Not Just for Buyers  The LBO Model is also used by lenders  Lenders like to see expected leverage and debt service coverage ratios based upon Company’s projected: – income statement, – balance sheet, – cash flow Copyright 2009

Pop Quiz  The goal of an LBO model is to establish expected internal rates of return (“IRR”) using a financial model that reflects:  a. Purchase price assumptions and uses of cash  b. Capitalization assumptions and sources of cash  c. Base case financial projections with assumptions  d. All the above. Copyright 2009

Components of LBO Model  Typical LBO Model will contain, at a minimum, the following items:  Purchase price assumptions  Uses of Cash Schedule  Sources of Cash Schedule  Capital Structure Alternatives  Pro Forma Balance Sheet  Integrated Financial Model  IRR Analyses Copyright 2009

Purchase Price Calculation and Considerations  Determination of the purchase price typically involves a full-scale valuation of the company:  Comparable Companies Analysis  Precedent Transactions Analysis  Discounted Cash Flow Analysis Copyright 2009

Capital Structure Alternatives  Debt may be comprised of different securities usually provided by different lenders  Revolver / Term loan (senior secured loans) – Usually provided by typical commercial banks – Have lower interest rates  Junior loans can be provided by public markets (high yield issue) and private placements  Often, the most junior piece on debt will have equity warrants attached Copyright 2009

Proforma Balance Sheet  Proforma balance sheet gives effect for the transaction  Adjusts the historical balance sheet for the new sources of debt and equity as well as any transaction-related adjustments:  Write-ups or write-downs  All financing fees incurred can be capitalized and amortized  Any Goodwill created by the transaction  The buyer typically assumes all of the normal-course short term liabilities  The “old debt” is typically eliminated Copyright 2009

Proforma Balance Sheet (cont’d)  Proforma Balance Sheet example (assets): Proforma Balance Sheet ($ in millions) Historical Financing/ Proforma Balance Sheet Dec. 31 Transaction Dec. 31 Assets 2008 Adjustments 2008 Cash $0.0 $0.0 $0.0 Accounts Receivable $16.0 0.0 16.0 Inventory $10.0 0.0 10.0 Other Current Assets $1.0 0.0 1.0 Total Current Assets $27.0 $0.0 $27.0 Gross PP&E $323.2 $0.0 $323.2 Cumulative Depreciation $45.0 0.0 45.0 Net PP&E $278.2 $0.0 $278.2 Amortizable Intangibles $0.0 $8.0 $8.0 Goodwill 5.0 65.2 70.2 Total Assets $310.2 $73.2 $383.4 Copyright 2009

Proforma Balance Sheet (cont’d)  Liabilities Balance Sheet Historical Dec. 31 Financing/ Transaction Proforma Dec. 31 & Equity Liabilities 2008 Adjustments 2008 Accounts Payable $11.0 $0.0 $11.0 Accrued Liabilities $2.4 0.0 $2.4 Other Current Liabilities $0.0 0.0 0.0 Total Current Liabilities $13.4 $0.0 $13.4 Existing Debt Revolving Credit Facility $40.8 ($40.8) $0.0 Term Loan $100.0 ($100.0) $0.0 Unsecured Debt $50.0 ($50.0) $0.0 New Debt Revolving Credit Facility $0.0 $0.0 $0.0 Term Loan 0.0 $120.0 $120.0 Senior Bonds 0.0 $90.0 $90.0 Unsecured Debt 0.0 $60.0 $60.0 Other Liabilities $2.0 $0.0 $2.0 Total Liabilities $206.2 $79.2 $285.4 Shareholders Equity Retained Earnings $94.0 ($100.0) ($6.0) Common Stock 10.0 $94.0 104.0 Total Shareholders Equity $104.0 ($6.0) $98.0 Total Liabilities and Equity $310.2 $73.2 $383.4 Copyright 2009

Financial Statement Projections  An LBO model must also include forecasted income statement, balance sheet, cash flow and debt schedule  This allows us to forecast performance of the company on a post-LBO basis to see:  How well the company is able to service the increased debt;  How profitable the company can be following the LBO; and  How the company might be valued at the end of the anticipated holding period Copyright 2009

Pop Quiz  Which of the following is not included in total uses of cash?  a. purchase price  b. transaction fees  c. debt service  d. other required cash payments in the transaction  e. none Copyright 2009

IRR Analysis  The IRR analysis accounts for:  Cash flows from the financial sponsor into the company  Cash flows to the financial sponsor during the holding period  Net proceeds to the sponsor following the sale of the company (aka “exit”) Copyright 2009

IRR Analysis (cont’d)  Example of exit value calculation: SALE OF COMPANY A IN 2013 Closing Date 31-Dec-13 2012 EBITDA $76.6 EBITDA Multiple 6.0x Transaction Value $459.5 Less: Total Debt (190.5) Plus: Cash Balance 0.0 Less: Transaction Fees (1) (6.6) Equity Value $262.4 % Equity to Sponsor 95.0% Equity to Sponsor $249.3 % Equity to Unsecured Lender 5.0% Equity to Unsecured Lender $13.1 (1) Assumes 1% of Purchase Price for Investment Banking Fees, plus $2 million in legal and other expenses. Copyright 2009

IRR Analysis for Financial Sponsors  Example of IRR analysis for financial sponsor: IRR to Financial Sponsor 12/31/08 12/31/09 12/31/10 12/31/11 12/31/12 12/31/13 Initial Equity Investment ($104.0) $0.0 $0.0 $0.0 $0.0 $0.0 Dividends 0.0 0.0 0.0 0.0 0.0 0.0 Proceeds at Sale 0.0 0.0 0.0 0.0 0.0 249.3 Total Cash Flows to Sponsor ($104.0) $0.0 $0.0 $0.0 $0.0 $249.3 IRR Calculation 19.1% Copyright 2009

Pop Quiz  The IRR analysis accounts for:  a. Cash flows from the financial sponsor into the company  b. Cash flows to the financial sponsor during the holding period  c. Net proceeds to the sponsor following the sale of the company  d. All of the above Copyright 2009

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About Investment Banking Institute  IBI is affiliated with the CFA Institute, NASBA (the national association of the state boards of accountancy –overseeing CPAs), and the CFP Board  IBI has trained analysts and associates for hundreds of organizations (a partial list can be viewed on our website), the in-class training we provide our individual students is the same exact training provided to corporate clients  Interview preparation, resume revision, and job contacts are available through our Human Resources division on a one-on- one basis with no set expiration date  The training program can be repeated free of charge at any future date to ensure your skills are sharp when you need them to be  Seasoned Investment Bankers are available for help outside of class whenever needed Copyright 2009

Investment Banking Institute Student Testimonial I am so thankful for the class I took at the Investment Banking Institute. It was both an enriching knowledge vault and a confidence booster! Your walkthrough of the DCF calculations was an excellent refresher. While I still remember bits and pieces of how DCF works from my on-campus interviews back in college and work at JP Morgan, your presentation helped to consolidate everything in my mind. I also appreciate how you tied things back to an estimate of the company's stock price at the end -- I actually once got an interview question on that exact topic! The details and examples of the LBO modeling were extremely helpful, and the encouragement you gave students throughout the class was equally invaluable. A huge thank-you for your insight into current market conditions, and on how the subprime crisis actually unfolded. Although I manage to gain exposure to macroeconomic and market valuation issues at work every day at JP Morgan, it was your engaging, concise teaching method and holistic approach to the course that put everything in perspective for me. I will definitely recommend your course to my future classmates at Harvard Business School as I am sure they will benefit tremendously from it. Thank you very much. Anthony, Boston Copyright 2009

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LBO Training Summary

by Private Equity Jobs on Dec 13, 2009

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