Ferdinand petra - introduction to LBO and Private Equity

1Ferdinand Petra – www.Ferdinand-petra.com – All rights reserved 2018 ©
Financial Training
Extract on LBO
www.ferdinand-petra.com
Prof: Ferdinand Petra (contact@ferdinand-petra.com)
Any reproduction, copy of this document is strictly forbidden without prior consent of the author

Introduction

What Is a LBO?
 A financing technique for acquiring a Target company
− Primarily funded with debt
− Proportionally small amount of equity
 Investors in LBO are called “Financial Sponsors” (important players in the M&A market)
 Their goal is to purchase assets, which they plan to sell in the short/medium term for a substantial profit
− Their time frame is typically 3 / 5 years
− Trade buyers, on the other hand, have a much longer time horizon
 Focus on cash flows generated by the Target company during the investment period
− Used to pay down debt
− Provides the financial buyers with leveraged returns
 The credit crunch (post subprime) has reduced significantly the amount of debt available and therefore
transaction values (and leverage)
− Since last year, we began to witness leverages coming back to pre-crisis levels!
 Sponsors evaluate investments with two metrics
− Internal Rate of Return which measures return on equity invested (Excel IRR() or XIRR() functions)
− Cash on Cash multiples (aka Money multiple)
Introduction

Structuring
NewCo
100%
Mezzanine
Funds
Cash
Management
Investment
Fund
Corporate
Banks
Mezzanine
Funds
NewCo
Selling
shareholders
Target
Capital
Cash
“Debt push-down”
Introduction

Financial Sponsors
 Investment or financial sponsors are professional financial investors (for instance insurance
companies or pension funds) who bring the rarest and most expensive resource, since it is the
most risky: equity…
 … whose objective is to create value by:
− Using the leverage effect
− Improving the profitability and accelerating organic growth
− Increasing external growth (build-up)
− Developing profit-sharing schemes for managers (MBO)
 Value creation:
− Materializes at the exit
− Is computed thanks to the IRR, generally in the region of 15 to 25%
 Financial sponsors became key players on the market and they now account for an estimated
20% of the European M&A market
Introduction

PE basics
LP
Reporting
Governance
Fund
Money
COC
IRR
Team control
Management
fees ( 2%)
Management
contract
GP
Carried interest
(20%)
Hurdle (8%)
Fees of GPs are increasingly under pressure from reluctant LPs
Introduction

Value Creation And Transfer In LBOs

How Can a LBO Create Value (For Shareholders)?
 Deleveraging
− Using available free cash flow to repay debt
 Enhancing Top line growth
− Market expansion
− Market share gains
− Consolidation: bolt-on acquisitions
 Operational improvements
− Margin improvements and higher efficiency
 Fiscal advantages
− Tax payments to the government are reduced by the tax shield on interest
 Multiple expansion?
− Can be a result of operating improvements or business turnaround
− Typically assume entry and exit at same multiple (iso-multiple)
 Some historical statistics (Jin and Wang 2002) – For all LBO’s from 1996 to 2000, value created came from
43% operating improvement (incl. top line), 24% Leverage and 22% multiple expansion (industry-wide
expansion), 11% multiple arbitrage (higher multiple at exit due to better business)

How Can a LBO Create Value? – Corporate Finance Vision
 Change in market valuation
 Private information (MBO)
 Superior market information
 Superior deal making
 Sale of noncore or underperforming assets
Financial Arbitrage
 Cutting costs
 Reducing WCR
 Removing inefficient managers
Increasing
Operational
Effectiveness
Financial
engineering
 Optimizing capital structure
 Reducing corporate tax
 Optimization of corporate scope
 No conglomerate cross-subsidy
Increasing
Strategic
Distinctiveness
 Debt discipline
 Improving incentive alignment (strategic value accountability)
 Monitoring and controlling
Reducing
Agency Costs
 Restoring entrepreneurial spirit
 Advising and enabling
Mentoring
Source: Berg and Gottschalg, Jensen

Ferdinand petra - introduction to LBO and Private Equity

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Ferdinand petra - introduction to LBO and Private Equity