Valuation and Investment

Banking
Unit – 10
LBO ANALYSIS
By
PREMALATHA K P
LBO – LEVERAGED BUY OUT
• Leveraged buy out is a financing technique when the debt is used to
purchase the stock of a corporation.
• Ratio of 90% debt to 10% equity.
• Going private deal is where a public company is taken private with
some debt and some equity.
• LBO’s are conducted for three reasons
• To take a public company private
• To spin off a portion of an existing business by selling it
• To transfer private property, as is the case with a change in small business
ownership
The LBO analysis
generally provides a
"floor" valuation for the
company, and is useful
in determining what a
financial sponsor can
afford to pay for the
target and still realize an
adequate return on its
investment.
Transaction Structure of an LBO
Applications of the LBO Analysis
• Determine the maximum purchase price for a business that can be paid
based on certain leverage (debt) levels and equity return parameters.
• Develop a view of the leverage and equity characteristics of a leveraged
transaction at a given price.
• 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.
Steps in the LBO Analysis
• Develop operating assumptions and projections for the standalone company to arrive at
EBITDA and cash flow available for debt repayment over the investment horizon (typically
3 to 7 years).
• Determine key leverage levels and capital structure (senior and subordinated debt,
mezzanine financing, etc.) that result in realistic financial coverage and credit statistics.
• Estimate the multiple at which the sponsor is expected to exit the investment (should
generally be similar to the entry multiple).
• Calculate equity returns (IRRs) to the financial sponsor and sensitize the results to a
range of leverage and exit multiples, as well as investment horizons.
• Solve for the price that can be paid to meet the above parameters (alternatively, if the
price is fixed, solve for achievable returns).
LBO Returns Attribution Analysis?
• An LBO Returns Attribution Analysis quantifies the contribution
from each of the main value creation drivers in private equity
investments.
• The framework for measuring the sources of value creation from a
leveraged buyout (LBO) transaction is composed of three main
parts:
• EBITDA Growth → Change in Initial EBITDA to Exit Year EBITDA
• Multiple Expansion → Change in Purchase Multiple to Exit Multiple
• Debt Paydown → Change in Initial Net Debt to Ending Net Debt
Financial / Capital Structure in an LBO Model
• Capital structure in a Leveraged Buyout (LBO) refers to the components of financing that
are used in purchasing a target company.
• Although each LBO is structured differently, the capital structure is usually similar in most
newly-purchased companies, with the largest percentage of LBO financing being debt.
• The typical capital structure is financing with the cheapest and less risky first, followed by
other available options.
• An LBO capital structure may include the following:
• Bank Debt / Senior Debt
• High yield / Subordinate Debt
• Mezzanine Debt
• Equity
LBO - Assumptions
• Before building the LBO model, assumptions need to be made
on inputs, including
• Financing,
• Operating metrics of the business,
• Sources, and uses of cash,
• Purchase price allocation, and
• Operating scenarios.