Case Study – Leveraged Buyout Modeling

KKR Capital is considering a leveraged buyout of SmallCapCo.

Beginning Debt:
SmallCapCo has had poor operating results over the last few years,
Interest:
with Revenue and EBITDA declining rapidly, but KKR Capital believes Tax Rate:
it has found a management team that will stabilize SmallCapCo.
SmallCapCo currently has EBITDA of $250m, and ABC believes that Year 1 Year 2 Year 3 Year 4 Year 5
the new management team could keep EBITDA flat for the next 5 EBITDA:
years.
KKR Capital has obtained debt financing of $750m at 10% interest, D&A:
and SmallCapCo expects working capital to be a source of funds at Interest:
$6m per year.
EBT:
SmallCapCo requires capital expenditures of $35m per year, and it Taxes:
has a tax rate of 40%. Assume no transaction fees, zero minimum
cash required, and that PP&E on the balance sheet remains constant Net Income:
for the next 5 years.
Assume that excess cash is NOT used to repay the debt, and instead CF Adjustments
simply accumulates on the balance sheet.
Calculate the purchase price required for KKR Capital to obtain a 3.0x Depreciation
multiple of invested capital (MOIC) if it plans to sell SmallCapCo after Working Capital
five years at an EV/EBITDA multiple of 6.0x. CapEx

Cash Generated

Debt Balance

EBITDA Exit Multiple:

Exit EV:
Debt:
Cash Generated:
Equity Proceeds:

Targeted MOIC:

Initial Investment:
 Leveraged Buyouts
John Green is a junior analyst at XYZ Equity Partners (XYZ), a private equity firm. Green is assigned 1 Is Green’s statement about LBO firms and VC firms correct?
to work with Sara Brown, a senior portfolio manager. Brown and Green meet to discuss existing and A Yes
potential investments. B No, because he is wrong with respect to VC firms
C No, because he is wrong with respect to LBO firms
Brown starts the meeting with a discussion of LBO firms and VC firms. Green tells Brown:
2 The multiple of expected proceeds at exit to invested funds for XYZ’s Stonehedge LBO investment is
LBO firms tend to invest in companies with predictable cash flows and experienced
closest to:
management teams, whereas VC firms tend to invest in companies with high EBITDA
A 2.77.
or EBIT growth and where an exit is fairly predictable.
B 2.89.
Brown and Green next analyze a potential investment in the leveraged buyout of Stonehedge C 2.98.
Industries. Specifically, they assess the expected gain if they elect to purchase all of the preference 3 The distribution available to the limited partners of the Venture Holdings fund from the first exit is
shares and 90% of the common equity through the LBO. Details of the LBO include the following: closest to:
■ The buyout requires an initial investment of $10 million. A $2 million.
■ Financing for the deal includes $6 million in debt, $3.6 million in preference shares that promise a B $8 million.
15% annual return paid at exit, and $0.4 million in common equity. C $10 million.
4 At the end of the most recent year, the ratio of total value to paid-in capital (TVPI) for the Venture
The expected exit value in six years is $15 million, with an estimated reduction in debt of Holdings fund was closest to:
$2.8 million over the six years prior to exit. A 0.29.
Brown and Green next discuss XYZ’s investment in Adventura Holdings, a private equity fund. B 1.34.
Selected details on the Adventura Holdings fund include the following: C 1.63.
■ Total committed capital is $115 million. 5 Based on Brown and Green’s estimate of NAV next year, the estimate of carried interest next year is
■ The distribution waterfall follows the deal-by-deal method, and carried interest is 20%. closest to:
■ On its first exit event a few years ago, the fund generated a $10 million profit. A $14.36 million.
B $22 million.
■ At the end of the most recent year, cumulative paid-in capital was $98 million, cumulative
C $25.46 million.
distributions paid out to LPs were $28 million, and the year-end NAV, before and after
6 Which of Green’s conclusions regarding the BlueBay Fund and the GreyPort Fund is correct?
distributions, was $170.52 million and $131.42 million, respectively.
A Only Conclusion 1
■ Brown and Green estimate that the fund’s NAV before distributions will be $242.32 million at the B Only Conclusion 2
end of next year. C Both Conclusion 1 and Conclusion 2
Finally, Brown and Green evaluate two venture capital funds for potential investment: the BlueBay
Fund and the GreyPort Fund. Both funds are in Year 7 of an estimated 10-year term. Selected data for
the two funds are presented in Exhibit 1.
Exhibit 1: Selected Data for the Funds
BlueBay Fund GreyPort Fund
DPI 0.11 0.55
RVPI 0.95 0.51
Gross IRR -11% 10%
Net IRR -20% 8%
After reviewing the performance data in Exhibit 1, Green draws the following conclusions:
Conclusion 1 The unrealized return on investment for the BlueBay Fund is greater than the unrealized
return on investment for the GreyPort Fund.
Conclusion 2 The TVPI for the GreyPort Fund is higher than the TVPI for the BlueBay Fund because the
GreyPort Fund has a higher gross IRR.