Private Equity Excel Assignment 2 essay paper
Private Equity Excel Assignment 2
Apollo discussion v13.ppt
STRICTLY CONFIDENTIAL
Investment Banking
Valuation, Leveraged Buyouts, and Mergers & Acquisitions
Chapter 5: LBO Analysis
JOSHUA ROSENBAUM & JOSHUA PEARL
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Copyright © 2013 by Joshua Rosenbaum and Joshua Pearl. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4470, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressedPrivate Equity Excel Assignment 2 to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.Private Equity Excel Assignment 2
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Private Equity Excel Assignment 2
Library of Congress Cataloging-in-Publication Data:
ISBN-13 978-0-470-44220-3
Printed in the United States of America
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Overview of LBO Analysis
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- Core analytical tool used to assess financing structure, investment returns, and valuation in leveraged buyout scenarios
- Same techniques can also be used to assess refinancing opportunities and restructuring alternatives for corporate issuers
- Requires specialized knowledge of financial modeling, leveraged debt capital markets, M&A, and accounting
- At the center of an LBO analysis is a financial model (the “LBO model”)
- Constructed with the flexibility to analyze a given target’s performance under multiple financing structures and operating scenarios
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Apollo discussion v13.pptPrivate Equity Excel Assignment 2
Overview of LBO Analysis
Valuation
- LBO analysis is used by sponsors, bankers, and other finance professionals to determine an implied valuation range for a given target in a potential LBO sale based on achieving acceptable returns
- Valuation output is premised on key variables such as financial projections, purchase price, and financing structure, as well as exit multiple and year
- In an M&A sell-side advisory context, the banker conducts LBO analysis to assess valuation from the perspective of a financial sponsor
- Similarly, on buy-side engagements, the banker typically performs LBO analysis to help determine a purchase price range
- For a strategic buyer, this analysis is used to frame valuation and bidding strategy by analyzing the price that a competing sponsor bidder might be willing to pay for the target
Financing Structure
- On the debt financing side, the banker uses LBO analysis to help craft a viable financing structure for the target, which encompasses the amount and type of debt, as well as an equity contribution from a financial sponsorPrivate Equity Excel Assignment 2
- The analysis of an LBO financing structure is typically spearheaded by an investment bank’s leveraged finance and capital market teams
- Once the private equity buyer chooses the preferred financing structure the deal team presents it to the bank’s internal credit committee(s) for approval
- Following committee approval, the investment banks typically provide a financing commitment, which is then submitted to the seller and its advisor(s) as part of its final bid package
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LBO Analysis Steps
Step I. Locate and Analyze the Necessary Information
Step II. Build the Pre-LBO Model
a. Build Historical and Projected Income Statement through EBIT
b. Input Opening Balance Sheet and Project Balance Sheet ItemsPrivate Equity Excel Assignment 2
c. Build Cash Flow Statement through Investing Activities
Step III. Input Transaction Structure
a. Enter Purchase Price Assumptions
b. Enter Financing Structure into Sources and Uses
c. Link Sources and Uses to Balance Sheet Adjustments Columns
Step IV. Complete the Post-LBO Model
a. Build Debt Schedule
b. Complete Pro Forma Income Statement from EBIT to Net Income
c. Complete Pro Forma Balance Sheet
d. Complete Pro Forma Cash Flow Statement
Step V. Perform LBO Analysis
a. Analyze Financing Structure
b. Perform Returns Analysis
c. Determine Valuation
d. Create Transaction Summary Page
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LBO Analysis Output
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Step I
Locate and Analyze the Necessary Information
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Step I: Locate and Analyze the Necessary Information
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- When performing LBO analysis, the first step is to collect, organize, and analyze all available information on the target, its sector, and the specifics of the transaction
- In an organized sale process, the sell-side advisor provides such detail to prospective buyers, including financial projections that usually form the basis for the initial LBO model
- This information is typically contained in a CIM, with additional information provided via a management presentation and data room
- In the absence of a CIM or supplemental company information (e.g., if the target is not being actively sold), the banker must rely upon public sources to perform preliminary due diligence and develop an initial set of financial projections
- Regardless of whether there is a formal sale process, it is important for the banker to independently verify as much information as possible about the target and its sector
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Step II
Build the Pre-LBO Model
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Step II: Build the Pre-LBO Model
Step II(a): Build Historical and Projected Income Statement through EBIT
Step II(b): Input Opening Balance Sheet and Project Balance Sheet Items
Step II(c): Build Cash Flow Statement through Investing Activities
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Step II: Build the Pre-LBO Model
Step II(a): Build Historical and Projected Income Statement through EBIT
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- Typically begin the pre-LBO model by inputting the target’s historical income statement information for the prior three-year period, if available
- Historical income statement is generally only built through EBIT, as the target’s prior annual interest expense and net income are not relevant given that the target will be recapitalized through the LBO
- Management projections for sales through EBIT, as provided in the CIM, are then entered into an assumptions page which feeds into the projected income statement until other operating scenarios are developed/provided
Additional Cases
- In addition to the Management Case, the deal team typically develops its own, more conservative operating scenario, known as the “Base Case”
- Base Case is generally premised on management assumptions, but with adjustments made based on the deal team’s independent due diligence, research, and perspectives
- The bank’s internal credit committee(s) also requires the deal team to analyze the target’s performance under one or more stress cases in order to gain comfort with the target’s ability to service and repay debt during periods of duress
- “Downside Cases” typically present the target’s financial performance with haircuts to top line growth, margins, and potentially capex and working capital efficiency
- The operating scenario that the deal team ultimately uses to set covenants and market the transaction to investors is provided by the sponsor (the “Sponsor Case”)
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Step II: Build the Pre-LBO Model
Step II(a): Build Historical and Projected Income Statement through EBIT
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Step II: Build the Pre-LBO Model
Step II(b): Input Opening Balance Sheet and Project Balance Sheet Items
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- The opening balance sheet (and potentially projected balance sheet data) for the target is typically provided in the CIM and entered into the pre-LBO model
- In addition to the traditional balance sheet accounts, new line items necessary for modeling the pro forma LBO financing structure are added, such as Financing fees (which are amortized) under long-term assets and Detailed line items for the new financing structure under long-term liabilities
- Must then build functionality into the model in order to input the new LBO financing structure
- Accomplished by inserting “adjustment” columns to account for the additions and subtractions to the opening balance sheet that result from the LBO
- Also insert a “pro forma” column, which nets the adjustments made to the opening balance sheet and serves as the starting point for projecting the target’s post-LBO balance sheet throughout the projection period
- Inputs for the adjustment columns, which bridge from the opening balance sheet to the pro forma closing balance sheet, feed from the sources and uses of funds in the transaction
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Step II: Build the Pre-LBO Model
Step II(b): Input Opening Balance Sheet and Project Balance Sheet Items
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Step II: Build the Pre-LBO Model
Step II(c): Build Cash Flow Statement through Investing Activities
Operating Activities: Income Statement Links
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- In building the cash flow statement, all the appropriate income statement items, including net income and non-cash expenses (e.g., D&A, amortization of deferred financing fees), must be linked to the operating activities section of the cash flow statement
- Net income is initially inflated in the pre-LBO model as it excludes the pro forma interest expense and amortization of deferred financing fees associated with the LBO financing structure
- Amortization of deferred financing fees is a non-cash expense that is added back to net income in the post-LBO cash flow statement
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Step II: Build the Pre-LBO Model
Step II(c): Build Cash Flow Statement through Investing Activities
Operating Activities: Balance Sheet Links
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- Each YoY change to a balance sheet account must be accounted for by a corresponding addition or subtraction to the appropriate line item on the cash flow statement
- YoY changes in the target’s projected working capital items are calculated in their corresponding line items in the operating activities section of the cash flow statement
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Step II: Build the Pre-LBO Model
Step II(c): Build Cash Flow Statement through Investing Activities
Investing Activities
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- Capex is typically the key line item under investing activities, although planned acquisitions or divestitures may also be captured in the other investing activities line item
- Projected capex assumptions are typically sourced from the CIM and inputted into an assumptions page where they are linked to the cash flow statement
- The target’s projected net PP&E must incorporate the capex projections (added to PP&E) as well as those for depreciation (subtracted from PP&E)
- The sum of the annual cash flows provided by operating activities and investing activities provides annual cash flow available for debt repayment, which is commonly referred to as free cash flow
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Step II: Build the Pre-LBO Model
Step II(c): Build Cash Flow Statement through Investing Activities
Financing Activities
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- The financing activities section of the cash flow statement is constructed to include line items for the (repayment)/drawdown of each debt instrument in the LBO financing structure
- These line items are initially left blank until the LBO financing structure is entered into the model (Step III) and a detailed debt schedule is built (Step IV(a))
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Step II: Build the Pre-LBO Model
Step II(c): Build Cash Flow Statement through Investing Activities
Cash Flow Statement Links to Balance Sheet
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- Once the cash flow statement is built, ending cash balance for each year in the projection period is linked to the cash and cash equivalents line item in the balance sheet, thereby fully linking the financial statements of the pre-LBO model
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Step III
Input Transaction Structure
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Step III: Input Transaction Structure
Step III(a): Enter Purchase Price Assumptions
Step III(b): Enter Financing Structure into Sources and Uses
Step III(c): Link Sources and Uses to Balance Sheet Adjustments Columns
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Step III: Input Transaction Structure
Step III(a): Enter Purchase Price Assumptions
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- A purchase price must be assumed for a given target in order to determine the supporting financing structure (debt and equity)
Purchase Price Assumptions ― Private Company
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Step III: Input Transaction Structure
Step III(a): Enter Purchase Price Assumptions
- For a public company, the equity purchase price is calculated by multiplying the offer price per share by the target’s fully diluted shares outstanding
- Net debt is then added to the equity purchase price to arrive at an implied enterprise value
Purchase Price Assumptions ― Public Company
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Step III: Input Transaction Structure
Step III(b): Enter Financing Structure into Sources and Uses
- A sources and uses table is used to summarize the flow of funds required to consummate a transaction
- Sources of funds refer to the total capital used to finance an acquisition while uses of funds refer to those items funded by the capital sources
- Sum of the sources of funds must equal the sum of the uses of funds
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Step III: Input Transaction Structure
Step III(c): Link Sources and Uses to Balance Sheet Adjustments Columns
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- Once the sources and uses of funds are entered into the model, each amount is linked to the appropriate cell in the adjustments columns adjacent to the opening balance sheet
- Any goodwill that is created, however, is calculated on the basis of equity purchase price and net identifiable assets (Calculated as shareholders’ equity less existing goodwill)
- The equity contribution must also be adjusted to account for any transaction-related fees and expenses (other than financing fees) that are expensed upfront
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Step III: Input Transaction Structure
Step III(c): Link Sources and Uses to Balance Sheet Adjustments Columns
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Step IV
Complete the Post-LBO Model
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Step IV: Complete the Post-LBO Model
Step IV(a): Build Debt Schedule
Step IV(b): Complete Pro Forma Income Statement from EBIT to Net Income
Step IV(c): Complete Pro Forma Balance Sheet
Step IV(d): Complete Pro Forma Cash Flow Statement
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Step IV: Complete the Post-LBO Model
Step IV(a): Build Debt Schedule
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- The debt schedule is an integral component of the LBO model, serving to layer in the pro forma effects of the LBO financing structure on the target’s financial statements
- Debt schedule enables the banker to:
- Complete the pro forma income statement from EBIT to net income
- Complete the pro forma long-term liabilities and shareholders’ equity sections of the balance sheet
- Complete the pro forma financing activities section of the cash flow statement
- Applies free cash flow to make mandatory and optional debt repayments, thereby calculating the annual beginning and ending balances for each debt tranche
- Debt repayment amounts are linked to the financing activities section of the cash flow statement and the ending debt balances are linked to the balance sheet
- Also used to calculate the annual interest expense for the individual debt instruments, which is linked to the income statement
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Step IV: Complete the Post-LBO Model
Step IV(a): Build Debt Schedule
Forward LIBOR Curve
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- For floating-rate debt instruments, such as revolving credit facilities and term loans, interest rates are typically based on LIBOR plus a fixed spread
- To calculate projected annual interest expense, must first enter future LIBOR estimates for each year of the projection period
- Pricing spreads for the revolver and TLB are added to the forward LIBOR in each year of the projection period to calculate annual interest rates
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Step IV: Complete the Post-LBO Model
Step IV(a): Build Debt Schedule
Cash Available for Debt Repayment (Free Cash Flow)
- The annual projected cash available for debt repayment is the sum of the cash flows provided by operating and investing activities on the cash flow statement
- For each year in the projection period, this amount is first used to make mandatory debt repayments on the term loan tranches
- Remaining cash flow is used to make optional debt repayments, as calculated in the cash available for optional debt repayment line item
- In addition to internally generated free cash flow, existing cash from the balance sheet may be used (“swept”) to make incremental debt repayments
- In the event the post-LBO balance sheet has a cash balance, it is common to keep a constant minimum level of cash on the balance sheet throughout the projection period by inputting a dollar amount under the “MinCash” heading
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Step IV: Complete the Post-LBO Model
Step IV(a): Build Debt Schedule
Cash Available for Debt Repayment (Free Cash Flow)
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Step IV: Complete the Post-LBO Model
Step IV(a): Build Debt Schedule
Revolving Credit Facility
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- In the “Revolving Credit Facility” section of the debt schedule, input the spread, term, and commitment fee associated with the facility
- Facility’s size is linked from an assumptions page where the financing structure is entered and the beginning balance line item for the first year of the projection period is linked from the balance sheet
- The revolver’s drawdown/(repayment) line item feeds from the cash available for optional debt repayment line item at the top of the debt schedule
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Step IV: Complete the Post-LBO Model
Step IV(a): Build Debt Schedule
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Step IV: Complete the Post-LBO Model
Step IV(a): Build Debt Schedule
Term Loan Facility
- In the “Term Loan Facility” section of the debt schedule, the banker inputs the spread, term, and mandatory repayment schedule associated with the facility
- Facility’s size is linked from the sources and uses of funds on the transaction summary page
Mandatory Repayments (Amortization)
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- Unlike a revolving credit facility, which only requires repayment at the maturity date of all the outstanding advances, a term loan facility is fully funded at close and has a set amortization schedule, typically 1% per year
Optional Repayments
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- A typical LBO model employs a “100% cash flow sweep” that assumes all cash generated by the target after making mandatory debt repayments is applied to the optional repayment of outstanding prepayable debt (typically bank debt)
- For modeling purposes, bank debt is generally repaid in the following order: revolver balance, term loan A, term loan B, etc.
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Step IV: Complete the Post-LBO Model
Step IV(a): Build Debt Schedule
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Step IV: Complete the Post-LBO Model
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Step IV: Complete the Post-LBO Model
Step IV(b): Complete Pro Forma Income Statement from EBIT to Net Income
- The calculated average annual interest expense for each loan, bond, or other debt instrument in the capital structure is linked from the completed debt schedule to its corresponding line item on the income statement
Cash Interest Expense
- Refers to a company’s actual cash interest and associated financing-related payments in a given year
- It is the sum of the average interest expense for each cash-pay debt instrument plus the commitment fee on the unused portion of the revolver and the administrative agent fee
Total Interest Expense
- Sum of cash and non-cash interest expense, most notably the amortization of deferred financing fees, which is linked from an assumptions page
Net Income
- Subtract net interest expense from EBIT, which creates earnings before taxes (EBT)
- Multiply EBT by target’s marginal tax rate to produce tax expense, which is netted out of EBT to calculate net income
- Net income for each year in the projection period is linked from the income statement to the cash flow statement as the first line item under operating activities
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Step IV: Complete the Post-LBO Model
Step IV(b): Complete Pro Forma Income Statement from EBIT to Net Income
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Step IV: Complete the Post-LBO Model
Step IV(c): Complete Pro Forma Balance Sheet
Liabilities
- The balance sheet is completed by linking the year-end balances for each debt instrument directly from the debt schedule
- The remaining non-current and non-debt liabilities, captured in the other long-term liabilities line item, are generally held constant at the prior year level in the absence of specific management guidance
Shareholders’ Equity
- Pro forma net income, which has now been calculated for each year in the projection period, is added to the prior year’s shareholders’ equity as retained earnings
Step IV(d): Complete Pro Forma Cash Flow Statement
- To complete the cash flow statement, the mandatory and optional repayments for each debt instrument, as calculated in the debt schedule, are linked to the appropriate line items in the financing activities section and summed to produce the annual repayment amounts
- Annual pro forma beginning and ending cash balances are then calculated accordingly
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Step IV: Complete the Post-LBO Model
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Step IV: Complete the Post-LBO Model
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Step V
Perform LBO Analysis
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Step V: Perform LBO Analysis
Step V(a): Analyze Financing Structure
Step V(b): Perform Returns Analysis
Step V(c): Determine Valuation
Step V(d): Create Transaction Summary Page
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Step V: Perform LBO Analysis
Step V(a): Analyze Financing Structure
- A central part of LBO analysis is the crafting of an optimal financing structure for a given transaction
- From an underwriting perspective, this involves determining whether the target’s financial projections can support a given leveraged financing structure under various business and economic conditions
- A key credit risk management concern for the underwriters centers on the target’s ability to service its annual interest expense and repay all (or a substantial portion) of its bank debt within the proposed tenor
- The primary credit metrics used to analyze the target’s ability to support a given capital structure include variations of the leverage and coverage ratios outlined in Chapter 1 (e.g., debt-to-EBITDA, debt-to-total capitalization, and EBITDA-to-interest expense)
- The next slide displays a typical output summarizing the target’s key financial data as well as pro forma capitalization and credit statistics for each year in the projection period
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Step V: Perform LBO Analysis
Step V(a): Analyze Financing Structure
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Step V: Perform LBO Analysis
Step V(b): Perform Returns Analysis
- After analyzing the contemplated financing structure from a debt repayment and credit statistics perspective, determine whether it provides sufficient returns to the sponsor given the proposed purchase price and equity contribution
- Sponsors have historically sought 20%+ IRRs in assessing acquisition opportunities
- If the implied returns are too low, both the purchase price and financing structure need to be revisited
- IRRs are driven primarily by the target’s projected financial performance, the assumed purchase price and financing structure (particularly the size of the equity contribution), and the assumed exit multiple and year (assuming a sale)
- Although a sponsor may realize a monetization or exit through various strategies and timeframes, a traditional LBO analysis contemplates a full exit via a sale of the entire company in five years
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Step V: Perform LBO Analysis
Step V(b): Perform Returns Analysis
Return Assumptions
- In a traditional LBO analysis, it is common practice to conservatively assume an exit multiple equal to (or below) the entry multiple
Calculation of Enterprise Value and Equity Value at Exit
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Step V: Perform LBO Analysis
Step V(b): Perform Returns Analysis
IRR and Cash Return Calculations
- Assuming no additional cash inflows (dividends to the sponsor) or outflows (additional investment by the sponsor) during the investment period, IRR and cash return are calculated on the basis of the sponsor’s initial equity contribution (outflow) and the assumed equity proceeds at exit (inflow)
- The initial equity contribution represents a cash outflow for the sponsor
- Cash distributions to the sponsor, such as proceeds received at exit or dividends received during the investment period, are shown as positive values on the timeline
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Step V: Perform LBO Analysis
Step V(b): Perform Returns Analysis
Returns at Various Exit Years
- On the next slide, we calculated IRR and cash return assuming an exit at the end of each year in the projection period using a fixed 8.0x EBITDA exit multiple
- As we progress through the projection period, equity value increases due to the increasing EBITDA and decreasing net debt
- Cash return increases as it is a function of the fixed initial equity investment and increasing equity value at exit
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Step V: Perform LBO Analysis
Step V(b): Perform Returns Analysis
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Step V: Perform LBO Analysis
Step V(b): Perform Returns Analysis
IRR Sensitivity Analysis
- Sensitivity analysis is critical for analyzing IRRs and framing LBO valuation
- IRR can be sensitized for several key value drivers, such as entry and exit multiple, exit year, leverage level, and equity contribution percentage, as well as key operating assumptions such as growth rates and margins
- It is also common to perform sensitivity analysis on a combination of exit multiples and exit years
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Step V: Perform LBO Analysis
Step V(c): Determine Valuation
- Sponsors base their LBO valuation in large part on their comfort with realizing acceptable returns at a given purchase price
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Step V: Perform LBO Analysis
Step V(d): Create Transaction Summary Page
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- Once the LBO model is fully functional, all the essential model outputs are linked to a transaction summary page
- This page provides an overview of the LBO analysis in a user-friendly format, typically displaying the sources and uses of funds, acquisition multiples, summary returns analysis, and summary financial data, as well as projected capitalization and credit statistics
- Allows the deal team to quickly review and spot-check the analysis and make adjustments to the purchase price, financing structure, operating assumptions, and other key inputs as necessary
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Step V: Perform LBO Analysis
Step V(d): Create Transaction Summary Page
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