Hello everyone,
Here is a question about LBO that I have been thinking for a while.
Let's say a company that has 100M cash and 400M debt on its balance sheet. Currently equity value is 700M.
So...
Enterprise Value = 700M + (400M - 100M) = 1B
And we are going to use an LBO to buy the company with 50% equity and 50% debt.
So on a cash-free-debt-free basis...
we use 500M new cash, 500M new debt, 100M old cash on BS, to pay off 400M old debt and give 700M to the seller.
The question, however, is that after the LBO, the company's balance sheet look like this: 0 cash, 500M debt and 500M equity.
I understand that some operating assets/liabilitites (AR/AP) have been kept. But does the company need a minimal level of cash to run the business?
Hypothesis: is it because revolver is included in the 500M debt so the company does not need cash on the balance sheet to run its business?
Thanks a lot!
The debt might include a revolver but you can also assume the company would keep 10mln on its balance sheet, so you would need to raise 10mln more to fund your acquisition
Thanks, masters.
Does this mean that when we do Sources & Uses, we ususally add minimal cash (let's say 10M) to the Uses part and make Investor Equity in the Sources part 10M larger?
"I understand that some operating assets/liabilitites (AR/AP) have been kept. But does the company need a minimal level of cash to run the business?"
Yes, and part of the answer is understanding that TEV isn't just equity + debt - cash, it's more specifically equity + debt - EXCESS cash (potentially also adjusting for other things like unfunded pension liabilities, etc. but those aren't relevant here).
Thanks CHItizen.
So you mean, when deal team is negotiating the transaction with seller and banker, they will define the amount of "Excess Cash" and the adequate level of Operating Assets & Liabilitites. After those definitions, a number of TEV will be calculated. Am I correct? Also, as the follow-up question above, does this mean that when we do Sources & Uses, we ususally add minimal cash (let's say 10M) to the Uses part and make Investor Equity in the Sources part 10M larger?
I guess that works. I would just change the Sources though so you have 90mm from excess cash and 510mm of new cash/sponsor equity and then just subtract 90mm of cash when you are pro-formaing the balance sheet.
Check out this article on working capital pegs, which tries to solve the issues you are describing: http://www.stikeman.com/cps/rde/xchg/se-en/hs.xsl/16771.htm
In reality, a working capital adjustment is made to the S&U. In negotiations you agree on an appropriate level of working capital which goes to serve a few purposes:
Thanks, George. That is very instructive. One more question, so the definition of "Cash-Free-Debt-Free" does not mean "Zero Cash" in balance sheet after the transaction. It actually means "Excess Cash Free" and "Debt-Free".
Am I right?
More or less, yes. It's easy to fall into the trap of thinking a model in excel is the entirety of a company. Up until the moment the deal closes and beginning the second after the deal closes, the business is fully operating and moving cash into and out of accounts both internally and externally. The model where you start with 0 cash on day 1 and then on day 2, or month 2 or quarter 2 or whatever you have next doesn't really capture what happens every day or minute or hour at the business. You need to remember that it doesn't stop and then restart.
Think of it like a gas tank in your car. You fill up when its empty, but there is always a little left to get you to the station with a little comfort, even if your distance to empty is 0 (live dangerously).
"The question, however, is that after the LBO, the company's balance sheet look like this: 0 cash, 500M debt and 500M equity."
How could this possibly be the balance sheet. It doesn't balance. Your balance sheet would look like this:
Assets:
$500M Cash $500M Other Assets
Debt + SE:
$1,000M
This is incorrect. In the original situation with no operating cash, it would be:
Assets: 0 cash, 1000 other assets Debt and equity: 1000
You're right.
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