Entry Multiple in Case Study / PE Modelling Test

How do you determine what is an appropriate entry multiple in a PE case study or modelling test where they don't give you any information on it and you are not familiar with the industry they have chosen?

 

So you know what the industry is that they have chosen? If so, run some quick comps on companies in that industry and see what EBITDA margins look like at the various multiples. Trick is to balance being conservative enough but also not so conservative that you're unable to place a competitive bid. You should be able to exit the business at or above the multiple you paid.

 
Best Response
CaliBankerSF:

So you know what the industry is that they have chosen? If so, run some quick comps on companies in that industry and see what EBITDA margins look like at the various multiples. Trick is to balance being conservative enough but also not so conservative that you're unable to place a competitive bid. You should be able to exit the business at or above the multiple you paid.

I'm assuming the OP is referring to on-site case studies where there is no opportunity to run comps. If you're given a share price (fairly common, in my experience), run the LBO based on a 20-30% premium to current trading. In modeling tests where you are not provided a share price, you will generally be given an entry / exit multiple assumption in the primer pack.

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."
 
CaliBankerSF:

You should be able to exit the business at or above the multiple you paid.

If one was truly being conservative and using 70% debt, shouldn't they assume the same or even a 1/2 turn lower for the exit if it is a mature buyout?

I'm not talking about growth equity or LBOs with a growth story (whether that be add-ons lined up or solid sales growth).

 

I think you guys are saying similar things but not totally the same (i.e., neither of you are wrong).

CaliBanker is saying you should pick an entry multiple that is conservative because it is a floor for your exit multiple, with further upside for mult expansion. This is more of a comps based approach - one way you'd do this if you had time to research is you'd look at your peers and might use the min as a benchmark.

You're essentially taking a different view - you should pick an entry multiple that is conservative enough such that the returns work, even if you lose half a turn. This is more of a mechanical approach, better suited for a case because you don't actually need to run comps to do this. You just back into an acceptable returns range.

 

In case absolutely no info is given, I'd try to make an informed guess based on the financial profile (growth, profitability, capex intensity, etc) and - most importantly - assume entry=exit multiple. That way you mitigate being way off a little. I'd always be careful to use different assumptions for the exit unless there is very clear rationale for multiple expansion.

 
EuroLocust:

In case absolutely no info is given, I'd try to make an informed guess based on the financial profile (growth, profitability, capex intensity, etc) and - most importantly - assume entry=exit multiple. That way you mitigate being way off a little. I'd always be careful to use different assumptions for the exit unless there is very clear rationale for multiple expansion.

If you're given absolutely no information, I would just back into a (sanity checked) multiple that yields ~20% IRR with no multiple expansion / contraction. It's much easier to explain that you were illustrating the purchase price at which the deal would make sense or, alternatively, what you would need to believe in order to make the deal work.

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."
 

One other point to keep in mind is that this is a real struggle faced everyday by PE firms - they are presented with opportunities in industries (or sub-industries) that they are not familiar with. That means you need to be somewhat conservative (perhaps even moreso... but still reasonable). If your bid is just not competitive, I'd argue that's OK because (in real life and also in this case study universe) it's better to lose a deal that has a lot of uncertainty and unknowns than to win a deal of the same nature. I think that could actually be a pretty strong point to make if you can explain it clearly.

You should note that my comments above really only apply if you're interviewing at a firm that looks at a variety of industries. If you're interviewing at a firm that focuses solely on industrial companies and you don't know what an reasonable multiple range might be for a typical auto OEM might be, well then maybe you should question whether this firm is the best fit for you.

 

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