LBO VALUATION - Question?
Hey everyone,
I am heading to a superday this coming Friday and was wondering if someone could help me clear up a doubt related to LBO modeling. I had an SA stint this past summer and helped put together DCF models as well as M&A and Pub comp valuations. I did some work with LBOs but not enough to make me feel comfortable discussing all their ins and outs. At a basic level I understand how an LBO works: Small amount of equity down with the rest of the cap structure being made up of debt. Over the years the equity stake grows percentage-wise as the debt gets paid down. There is usually a lot of debt to help firms reach their desired IRR and there are usually several tranches of debt used to accomplish the financing. Obviosuly I get the whole pro-forma modeling thing as well where you change the BS going forward and see if the company can handle the debt, at what price, and assuming a certain exit multiple (typically same as the one the company bought in at) etc etc etc
My question relates more to using a DCF model as a valuation method. I've never actually done this myself but I've seen lbo's on football fields as well as several posts on the site discussing this. After going through them I am still a bit unclear as to how to go about it. Can someone help explain it to me? I just don't get which # in the model you work towards to use as a valuation figure for a football field. I mean, do you discount the debt loaded FCFs in a DCF-like manner, try to back into the buy-in price making assumptions about the PE firm's IRR and the amount for which they will sell the company at a couple of years down the road (and if so, how do you decide what the company will be sold for at that date), etc etc etc...
Thank you so much
I apologize if my thoughts are a bit all over the place
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Don't worry about LBOs
they are soooooo 2007...
Haha true. The value
Haha true.
The value (debt+equity) the buyer can pay for the company that yields an above hurdle IRR in the exit year.
You can go to
You can go to www.damodaran.com, and he has a spreadsheet for LBO valuation, it's on the valuation entry page.
so its pretty much the PV of
so its pretty much the PV of the free cash flows modeled on a proforma basis loaded with all the extra heavy int payments cause of the added debt?
While we're on this topic,
While we're on this topic, can someone explain where the entry/exit multiple is usually coming from? Is it the EV/EBITDA multiple, or is it a different metric? And is that metric an industry one or firm specific?
Industry specific
Industry specific multiples
EBITDA is common
Outputs of the model are
Outputs of the model are usually IRR and MOIC along purchase price, exit multiple, and leverage sensitivities.
DCF, LBO, etc.
Your original post was worded in a confusing fashion, but here are my answers to the questions I think you asked:
- DCF model - discounted cash flow analysis measures the intrinsic value of a company based on the present value of its projected cash flows
- LBO model - helps you assess the returns that a PE firm can get by buying a company in a leveraged transaction. Essentially the purpose of a leveraged transaction is to acquire a company with a large amout of debt but an amount that can still be serviced or paid down via cash flow generation. Over time, debt obligations are paid off which expands equity value (remember that EV = equity + debt - cash), so ultimately the goal is to expand enterprise value and thereby equity value off of a small initial equity commitment. I assume you know this if you made it to the final rounds of a leveraged finance interview. Anyway, LBO models enable PE investors to assess the internal rate of return (IRR) of a prospective investment and how that may vary based on different sensitivities and capital structures, which are things that basic DCF's do not enable you to do.
- Entry/exit multiples - your entry multiple is just the EV/EBITDA multiple that you pay for a particular investment. Usually you come up with this number based on comps and precedent transactions. Your exit multiple is just the multiple you think you can sell the company at when you exit. Normally you assume no multiple expansion unless you have some compelling reason otherwise because of industry trends, favorable organic growth or expansion through acquisitions, or just a better market environment overall. Given the current state of the economy, I don't think there is a good reason to bake multiple expansion into your model.
- Other things you should know about the current deal environment, just so you aren't completely out of touch with what's happening on Wall Street: you're looking at senior debt with interest upwards of 8-9% (think LIBOR + 450-550 bps) and mezz debt upwards of 15% right now, with many lenders expecting the credit environment to further deterioriate through early 2009. Credit is very hard to come by right now, but there is still some available financing in the middle markets. What'll eventually happen is that as interest rates come down to stimulate the general economy, more lenders will enter the market because they know that they can extend credit at lower rates and still make a killing...so like everything else, things come in cycles and credit will eventually be available again. But right now things are not looking good; credit is very expensive and a lot of PE shops are really focusing on portfolio management rather than new deals from now through year end. Capital structure of a lot of transactions, at least in the middle market (where I work), is usually something like 40% senior debt/20% mezz/40% equity these days. No more 80% debt/20% equity transactions -- not now, and not for a while.
Hope this helps...some of it was hastily written because I want to go to bed, but hopefully it's still all coherent. Good luck with your interview.