Case Study Approach: Credit Investment

How would you approach the following case study?

You are asked to recommend investing (or not) in an issuer's TLB in the secondary market and provide your answer in the form of an IC memo. You are provided with its current YTM. You are also asked to determine the maximum debt it could take on (and the appropriate tranching and respective pricing) if it were the target of an LBO.

The issuer itself is public and currently trading at 20x EBITDA. You are asked to only use public information.

My approach would be the following:

• Credit analysis: Identify key credit risks and mitigants to determine the risk involve
• Comps/relative value analysis: Since we are only using public data, I would look at the 10-Ks for BDCs such as ARCC or OCSL to determine pricing for comps (based on comparable peers with similar credit ratios), notwithstanding that data is not live and may be stale.
  • I am not sure if there is a better way to do relative value analysis using only public data (is there perhaps an index that tracks this?)
• LBO:
  • Debt capacity to be determined by looking at the current capital structure of other public comps (as well as at the time of their refinancings/LBO, if applicable). As a general rule of thumb, I would have bank debt 4x, TLB 4x-6x, unsecured notes 6x-8x, PIK 8x-10x, Preferred equity 10x-13x, and the remainder with equity. I think this is appropriate for the bank debt and TLB, but can anyone comment if this is appropriate for the lower pieces of the capital stack?
  • Pricing of debt tranches: I'm a bit lost here, but my initial thought is to create an LBO and then target an IRR (with each junior piece of debt requiring a higher IRR)? But if this is the right approach, unsure how to set the correct IRR target, and if comps analysis would be relevant if capital structures are different across peers.