I recently had an interview with a MM shop and was asked to name the 4 valuation techniques. DCF, comparable and precedent are obviously the first 3. I work in corp dev so I know that liquidation value, replacement value and sum of the parts for diversified firms are potential methods for very specific scenarios and that LBO is a method as well. But my interviewer informed me that LBO was considered one of 4 main methods for valuing a company. I was not aware of this, hadn't learned this in undergrad/b school or heard of it in common practice. So I may have flubbed the question. Am I off base? Did this become a readily acceptable valuation technique?
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Yeah wouldn't really consider it a valuation technique. That being said you can back into a PE valuation - what a sponsor would be willing to pay in order to achieve a 15/20/25% IRR - using an lbo model. Common exercise for bankers running a sell side
Memes are for pussies that can't make arguments. Man up little one.
Real option valuation, where everything is made up and the numbers don't matter.
Real option valuation is just one subsect of option based valuation approaches. Have you heard of Black Scholes? Also, what's 'real' in your DCF models?
I think the kids call it Black-Scholes-Merton now so I am familiar with it. Yeah, DCF is a lot of make believe too but the PV of the cash flows from DCF goes into the B-S-M formula with other assumptions, like using implied volatility. So you start making more assumptions off of previous assumptions. So ROV can get pretty nutty. Just my hot take.
OP, the LBO is technically not a valuation technique, but given then PEGs frequently participate in the M&A process, an LBO is generally run alongside the DCF and comps, which is probably why your interviewer lumped it in here. Even in corp dev, we will run LBOs just to see how we are bidding vs. what a PEG might bid. You answered the question fine in my book, but unfortunately, most ib interviews are a game of elimination, and you gave the interviewer an easy out, so to speak.
It's a silly semantics question. What the interviewer meant by "LBO" is simply a levered DCF that discounts free cash flow to equity (or expected dividend and exit payments) at the cost of equity (or the fund's hurdle rate). In practice, no one actually does this - you run a base case LBO model and look at the IRR... purchase price has to be low enough as to allow for IRR > hurdle rate. So basically a reverse "goal seek" DCF. The interviewer is still wrong to call an LBO a "valuation technique" though.
As a former banker and now junior PE professional, I think one of the nice things about LBO relative to DCF is that there are fewer "made-up" inputs (like WACC).
Everyone knows the sponsor cost of capital (~20%). You use the same operating projections provided through the rest of the valuation methodologies (DCF, comps, etc.), so those are given. LevFin / Financing team provide the leverage read.
The rest is just basic math. Assume same exit multiple as entry multiple for base case, but can obviously show a range. That's how much the average sponsor can pay.
You can make a DCF say whatever you want: tweak the WACC, tweak the perp growth, etc. You can obviously do the same with LBO, but the simple base case LBO is harder to fudge.