Basic question driving me nuts - valuations and LBO
Valuation methods - comps, precedents, dcf. These are all straightforward. But LBO being a valuation method, I will not understand. I've done basic LBO models but I can't see how it is a valuation method. Mind you, I am interviewing for IB positions and this is in the context of interviews. To me, LBO is primarily a returns analysis. Sure, there are assumptions on the entry value and exit value, but that is literally based on EBITDA and the multiple. The only thing I see that is valuation is that.
So it's hard for me to see how LBO is valuing anything. I guess if you solve for goal seek a specific IRR in an LBO, you can arrive at a specific valuation? But I feel that's not what I have typically come across.
Not to mention, it's even more confusing when people compare DCFs vs LBOs and they just seem to be inherently different. If anybody can help me understand what people mean when they say LBO is a valuation method and provide a nice framework to understand for an interview, it would be great. Again, I just see LBO as a return analysis framework more than valuation - although I guess I can see how they are linked?
it sets a ceiling on how much you can pay for a company to achieve the IRR
thinki it this way, any valuation exercise is to set a price on an asset to understand for how much you should buy it
in an LBO, you have an idea of how much the asset is worth (DCf), but the LBO valuation tells you how much you are ready to pay for this asset
different companies will have different LBO "prices/ceilings", which means that the value given by the LBO is intrincically linked to the casf flows of the asset, it's just that you impose an external limitation to the value: your capital constraints/desired IRR
or even easier: valuation as a whole tells me "how much should I pay for X", an LBO also answers to this company but considering IRR, not only the company/CF
Try using AI/ChatGPT. And I don't mean this as a meme/joke. I used it to prep for interviews and I was stunned how it basically can break you down concepts you don't understand and solidify it with concrete examples.
Of course there is a cap on complexity, but your questions seem pretty basic. Give it a try and prompt it to calculate LBOs. Let it change assumptions and explain you the key dynamics of the model, sensitivities, etc.
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