Buyout Debt Levels?
We were having this discussion internally today and I thought I would ask the broader community.
Let's say you have two companies, one in the Upper Mid-Market (A) and one in the Lower-Mid Market (B).
Company A has an EV/EBITDA of 18x and is CAPEX heavy so ~50% FCF conversion. Of the 18x, it has an aggressive gearing ratio of 7x Net Debt/EBITDA and 11x Equity (39% LTV).
Company B has an EV/EBITDA of 6x is CAPEX light with 95% FCF conversion. Of the 6x, it has 3.5x Net Debt/EBITDA and 2.5x Equity (58% LTV).
Company A has less cash and more aggressive leverage but assuming its valuation is actually reasonable (comps are at ~24x+) its overall LTV is lower. Company B is a smaller business with less turns of debt and higher cash conversion to support the debt load but the debt as a % of EV is much higher.
In these instances, how do you feel about debt levels? Are you more concerned with cash generation and how many turns there are of debt in comparison to EBITDA or are you more concerned with overall LTV? Curious to get peoples opinions.
This is a bizarre discussion without some key details. Are you asking from the perspective of the equityholder or debtholders?
Hard to evaluate the debt without some details assuming the same yield? Knowing nothing, my guess is company A has 1L/Unsecured or 1L/2L debt and company B is all 1L. Company B 1L pricing is definitely higher (ie riskier) assuming parameters above. 3.5x leverage on a 6.0x EV for a company with 95% FCF makes me think its a real turd.
From the perspective of an equity holder.
Why would you think company B is a turd? Assume it has 35% EBITDA margins
the EV multiple, nothing with good margins trades that low unless there's something critically wrong with it
So you're saying it has minimal capex, 35% ebitda margins and yet trades at 6x....clearly there is something that doesn't add up here.
We find a lot of businesses that look like this. What I omitted was the sector that it's in so 6x may or may not look that cheap. Also, as I stated above, it's the lower mid market so don't expect 10x+.
Based on the extremely limited info you provided...company A is more of a concern. Leverage is a better metric to focus on, not LTV (though somewhat tied)...if multiples compress and/or earnings stagnate/decline...you're gonna have a tough time getting that paper refinanced. Walking a real tight line with such elevated leverage out of the gate...better be sure no speed bumps are hit. With Company B that is not as much an issue.
Yep that's what we were thinking as well
…Partner? Lmao
B. Cash flow is king.
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