Hi guys:
I have a quick question please.. in some cases, why would IRR of an LBO be more sensitive to EBITDA margin change than to Revenue CAGR change?
For example, my IRR declines ~2% for each 1% decline in revenue CAGR during projection period; but my IRR declines ~3% for every 1% decline in annual EBITDA margin during projection period.
How can one ball-park test if these are correct? How can one think about these?
Thanks!
It’s all situation dependent but generally if your revenue base is $100 and margin is 30%. A 100bps absolute change is margin is $1 of value (don’t forget about the ongoing multiple effect) but 1% increase of revenue is on $0.30 of value that year (and more value when multiplied by the exit multiple) yet this is lower than 100bps change in margin.
I would think about this in terms of the nature of the investment and drivers of return. It
sounds like you are evaluating an opportunity that is profitable / cash generative, and exiting off an EBITDA multiple. In that case, your return will be much more sensitive to changes in EBITDA / margin much more than revenue (as a $1 increase or decrease to revenue obviously only passes through at a certain percentage).
On the other hand, if you were looking at a growth opportunity that may be unprofitable or just reaching breakeven where exit will be driven off revenue multiple (which is usually in-turn a function of revenue growth), then your return should be more sensitive to changes to revenue / growth.
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