Levered FCF - Interest & Net Borrowings
Briefly revisiting levered FCF (as we hardly ever use it at work) and something caught my eye.
When getting to levered FCF from net income: you do not add back interest (reducing resulting LFCF figure), but you do add net borrowings. The justification being they’re included because the proceeds can be used to distribute dividends or purchase back equity (buy-backs) for shareholders.
In this case, is the debt treated as a ‘future financial obligation’ because it’s still required to be returned to the lender at some point?
My question is: would you add the net borrowings if the debt was owed within the year of the LFCF calculation?
Or does the concept of LFCF completely disregard any principal repayment, and thus is this why it is never used in practice?
Cheers
I would read the credit docs and see what the debt is permitted to be used for. Usually, lenders won't let you use the cash they gave you to pay out equity holders. Though if the capital was specifically for a div recap, it would be alright to add it back.
Edit: Never used in practice? Erm, what the sigma. You need LFCFs for LBOs and equity waterfalls.
If you didn’t understand, my point with the above is that LFCF is supposed to represent cash flow available to equity holders. That means LFCF is the portion of free cash flow left for equity after all mandatory debt obligations, operations, etc. has been paid out. Mandatory debt servicing should be included in the calculation of LFCF as that has to be paid before an equity holder can get paid, generally speaking.
Though, you also have to ask yourself. With the loan agreement, am I free to use the debt proceeds for whatever I want or am I only allowed to use it for something specific? Per the above, lenders will not want or allow you to use their loan to give yourself (the equity holder) free money. If this is the case and the cash is restricted, you’re not going to include the borrowings portion in your LFCF calc because it cannot be distributed to equity holders.
You are confusing LFCF (Leveraged Free Cash Flow) with FCFE (Free Cash Flow to Equity), FCFE = LFCF + Net borrowings = LFCF + (new debt - principal repayments), and LFCF = Net Income + Non-Cash items (e.g., D&A) - DeltaWC - CapEx
Also seen LFCF before debt service and after debt service; at the end, there are thousands of definitions, choose yours and be clear on it's components
Then is the academic definition of LFCF from OP wrong? I thought LFCF represented “cash flow to equity”
Non-GAAP term issues 🤷. At my firm we consider LFCF, as cash flow after all mandatory debt obligations, including mandatory debt amortization. Though, for clarity, this does not include any sweeps.
Perhaps my own bias, but at least on my deals, I haven’t seen much value in calculating levered free cash flow by the definition you’ve underlined (I.e., without mandatory debt amortization).
net borrowing = new debt issuance in current year - debt principal repayments in same year, so... ?
if you want to get more granular and want to consider some gap between borrowing and paying then sure, split in quarters/month and do the same formula
Standard definition in public markets of FCF (which is always LFCF in public markets) is simply CFO less capex (per US GAAP — note in IFRS cash interest can be outside CFO / in financing section).
Because sponsors frequently use amortizing TL B and more heavy use of finance leases versus bond capital structures in public markets, for purposes of LBOs or credit investing in the loans/bonds of LBOs, you subtract out mandatory debt principal payments and finance leases principal payments.
Furthermore, some people exclude growth capex, as, in theory, this component of capex could be paid out as a dividend and would only be invested if the ROIC on such investment > WACC (putting mgmt incentives aside…)
So the formula is CFO less capex less mandatory debt / lease principal. Or equal to Adj EBITDA, less cash adjustments, less cash interest, less cash tax, less increase in NWC, less capex, less mandatory debt / lease principal payments.
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