Private Equity technicals
Hi all, I need help with a few questions:
- Company A has GM of 80% and company B of 40%, EBITDA margin is 30% for both. Which would ould you invest in and why?
- Your client sells subscription contracts. On Jan 1 it sells a 1-year contract for a TCV of 120 but the contract starts July 1. Walk me through the 3 statements in year 1 and year 2 selling the same contract.
- What happens to the PE ratio after a dividend recap
Feel free to add other questions.
1) Company A... operating leverage opportunity on fixed cost base with scaling.
2) Just a Non-gaap bookings/billings/RPOs and deferred revenue/DTA accounting question.
3) First instinct; lower P/E ratio. But Price is market driven so potentially higher if recap is seen as conviction.
Could you elaborate 1 and 2 please? Thanks
1) Bridge between gross profit and EBITDA is mostly fixed costs whereas COGS are mostly variable that don’t scale well.
2) TCV is your Bookings. Find the billings. Then find where cash is paid ahead of performance obligations to get deferred revenue. Track the DTAs on a separate schedule. Google revenue recognition for SaaS.
3) You can think about multiples from a calculation perspective (numerator divided by denominator). Immediately the P/E falls as earnings won’t change until the new debt starts bearing interest.
Helpful to think about the multiple (or yield) as the perception of growth and risk/necessary reward.
More debt means the cost of equity is for something further levered down in the risk structure. Lower price will be offered to get that higher required return.
For 3) I think you could also argue that dividend recap means more interest expense so lower earnings and higher P/E. But you're also adding leverage so those cash flows are discounted at a higher rate so arguably lower P/E ratio. Tough to say where things shake out?
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