Rollover of Existing Debt
Hi all, sorry for the basic question but having some trouble grasping this.
Let's say a sponsor is buying a public company at a 20% premium to its current share price, which would give us a $1,000 equity value, and the company has $200 of existing debt (therefore TEV = $1,200), and the debt is refinanced in the transaction.
What is actually happening to the debt in this case? I've read a lot that LBOs are "cash free debt free" which implies the seller uses its proceeds to pay off any existing debt - would that mean that the seller gets $1,200 here and then uses $200 to pay off the debt? I don't understand why we say the debt is "refinanced" then, since then isn't the TEV of the company only $1,000 and so the sponsor isn't actually raising debt to refinance the $200?
Any insights much appreciated, have been struggling with this
The debt is actually being repaid. A change of control provision would be triggered which requires the debt to be repaid. The bankers/lenders will reunderwrite the debt and refinance the company.
Offer TEV of the target is still 1,200. The offer equity price is 1,000. A way to actually see the debt repayment if you lay out your sources and uses as the below.
Uses - Offer equity price: 1000 - Existing net debt: 200
Sources - New (refinanced) debt: 700 - Sponsor equity (plug): 500
The new debt raised by the sponsor will be used to pay off the old 200 of debt. This will all be in the closing legal documents and is mandatory for the transaction to close.
Thanks very much, apologies as I am still a few steps behind you:
Are the proceeds to the seller $1,200 then? I'm just confused by the whole "cash free, debt free" basis thing (don't know I fully understand what it means)
Proceeds to seller are the offer equity price of 1,000. Seller gets a wire for 1,000. Old lenders get a wire for 200 in order to pay off their debt.
Cash free debt free is normally used so people can further simplify the offer price. Buyers don’t really care how much the sellers get with respect to dollars. So the simplifying assumption is made to start modeling the company on cash free debt free basis. This doesn’t really make sense to do on a public company bcs you should have all the debt info. But on a private company, it lets you say, okay I’m going to buy this company for 10x off it’s EBITDA of 120. Offer TEV is still 1,200. Cash free debt free sources and uses would be.
Uses: Purchase price: 1200
Sources: New debt: 700 Sponsor equity: 500
You can then run a model off this without knowing the old debt balance. All you really care about is if your new equity gets a nice return. You can work out exactly how much the seller gets paid for their equity later (which is dependent on the pre-transaction debt balance) but ultimately you don’t really care if it’s 700, 800 or 1,000.
This is so helpful and really clarifies what I've been spinning my wheels on. Thanks so much for taking the time to help out here, really appreciate it!!
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