Unlevered Free Cash Flows
Huge apologies if this is a repeat question, but is it often that a company with enterprise value exceeding the sum of its projected unlevered free cash flows is still a good buy? Is the sum of ufcf's an irrelevant quantity to private equity analysts?
Anyone have any thoughts?
In theory, no. In practicality, it can be still a good buy.
Most importantly you will have to do loads of returns analysis anyways and as long as you can meet your firm's hurdle with a good margin of safety, it can still represent a strong investment case.
That's super fair.
In PE - generally speaking, you should focus on Unlevered Free Cash flow (UFCF) yields.
In many ways the UFCF yields are representative of the earnings power or ROIC for the business, which is very important to understand overall business quality. Varies depending on the type of business / industry, but if a business can ideally hit 10-12% UFCF yields, there's probably enough levers through cost of financing, leverage %, value creation plan, etc to generate 20%+ IRRs which is the standard for PE.
You could also take this a step further to calculate the Levered Free Cash flow (LFCF) yields for the business if you have a view of the capital structure at buyout. I think in the old days of PE (pre-ZIRP), a good rule of thumb for traditional value PE investors was to buy businesses at ~10% LFCF yields, but with the amount of capital raised and deployed by PE funds in the past 5-10 years which has driven overall valuation multiples considerably up, the buy-in yields have definitely fallen 10%, which has large implications for whether PE can continually generate 20%+ returns.
It would be interesting to see how this trend moves over time, hope this was helpful.
This makes so much sense, thank you. I think UFCF yield in some ways is more intuitive too because it's not necessarily relying on some sum of a bunch of uncertain projections (some potentially 3 - 10 years in future) that are all, as you're also pointing out, really subject to change.
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