Value creation / LBO Model
Hi there,
I have a question regarding LBO models and PE interviews. I usually take the numbers from the CIM and plug in the numbers into the assumptions of the LBO model. However, I have two conceptual questions:
1) Do these (often aggressive) numbers already include value creation initiatives? Do PE firms normally "add" additional value creation levers on top of it (e.g., more aggressive margin expansion)?
2) If value creation is already factored in, I don't really understand the following: if PE firms participate in an auction, wouldn't they need some proprietary investment thesis to make the case work? Otherwise, they could just increase the multiples paid (and lowering their returns) until IRR = 0? Or what would be a reason why a certain PE firm can pay more than others?
Will give this a go, but keep in mind I’m in IB and not PE so happy for other to chime in.
1) In my experiences, the sell-side business plan usually include all of the value creation the management can think of, except for more intangible opportunities outside the business plan, such as M&A or some new potential tech / product launch still in early stage. It’s included in the marketing materials, but usually not in the numbers.
2) PE firms will study the sell-side plan, and make their own judgements with input from advisors (and even calls with the mgmt) to calibrate what is actually feasible. Hence, a haircut is often applied to mitigate risk. However, you can have views on cost cuts / optimisation, plans for a massive M&A rollup or a geographical expansion agenda, and attach future value to these initiatives. Some firms who knows the space well or have demonstrated large transformations and have confidence in these initiatives can therefore outbid others
Pulling punches less…these sell side projections are usually seen as BS. If you plug them into a model they will usually outperform the PE firm's target case.
PE firms generally are looking for a continuation of a proven strategy. So will use that as a starting point and layer on a few initiatives that they believe has a high probability of proving our during their holding period.
Well said, if management was so smart and found all of this opportunity to create value, why aren't they doing it themselves instead of having someone pay up for often mediocre assets.
Gotta love the CIMs where they add EBITDA to the forecast for M&A based on their 'extensive pipeline' when the company has done 0 M&A the past 5 years
Value creation in private equity can be deconstructed into three pillars: use of leverage, earnings growth (organic or inorganic), and multiple expansion.
PE firms will underwrite earnings growth that is justifiable at the accounting line item level. Top down benchmarking is often deployed to identify cost savings opportunities; identifying the right comparable companies to benchmark the LBO candidate's profitability, operating leverage or footprint, sales force, working capital management etc. is key and more art than science
Btw OP, this is how your returns bridge / paper LBOs start. Sometimes they're deconstructed even further
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