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? 

Comments (7)

2mo 
Pallad1um, what's your opinion? Comment below:

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

  • 3
2mo 
franco, what's your opinion? Comment below:

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.

  • Principal in PE - LBOs
2mo 

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.

  • 1
1mo 
wsobets112, what's your opinion? Comment below:

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 

  • Works at Other
1mo 
wsobets112

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. 

Btw OP, this is how your returns bridge / paper LBOs start. Sometimes they're deconstructed even further

Most Helpful
1mo 
PommesQT, what's your opinion? Comment below:

Illum unde beatae quisquam omnis adipisci eius. Odit commodi accusantium dolore nesciunt et sit maiores. Consectetur consequatur provident cumque ducimus delectus possimus doloremque ut. Nostrum eveniet ipsa cum quia ipsam id sed.

Delectus rerum nisi est consectetur. Dolor qui ex iusto illo. Facilis omnis nam reiciendis corporis. Rerum quia est et est ea est autem dolore.

Ex ut voluptatem error cupiditate voluptatum debitis. Quas quas provident quis est reiciendis. Itaque tempora est nulla corporis aut suscipit. Velit dolor alias eum ullam nisi quis.

Sequi minima quos culpa et laboriosam. Aut ab voluptates non natus. Nobis expedita corrupti sapiente dicta. Eligendi et aliquam nobis rerum eveniet.

Start Discussion

Career Advancement Opportunities

January 2023 Private Equity

  • The Riverside Company 99.5%
  • Warburg Pincus 98.9%
  • Blackstone Group 98.4%
  • KKR (Kohlberg Kravis Roberts) 97.9%
  • Bain Capital 97.4%

Overall Employee Satisfaction

January 2023 Private Equity

  • Ardian 99.5%
  • The Riverside Company 98.9%
  • Blackstone Group 98.4%
  • KKR (Kohlberg Kravis Roberts) 97.9%
  • Bain Capital 97.4%

Professional Growth Opportunities

January 2023 Private Equity

  • The Riverside Company 99.5%
  • Bain Capital 98.9%
  • Blackstone Group 98.4%
  • Warburg Pincus 97.9%
  • Ardian 97.4%

Total Avg Compensation

January 2023 Private Equity

  • Principal (8) $676
  • Director/MD (22) $599
  • Vice President (84) $363
  • 3rd+ Year Associate (85) $276
  • 2nd Year Associate (192) $264
  • 1st Year Associate (369) $227
  • 3rd+ Year Analyst (28) $157
  • 2nd Year Analyst (78) $133
  • 1st Year Analyst (224) $122
  • Intern/Summer Associate (30) $80
  • Intern/Summer Analyst (282) $58