Corp Dev LBO returns question: Levered and Unlevered IRR

Working on my first LBO case study for a Corp Dev/M&A role. Firm has sent me a CIM and asked me to prepare 10yr Base Case projections to stress test: 1) Purchase Price, 2) EBITDA CAGR, 3) Exit Multiple, 4) Leverage.

In showing the above sensitivity tables, they are looking for the resulting Levered IRR and Unlevered IRR as the ultimate factor to evaluate.

Below is my first attempt to showcase Lev/Unlev FCF (and calculated IRR). Wanted to make sure I wasn't missing anything as my sensitivity tables are looking weird and it's being driven by my Lev/Unlev FCF calculations. As a reference, within 10yrs I assume the amortizing senior debt will be repaid (5y term) and dividends will start to be paid out of FCF to keep minimum cash balance.

Can someone confirm that my tired brain isn't missing something?

Comments (15)

  • Analyst 2 in IB-M&A
Mar 27, 2020

I think you forgot to include the link?

Mar 27, 2020

For some reason the alt-text was messing with the attachment. Not sure. But I've updated the attachment so hopefully you're seeing the image link correctly. Should pop open the screenshot of my excel model now.

Mar 27, 2020

FYI - your name is in the screen shot (top right). didn't know if you wanted to keep anonymous

  • Analyst 2 in IB-M&A
Mar 27, 2020

Maybe I'm thinking about this differently, but a few things:
1) Why is enterprise value at exit the same as equity proceeds at exit?
2) Is there a reason you assumed all cash flows leave the company? Don't think this is a standard assumption

Mar 30, 2020

1) At exit (yr 10), there is no outstanding debt and company doesn't maintain any cash balance. Technically they have a Revolver that provides ~$5MM liquidity included in the model but business is seasonal and YE is when company tends to have lowest debt levels. Based on operating assumptions, they generate enough cash to have full repaid debt/Relov by yr 10. I've assumed that the revolver is held as available liquidity.
2) I've used WC assumptions/capex/debt service as main driving uses of cash. Company had a cash build on the balance sheet given fixed working cap/etc and so balance of cash was used as dividends once debt is repaid (and net of minimum cash balance). Typically I wouldn't have modeled out 10ys on an LBO; within 3-5 years there is still debt on the balance sheet but given the longer timeline, and no large growth capex factored into the case study scenario (company has minimal capex needs), there was a large cash build on the out years without the dividends.

Mar 29, 2020

A few observations:
1. How can you be tired at 1:13PM? All-nighter?
2. Check the way you included dividends in your calculations. In 2023 you leave c. 3m of cash in the company (cummulative cash flow minus dividend) which you never pay out?
3. Adjusted tax is somwhat of a DCF concept -> in LBO we use actual tax expense as the interest shield is not included in the WACC calculation.
4. Your interst rate looks very low if I try to reconstruct cashflow from operations from the number I can see here
5. Your debt + equity in levered scenario are not equal to the EV in unlevered scenario at entry. Is this because of issuance costs?
6. What is driving your EV at entry and exit? Common practice to use a the same EV/EBITDA multiple for both. Seems that in your case they differ.

Mar 30, 2020
  1. Too many nights at +4am in a row.
  2. I used excess LFCF towards discretionary debt prepayments. Once debt is fully serviced, I started paying dividends equal to LFCF after discretionary debt prepayments and minimum cash balance.
  3. Good to know. I found conflicting guidance on this one. Can you explain your rationale a bit for clarity?
  4. Yeah I started with a basic L+300 (case study outlined 3x leverage, all senior). 1mo LIBOR at 1% to start with a 25bps annual step-up. Based on the last few weeks, I know pricing would look very different. Figured I could call a few of my M&A connections and loosely price out the deal as a final step after I had built the model.
  5. Difference is due to debt prepayments not being captured within "Scheduled Debt Payments" as company is not required to prepay Senior Debt.
  6. At entry, it was based on purchase price (given in case overview) and middle of exit multiple range (range given). Both have been sensitized outside of what I've attached above, including the assumption that multiples at entry/exit are the same.
Mar 30, 2020

Re #3: semantics
Re #5: So are you including the LFCF in your IRR calc or not? Because if it's also repayed on debt, you are double counting. In addition: pls check and explain again: total debt repayments + free cash flow for discretionay debt repayment + equity do not equal EV of non-levered scenario.

Also make sure that the 'minimum cash buffer' is either paid out before exit or is trapped cash (in that case: is it also reflected in purchase price that way?)

Mar 30, 2020

I can help w the loan capital markets side w/ structure, pricing, fees, etc pretty quickly. I helped another guy on this yesterday too on WSO. getting on my computer in a few. or just DM

Mar 30, 2020