Direct lending case study
Hi WSO!
I have a direct lending case study coming up and would appreciate any advice on how to tackle it particularly around the model.
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for the revenue build, do I need to break it out into drivers (eg volume x price) for each forecasted year or can I just assume a high level revenue cagr for the forecasted period eg 2021-2027
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same thing for expenses, do I need to break out every expense (as a % of revenue) and give reasons for how this changes in the forecasted period
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is it best to from net income to FCF (under cash flows section) or from ebitda to FCF
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do I need to be able to model rcf draw? If so, does anyone have any advice on how to put this in.
sorry if these questions are quite basic!
Thanks
for the revenue build, do I need to break it out into drivers (eg volume x price) for each forecasted year or can I just assume a high level revenue cagr for the forecasted period eg 2021-2027 - No, come up with separate annual assumptions for price and volume with reasonable justifications for each. Applying a CAGR for revenue sort of defeats the purpose of having a revenue build in the first place
same thing for expenses, do I need to break out every expense (as a % of revenue) and give reasons for how this changes in the forecasted period - yes I would do that but break it out broadly ie. SG&A / R&D / etc. no need to go super granular unless they've provided information to help you forecast that
is it best to from net income to FCF (under cash flows section) or from ebitda to FCF - not really important how you get there as long as the math is right but typically see EBITDA to FCF given EBITDA is a more commonly used metric. But going from EBTIDA to NI to FCF will be just fine as well.
do I need to be able to model rcf draw? If so, does anyone have any advice on how to put this in.- yes you will likely. Look at practice models online for LBOs which have RCF funding options and you should get a good idea.
Thank you, this is helpful.
- for the revenue build, would I have to find out the 2 key drivers which I would then multiply together to get historical revenue? What if they don’t necessarily equal revenue for a particular historical year, would I carry this on for the forecasted period?
- when you say come up with annual assumptions for each year, can I say I expect price to increase by 1% each year going forward based on xxxx and volumes to remain flat based on xxxx. Will there always be information in the case study to base assumptions on? Most times, I think it can be a stab in the dark for the forecasted period, especially if there isn’t any commercial diligence/ industry analysis to support
Good questions.
My assumption is that you have historical revenue and are then building out the forecast on the price/vol model. If this is the case there is no need to back into historical price/vol so that it ties out to historical revs - this is a waste of your time and no one expects this and I'm not sure why you think this is required. I'd think that you're given at least some information on price/vol for the current period and that's what you can use for the forward projections.
For the annual assumptions, unless you have detailed industry data to go off of, it's fine to use the same growth rate every year. Always best to keep it low so that you can rely on the old defensible strategy of calling your projections overly conservative but yeah it'd be good to at least have some explanation based on the industry your company is in to say why pricing growth is exceeding volume growth or whatever etc. Basically make it thoughtful and logical, doesn't have to be 100% correct.
For context: I work in private credit and have hired people in my team. Focus on understanding the business (revenue drivers, costs, etc.) and where you sit in the capital structure. Model should work as a sensible check that your overall thinking is correct.
Don’t model revenues with granular drivers, a YoY change by division based on historicals is fine. Split costs between fixed and variable to get to EBITDA. Get to operating CF (take out growth CapEx after OCF), then unlevered FCF, debt service and FCF. Look at evolution of leverage metrics and cash coverage. Focus on a sensible downside case (economic recession but not WW3).
Model discussion will be 15min of a 1h interview. Rest will be making sure you can articulate merits&risk of the investment, commercial positioning of the company and how it generates cash.
Thanks. Would you expect period to create a stub period before full year in the model?
also can you explain what would change in my credit analysis if I was in the junior part of the capital structure rather than at the senior secured part of the structure?
thanks
Conceptually, a lot changes, but it's a simple exercise for operating model purposes. Assume you have a 2L and there are a couple tranches of 1L ahead of you - just show leverage, net leverage, and interest coverage through the 1L, then show the same through the 2L.
Yes on the stub.
Not much would change, just calculate credit metrics (gross/net leverage, LTV%) “through” the debt which sits ahead of you. Interest coverage should include all interest (incl PIK). Price it at 2-3% premium vs the senior layer.
Security will also be worse vs senior secured (second rank on the assets, or no asset security but share pledge if it’s an HoldCo instrument) but you are not expected to know the details.
To go off this, I just received an offer from a MF for private credit and this is pretty spot on. If you only have 3 hours, do not even build a full 3 statement model. The goal is to show you have a basic technical skill set, and that you understand how the assumptions you make drive things. I think the far more important thing to be able to show is that you can think about the business from a credit investor perspective.
what are the risks of the business? If you had more time what would you look deeper into? If you built a downside case, what would you flex, etc.
Thanks for this.
In your case study, did you create a sources and uses table, tranasction assumptions table etc in your model. Or is there no need for that in actual case study. Was your case study a take home or in house?
Thanks in advance.
Does anyone know if direct lending case studies are usually tlb and 2nd lien facilities or could I be asked to model a unitranche facility?
Sure and no difference. Just instead of 1L+2L choose a leverage in-between and call it unitranche. Cash interest, yield at 9-11%
Thanks.
Can you expand on what you mean by girl 9-11%? Is there a way for me to calculate the yield in excel?
I’m going through the following LBO prep (without the balance sheet section as it’s not needed for credit funds?!):
https://www.wallstreetprep.com/knowledge/leveraged-buyout-lbo-modeling-…
it goes through rcf draw/pay down and also excess cash flow sweep. Also has a debt schedule which is easy to follow- Is this sufficient for a case study?
Hi All,
Thanks for the comments so far. I have a few more follow up questions:
1) I've been looking at other threads on WSO and there has been mention of 'step-ups' in relation to the model. Can anyone explain what this means?
2) In the case study, would your LTM EBITDA be based on reported EBITDA (ie net income+ d&a+interest+tax etc) or adjusted EBITDA ( ie adjusted for synergies, cost-savings etc)?. Essentially what I'm asking is are case studies for debt funds provide info on adjustments for EBITDA like you would receive for a deal?
If information to adjust EBITDA is provided (and this becomes your leverageable EBITDA), does EBITDA in the forecasted years need to be adjusted as well or will forecasted EBITDA just be based on revenue-cogs-sg&a-r&d.
3) If the company's year end is Sept (for example), in my model, would the LIBOR for forecasted years be Sept 22, Sept 23 etc? From Chatham financial for example
1 - what exactly do you mean by step-ups? Is this referring to step-ups in a target's tax basis? This would certainly affect the model but certainly not in a case study context so stay focused on what's important here
2 - Always take historical EBITDA as reported by the case study at face value. There is no merit in making your own historical adjustments to EBITDA which are not made by the case provided to you. You may be provided info on adjustment for the forward period which you can use to adjust your fwd EBITDA but even with that i'd err on the side of caution and make sure you're not inflating your EBITDA on the account of potential addbacks
3 - No case study model will be this intricate or care. Just use a LIBOR rate appropriate with the period you forecast period. There is no need to adjust for weird fiscal-yr ends.
Bump
It would be easiest to model using adj. EBITDA. Easier to keep margins consistent. No need to forecast the adjustments themselves. They should roll into the reported figure within 12 months (for hard dollar costs in the LTM). The only caveat is in regard to synergies and/or cost savings. These are truly "phantom" EBITDA, and to the extent the realization period is elongated - or in the event they are not realized at all - can have a drag on cash flow in the forecast period. If they are outsized I would probably note that in your write-up.
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