EV / Equity value bridge Case Study
Seen a couple of LBO case studies where in the initial bridge from Equity value to EV, parts of the debt on the BS where left out.
E.g only taking Existing Term loan into consideration, leaving out Other current liabilities, and Other long term liabilities. Why?
Maybe because those count as operating assets and liabilities (ie working capital). Maybe because they don't carry interest rates like debt usually does.
Debt (like) items are not defined by interest. A fine you still have to pay does not accrue interest, but is a debt-like item.
@TS: be more specific.
On the BS there is “other current liabilities”, “other long term liabilities”
my understanding is the first one would count as NWC so not included in bridge, the second one I am unsure about? do you usually include ALL debt and debt like items in the bridge? and then also refinance this whole amount?
Not necessarily explanation on bridge between EV and equity value, but hopefully provides additional context to clarify.
Imagine a situation where you have $1M of trade payables and of that, $300K (exclusive of interest) payable to one supplier has accrued interest of 50K making your total current liabilities $1,050K.
Assuming this was a one-off situation (i.e. not as part of the company's operational practices to delay payment), as a buyer if you set a NWC Peg you wouldn't want to include that $50K as part of your peg, but include it as debt-like for a few reasons:
1) You shouldn't have this item left behind and be on the hook for it because the vendor refused to pay the supplier for x number of months. 2) You would be artificially understating your NWC peg, and therefore the vendor will leave less NWC behind once you take over.
As well, if the trade payable of $300k was under dispute, you would normalize your NWC peg for the amount of time it has been overdue for and add the $300K to your debt and debt-like items.
I've also seen instances where there have been indemnifications added to SPAs/APAs for outcomes related to this overdue payable.
Hopefully the above helps.
In an LBO, you are looking to get to from an EV to equity by subtracting net debt. The figure of net debt is calculated by adding up all financial debt-like items, short-term and long-term, less cash.
Other current liabilities and other long term liabilities, generally speaking, will not go into net debt. Why? Because they are not financial debt-like items. Typically, "other liabilities" is a catch-all category for a number of items, such as capital leases, deferred taxes, etc. It varies by industry and you can get a good idea of what they are by reading the footnotes in the annual report. There could be quite a few items in these categories. Other current liabilities are due in the next 12 months, other long-term liabilities are due some time beyond 12 months.
Therefore, stick to financial debt-like items when figuring out net debt. The only wrinkle that you might come across is sometimes there could be a large pension deficit in a company that you are targeting for an LBO. In this case, and depending on jurisdiction, a PE fund might have to finance a part of this deficit upon change of control (in that case, your net debt rises by the amount of the pension deficit you are asked to finance). However, I suspect this point is probably something you are unlikely to come across in your case study.
Good luck,
Tamara
But cap leases usually go into the ev/ equity bridge?
Thanks for your comment. If capital leases are like financial debt, then yes, you are absolutely right. You caught me! If they are like rent, then no. Perhaps you should call this item an operating lease in this case.
To answer the question precisely, it is best to see in the footnotes what is actually lumped under "other liabilities". There may not be any leases at all. Typically, you will see lots of random operating items and there is a low chance of finding something akin to financial debt. Therefore, if you need to make a quick and gross assumption in your calculation of net debt, you would typically exclude other liabilities.
If I were doing a case study during the interviewing process and there is no information about other liabilities, I would mention that you exclude these lines on the basis of your assumption that there are no financial debt-like items.
Thank you very much, really appreciate your help. Have a nice weekend!
Pleasure. I enjoyed your question and especially your excellent follow up!
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