Lets say we have a 2 hour LBO case study where the task is to build a 3 statement model. Lets say that the company operates in a roll-up friendly market and as such I want my management case in the model to include acquisitions. I would simply in the cash flow statement base acquisition spend on a % of sales and I could also assume that the acquisition does not entail any goodwill (although unrealistic), the Target has no debt and that it is financed with existing cash (i.e. no debt or stock issuance). By doing so, the effect on the balance sheet would simply be a reduction in cash through the change in cash for the period given acq spend is included in the cash flow statement as well as a reduction in equity as we eliminate Target's equity. We would not get any increase in assets, as the Target's assets would be offset by a reduction in cash on the pro-forma balance sheet
Although unrealistic, this should be fine right for a 2-3 h LBO model case study? I think this is what research analysts do when they forecast financials for companies they cover..
Do you have a case study asking for this without a business profile for the target addon to use?
Personally, I wouldn't do it the way you describe. Too many variables not taken into account and you likely aren't going to be doing transformative M&A with cash from your balance sheet. Even if the thesis includes strategic acquisitions, you want to underwrite the platform asset standalone as M&A is never a sure thing. Then present it as upside to your base case.
Instead, given the timed nature, I might put the functionality for add-ons with a separate basic P&L with dummy numbers, assume its financed with debt, maybe use the same entry multiple as the platform and have it toggled off. It is a simple approach but should show you are thinking about a roll-up strategy as part of the thesis. You could also replicate this for multiple targets given the simplicity just watch the overall leverage at the platform as it is all financed :)
No but I am practicing based on companies that are acquisitive.
I am putting together a management case and a base case, and so would like to include acquisitions at least in the management case as otherwise revenues are quite low and IRR not so high. but your solution seems too complicated for a 2 h LBO model
In real life, how do PE firms do this? If the IRR is based on acquisitions, would they model based on identified real targets to get the real effects on IS and BS?
Look at Compbankers answer here:
https://www.wallstreetoasis.com/forums/add-on-acquisitions-in-lbo
It's what I proposed initially
Well, usually in diligence you identify potential targets. Wouldn't put them in the model unless they are actionable (under LOI or we are moving towards getting them under LOI).
I don't think a firm would buy a platform that has poor returns by itself simply because they think they can go buy other companies to get a return. Think about it, what happens if you don't get any M&A done? You would have bought a struggling business with leverage and no way to get a real return out of it.
but could the PE firm buy the platform knowing that IRR is ~10%? I just did an LBO on a company a PE firm just bid for and with pretty realistic assumptions, and IRR is roughly 10% without any acquisitions..
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