Help!! LBO of a leasing company; include interest on capital leases in pre-financing fcf?

Peeps - desperately looking for some quick guidance on doing an lbo model for a leasing company (they buy ships via capital leases then lease them out to travel companies).

Do I include the interest they pay on the capital leases in the FCF before (or after??). I.e. FCF will be net of the interest payments on the capital leases and this resulting FCF will form the basis of the FCF used to calculate debt capacity/purchase price for an LBO valuation.

Any thoughts?

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Comments (6)

Feb 29, 2012 - 10:53am

Anybody: Correct me if I'm wrong, but with leasing companies, wouldn't you also consider a securitization of your leasing portfolio, in lieu of issuing high yield?

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Best Response
Feb 29, 2012 - 5:34pm

Typically, no since if you're doing a DCF, you should use unlevered FCF to value the business and capital lease obligations are viewed as a debt-like instrument.

That said, if the interest payments are material and have always been a normal cost associated with running the business, I would argue to include them in FCF, similar to an operating lease.

Remember when valuing a business based on its cash flows, you don't want capital structure issues to muddy the waters and that's why you use unlevered free cash flow. However, in this case, it sounds like the capital lease interest payments are a normal operating cost.

Feb 29, 2012 - 5:51pm

Pre-FCF given that you're trying to workout debt capacity, and these leasing costs would still be there if the company was sponsor owned (and cap structured changed). Or just have FCF pre-lease obligations and FCF post-lease obligations, and use the later to workout the debt capacity of the firm.

Only reason to exclude it is if the sponsor plans to start buying ships outright post-LBO.

Mar 4, 2012 - 11:04am

first of all if i assume you're probably doing more of a DCF rather than an LBO because you'd have the cap structure already set and just be modeling out the cash flow to equity, but to your question...

I agree with NewGuy that if it's essentially an operating business expense then it should come pre-FCF, especially if it's standard in the industry to lease. You can think about it this way- if another company had operating leases rather than capital leases it would just be a normal expense and lower EBITDA and hence FCF. Just because the question in company is treating them as capital leases doesn't mean they have inherently higher FCF generation

Mar 4, 2012 - 11:05am

LBO of a leasing company: what to include? (Originally Posted: 02/29/2012)

Peeps - desperately looking for some quick guidance on doing an lbo model for a leasing company (they buy ships via capital leases then lease them out to travel companies).

Do I include the interest they pay on the capital leases in the FCF before (or after??). I.e. FCF will be net of the interest payments on the capital leases and this resulting FCF will form the basis of the FCF used to calculate debt capacity/purchase price for an LBO valuation.

Any thoughts?

Mar 4, 2012 - 11:06am

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