How does your "perfect LBO candidate" checklist look like ?
Anyone ready to share their own "LBO candidate checklist" or point out useful resources explaining financial characteristics of a "good LBO candidate"?
I am a fintech developer on a short break and would like to build a simple LBO candidates screener because working on stocks screeners, data scrapers and managing offshore dev. teams is boring - actually, I am done with this for some time. After checking different corporate finance sites I found out that majority of them just recycle the same old text over and over again.
For example, bellow you can read an excerpt from one of those sites which can be seen all over the internet.
While is it very unlikely that any one company will meet all these criteria, some combination thereof is need to successfully execute an LBO.
- Strong, predictable operating cash flows with which the leveraged company can service and pay down acquisition debt
- Mature, steady (non-cyclical), and perhaps even boring
- Well-established business and products and leading industry position
- Moderate CapEx and product development (R&D) requirements so that cash flows are not diverted from the principle goal of debt repayment
- Limited working capital requirements
- Strong tangible asset coverage
- Undervalued or out-of-favor
- Seller is motivated to cash out of his/her investment or divest non-core subsidiaries, perhaps under pressure to maximize shareholder value
- Strong management team
- Viable exit strategy
Then I found another article with relatively dry insights (it is about several public companies ripe to go private).
10 Cheap LBO Targets to Buy
In order to come up with a list of attractively-valued profitable companies with the potential to be taken private, we used the (CENSURED) stock screener select U.S. stocks using these criteria:
- Market Capitalization between $1 billion and $10 billion
- Price/Trailing Earnings ratio below 10
- Price/Forward Earnings ratio below 10
- Price/Cash below 5
- Price/Free Cash flow below 12
- Positive Return on Equity
Again another article called
S&P's List of LBO Candidates: Kodak, Oshkosh and GameStop
I was also checking WSO forums for more detailed posts on “screening processes” but wasn’t able to find anything related to ratios/indicators.
All those article mentioned above are informative but I want to focus exclusively on financial characteristics and understand what analysts and deal sourcing specialists are looking for when doing initial screening for their LBO candidates (leave aside industry trends, management team, divestment opportunities, technological change & requirements...)
I assume they want to seeClean balance sheet with no or low outstanding debt.
Here I can focus on company’s debt profile and financial leverage and check their1. Debt-to-EBITDA Ratio = total debt / EBITDA 2. EBITDA-to-interest coverage ratio = EBITDA / total interest payment3. Financial lev. = financial and business liabilities / capital or another formula I found for4. Financial lev. = EBIT/EBT
5. Debt Ratio = total debt / total assets checking how much of a company’s assets are financed with debt.
In the next step I assume analysts will definitely check company's positive working capital, low CAPEX and steady cash flow.
The most critical element of the whole process is to find a company with available free cash flow to service the debt and operate efficiently. I can conclude that at this stage they move forward and trying to find companies with enough working capital; Meaning short term funds available from current assets are more than adequate to pay for current liabilities while low CAPEX means the lower the CAPEX is the higher the free cash flow and the ability for the company to pay interest and principal obligations are. In the next step we can also check operating cash flow (stable and recurring cash flow is a must because it represents a cash generated by company's day-to-day business operations and allow business to maintain and grow its operations). Positive free cash flow is important factor of this analysis because in ideal scenario PE Funds want to buy the company with senior debt and then use the free cash flow of the acquired company to pay the principal and interest. 1. Working capital = current assets - current liabilities 2. CAPEX = Current PP&E - Prior PPE + Current Depreciation3. Operating Cash Flow = positive numbers 4. Free Cash Flow = positive numbers
Is there anything else I need to take in consideration when building my own checklist?
Edit:
I am thinking to cross check companies real estate ownership data
Please keep in mind that I am trying to build a "vanilla" screener and not CapitalIQ, Blookmberg platform
Powered by [GPT-3]
There's no formulaic way to screen for LBO candidates.
I would say the first set of characteristics / bullets you pasted are typical of what associates look for.
With PE, you're looking for companies that can deliver strong investment returns over a short period of time. How do you deliver returns? It's a function of cash outlay & cash inflows. You want to minimize the cash you put in and maximize your yearly cash inflows. These are capture by those points you pasted.
Generally, yes, you would want a low capex. Correct me if I'm wrong, but Working capital does not necessarily have to be positive. A negative change in NWC would imply increasing receivables and inventories, and would highlight to me areas of their operations that could be tweaked, not necessarily deal breaker.
No debt is not always a requirement either. There are tons of cases of LBOs with refinanced pre-existing debt. It matters more about the company's ability to service the debt. If they have ample cash flow, they will be able to do so.
Things like revenue growth and multiple expansion are nice levers to have, but they're less prominent and mature companies.
How helpful would it be to be look at EBIT/Int. Expense? I mean, when you do an LBO, you pretty much construct the capital structure from scratch, so how telling really is that ratio? A company with minimal debt could have a great ratio, but when you lever it up, the ratio could go down the gutter, no?
Operating leverage and moats.
Why the importance on operating leverage?
Serves as an extra barrier to entry for competitors and any incremental revenues go straight to the bottom line.
Someone else with ideas or comments ?
I don't have a lot of knowledge in this area. But I'd love to see what you come up with. I'm looking at something similar, focused on practising LBO skills.
My comment, given the above caveat, is that it doesn't look like you've considered the current ownership and governance of the business. Some owners and boards may be less willing to sell the business than others.
Well, you are right.
Some owners are indeed more willing to sale than others.
Unfortunately "willingness to sale" is difficult to measure because only data accessible to me are balance sheets, income statements, real estate ownership, corporate ownership structure.
I am surprised that no one shared their criteria/checklist.
Aperiam voluptas ratione magni voluptatem. Exercitationem voluptatem minima unde temporibus id voluptatem. Dicta dolores ut eos consectetur et.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...