IRR more sensitive to EBITDA margin than Revenue CAGR - why?
Hi guys:
I have a quick question please.. in some cases, why would IRR of an LBO be more sensitive to EBITDA margin change than to Revenue CAGR change?
For example, my IRR declines ~2% for each 1% decline in revenue CAGR during projection period; but my IRR declines ~3% for every 1% decline in annual EBITDA margin during projection period.
How can one ball-park test if these are correct? How can one think about these?
Thanks!
It’s all situation dependent but generally if your revenue base is $100 and margin is 30%. A 100bps absolute change is margin is $1 of value (don’t forget about the ongoing multiple effect) but 1% increase of revenue is on $0.30 of value that year (and more value when multiplied by the exit multiple) yet this is lower than 100bps change in margin.
I would think about this in terms of the nature of the investment and drivers of return. It
sounds like you are evaluating an opportunity that is profitable / cash generative, and exiting off an EBITDA multiple. In that case, your return will be much more sensitive to changes in EBITDA / margin much more than revenue (as a $1 increase or decrease to revenue obviously only passes through at a certain percentage).
On the other hand, if you were looking at a growth opportunity that may be unprofitable or just reaching breakeven where exit will be driven off revenue multiple (which is usually in-turn a function of revenue growth), then your return should be more sensitive to changes to revenue / growth.
Et facilis sint est quidem. Ut deleniti et eius laboriosam voluptatum ut maiores. Illo rerum aut quod qui repellendus sint ad et. Consequatur sed fugit aut sequi doloribus molestiae. Quia corporis sint perferendis quia. Molestiae adipisci dicta impedit excepturi quas modi. Omnis ut voluptas nihil eos vero.
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...