LBO Case Study: Capital Structure

All,

Have a PE case study coming up, and was wondering if someone can help me with capital structure.

For deciding what cap struc to put on your LBO, how do you decide between what you put in the various tranches etc? Obviously the total amount of debt is limited by your credit metrics, and you aren’t going to put in 80% debt into the structure – but as always the devil is in the detail.

Lets say for a USD1bn EV business, no debt currently on balance sheet, acquired at 10x, and you are going to put 6x debt on balance sheet. How would you structure it?

Obviously this depends on industry, asset backed, etc etc (but don’t think (/ hope!!) they would need this level of knowledge from someone who is not a Lev Fin background)

Its more about how you pick out TLA, TLB, Mezz, HYB etc etc (for costing and maturity, fair to assume TLA 5 years, TLB / Mezz / HYB @ 7 years and basing it on what recent debt is pricing at?)

Thanks all for any help as always!

M

 

5-year for TLA/7-Year for TLB are good assumptions. Jr debt is typically at least 6 months outside the TLB.

60% Debt/TIC is pretty moderate leverage these days though not all 10x multiples are created equal. I'd say 4x 1st lien and 2x of mezz/jr/unsecured would be reasonable for a modeling case study unless you want to do more tranches to show off.

Not all deals have a TLA but I'd include it to show you know the difference (higher amort, usually no floor)-say 50/50 split with TLB.

Disclaimer: this is from a credit-side view, have never done a sponsor-side case.

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4x senior leverage would be considered stretch. I would go out 3x through the first lien and back up pricing on the TLB relative to the TLA about 100-150bps (institutional investors will demand that additional yield on a relative value basis). For a business that size (100MM EBITDA) you can probably get at least 2 turns of senior unsecured debt (HY bonds) and then a turn for mezz/jr capital if needed

 
Best Response
Butch:
4x senior leverage would be considered stretch. I would go out 3x through the first lien and back up pricing on the TLB relative to the TLA about 100-150bps (institutional investors will demand that additional yield on a relative value basis). For a business that size (100MM EBITDA) you can probably get at least 2 turns of senior unsecured debt (HY bonds) and then a turn for mezz/jr capital if needed

LCDComps avg 1st lien leverage deals closed Dec/Jan/Feb/Mar have been 4.6x/3.4x/3.8x/3.5x EBITDA respectively. For a 10x biz 4x isn't that much of a stretch IMO. Not all 10x multiples are created equal of course.

There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.
 

For $100-$500mm transactions, debt levels were 61%, compared to 55% for $500mm+ per Pitchbook's report today. I think 60% is relatively normal, though as you mentioned Kenny, a higher amount could be justified if the specifics indicate so.

I'd structure it as 40% equity, 40% senior and 20% mezz/sub, which is how Kenny laid it out. Across all deals in 2012, PE firms used an average of 40/39/21, so very close.

 

Think everyone above has it correct. However, w/ a +1bn EV and no debt existing on the B/S at current, I would doubt you would bring in any mezz. money (sans a partnership structure, e.g. REIT, MLP).

W/ the current HY market and (assuming) target's low cost of debt, between the BB availability, term loans and sellers cash, you should be able to plug the remaining cap. needed via sub / HY notes.

(Caveat: the case study makes some sort of sr. debt convenant constraints where your sub debt is capped, then you would have to seek out specialty financing.)

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Thanks all for the replies! I guess the next question is around I say i have gone with x capital structure (nb the numbers I chose were made up, just for simplicity of discussion):

  • Ok you have gone with 4x senior, and 2x HYB -- why have you split 1x TLA, 3x TLB / 1st Lien? why have any first lien? Why not subordinated debt vs an HYB? How are you backing up the pricing etc?

I guess I am questioning whether they will really dig into me (NB I come from a generalist BB M&A team, not lev fin) or am I just getting concerned over nothing, and they will usually give you the cap structure / not dig in too much unless you have been a tard (90% lvg all TLA?)

Thanks again for the very helpful replies all m

 
moneypants3:
  • why have you split 1x TLA, 3x TLB / 1st Lien? why have any first lien?

What he said was 3x TLA, 1x TLB. "I would go out 3x through the first lien ("TLA") and back up pricing on the TLB relative to the TLA about 100-150bps"

Meaning TLB will be 100-150 bps higher. You have first lien to get lower pricing. If the creditors have first lien on assets, there is less risk, so they'll require a lower IR for default protection.

moneypants3:
Why not subordinated debt vs an HYB?

I think Stringer's point is that you can get cheaper debt via HYBs right now than Sub Debt lenders. HYBs are raised through issuance to the public debt markets. Whereas, Sub Debt comes from private markets. At the moment, risk appetite for HYBs is strong, so the pricing may be more competitive there.

 
moneypants3:
I guess I am questioning whether they will really dig into me (NB I come from a generalist BB M&A team, not lev fin) or am I just getting concerned over nothing, and they will usually give you the cap structure / not dig in too much unless you have been a tard (90% lvg all TLA?) m

Question, have you done an LBO model? I ask that b/c most M&A guys know the LBO model, especially from a BB, and these items are directly from that.

If not, what were you doing? Strategic M&A (accretion/dilution)?

 

Fully know the LBO model, have done a bunch -- it's just more very specifically on the capital structure how much digging they will do on the rationale for each tranche of debt sizing, margin etc (have done and passed a couple of mm case studies before, just this one is an MF so wondering if diff approach)

 
moneypants3:
Fully know the LBO model, have done a bunch -- it's just more very specifically on the capital structure how much digging they will do on the rationale for each tranche of debt sizing, margin etc (have done and passed a couple of mm case studies before, just this one is an MF so wondering if diff approach)

Got it. Good luck.

 

(Disclaimer, this is for midcap, not 1billion EV...) I would say for this to simply look at the comps and go with that, every lender publishes the going rate for interest, security, and multiples of EBITDA the tranches are at, as well as the market trends.

In practice, usually you will call up a few debt sources, spitball for 30 minutes, give them a pitch on the acquisition, the assets and cashflow, your growth plan, industry etc. And they will give you a rough estimate as to what they're willing to offer. Repeat for a few more debt sources. Model them. Call back the winner. Have them sign an NDA or not depending on how wide yours is. Send over information, receive a letter of support (a more formal assertion of what they're offering you), attach to IOI and bid.

 

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