LBO confusion with cash and enterprise value
In theory could a PE firm make an acquisition, pocket the cash, and then sell the firm? Where is the hole in my logic?
If a target's Equity Value is $120, including $20 cash and $0 debt, it's enterprise value is therefore $120+$0-$20=$100.
So a PE firm acquires this target for $100. It pockets the $20, leaving the target with $0 on its balance sheet. The target's equity value is now $100, and since it's cash balance is $0, it's enterprise value is also $100.
So the PE firm sells the target for $100. Now it has $120 for doing nothing.
Surely this can't be the case. Am I misunderstanding something?
Where you are going wrong is that you are going to have to purchase the Equity not the Enterprise value. You have to buy 100% of the Equity value ($120 in this case) to get the Cash. So you can pocket the cash. The Equity value has not changed but the EV has gone up to $120, because there is only Equity in the company. So in this example without any deal fees, yes you walk away with and extra $20.
In the real world you would not be able to do this because most deals require a minimum operating cash to be included in the transaction and then the owner gets to walk away with any surplus cash prior to keys changing hands. A lot of LMM deals get hung up on NWC negotiations.
Would it be right to say that after you pocket the cash, the equity value falls from $120 to $100, because equity value includes cash. Because enterprise value is just equity value here, the enterprise value also falls to $100. So after you pocket the cash only equity value decreases by $20?
Also, when Michael Dell and Silver Lake took Dell private, they used the $7.7 billion on the balance sheet to pay off shareholders. Why were they able to do this? Did they in a way just get free money? What am I not understanding about this scenario?
1. Equity value should remain constant (assuming that removing the cash does not have an adverse effect on the business operations)
2. I am not familiar with the Dell case. I am sure there are cases where public companies have to much cash and in that, then yes, you theoretically get to extra money. AAPL comes to mind as one that you could probably model this with.
Then in theory if a company has too much cash, and a sponsor is looking to acquire it, shouldn't existing shareholders pay out a dividend so that all the excess cash is pocketed by them before the deal goes through?
Yes.
This is just not right… enterprise value remains constant, equity value would move around. This is why enterprise value is usually a multiple of EBITDA - it is an operating metric while equity value is a derivative metric based on financing.
In your example, EV is $100, cash is $20 so equity value is $120. You purchase the equity of the company at close so you pay $120 and get the cash. Then, if you sweet the cash and go to sell it, the enterprise value is still $100, but there is no cash so you can only sell it for $100. You still have a total of $120 in value
If operation remain the same, why would Equity change?
In a private deal context, transactions are done on a cash-free / debt-free basis - basically you’ll need to pay the extra $20mm to the seller for the cash.
In the public market theoretically you’re probably right that this could technically happen - a long time ago, the whole Graham-early Buffett strategy was buying companies that traded at a discount to liquid assets on the B/S.
Saepe voluptatem doloremque atque distinctio et id. Repellendus architecto maxime quo voluptatem praesentium aut. Sint saepe doloribus non ea tenetur. Nostrum est error debitis dicta dolorem repudiandae quia.
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...