LBO pro forma balance sheet stub period
Hi,
I have been working on an lbo model which assumes a transaction closing date on 3/31/2016. I have the company's latest financial dated 12/31/2015. I understand that I need to create a stub period between then and 12/31/2016 fiscal year end. However, I am not exactly sure how I should deal with the period before closing (between 12/31/2015 and 3/31/2016). i.e., do I need to project Q1 financials in order to get the Q1 balance sheet account before making pro-forma balance sheet, or do I just do the pro-forma against the 12/31/2015 financials?
I have searched on the internet and looked up my training materials and various modelling books. By now I am pretty much convinced that in many cases, I can simply ignore Q1 financials pro-forma balance sheet based on 12/31/2015 financials.
I kind of get a sense that the logic behind this simplification is that balance sheet pro-forma does not really impact the future cash flows. But this bugs me a lot as it doesn't seem to be "absolutely" correct. For example, what if the company has to burn a lot of Capex in Q1, and the cash balance at 12/31/2015 will not be available as part of the finance source any more on 31/12/2016? Does this imply a need to change financing package?
Thank you so much for helping!
I recently faced this faced this problem too. But I had 1st quarter results. I am assuming your first year of projection is is 1/1/ 2016 . But transaction closes at 3/31 so that makes the cash flow hstorical. So Subtract your annual fcf for year one projection from 1st quarter results when you have if(if you done fine) you have 0.75 for the remaining quarter of the year.
Now for discount period, year one would be your stub year one period from year 1 would be 0.6 ish not 1. For mid year conversion divide by 2. For next year add one to the stub fraction of the previous year and to get the mid year for the period minus 0.5 and do this for each subsequent period
TO calculate stub fraction( I just copied the one in my template, I never know the equation off hand) Days(Next year, valuation date)/days(next year,Historical year).
Hope I have not confused you further. You pm the model if yo u like
Thanks for your answer, IBDrake.
I fully understand the stub fraction and discount factor adjustment part.
My confusion is more on the pro-forma balance sheet. Since you had your Q1 financials on hand already, it wouldn't have been a problem to you then.
I can certainly first break up year 1 financials into Q1 and the remaining 3 quarters by the portion of 0.25:0.75, project Q1-end balance sheet with Q1 financials before transaction closes, then do the LBO pro-forma at closing (at Q1-end).
But this will create a lot of extra work. Plus, I can tell from various sources (Note 1) that normally people don't project balance sheet prior to closing. Instead, they just pro-forma closing balance sheet directly (as of 3/31/2016 in my case) with the latest actual balance sheet (as of 12/31/2015 in my case).
So the question is really: 1. In the case you don't have the actual balance sheet at closing, will you first project it? 2. How would the simplified approach that many people use potentially affect the accuracy of the model?
Thanks!
Note 1: 1. on macabacus website - lbo-model - pro-forma-balance-sheet page, In the excel sheet demonstrated on this website, closing balance (dated 7/31/2008) is pro-forma directly against 3/31/2008 balance sheet (I can't paste link)
in forum topic title "LBO/Modeling Questoion" dated 8/19/2010 on WSO, the answer was that you dont normally need to do the projection first. (I can't paste link)
On page 201 of Investment Banking: Valuation, LBOs and M&As written by J Rosenbaum, it reads "The opening balance sheet (and potentially projected balance sheet data) for the target is typically provided in the CIM and entered into the pre-lbo model. If the banker is analyzing a public company as a potential LBO candidate outside of (or priorto) an organized sale process, the latest balance sheet data from the company’s most recent 10-k or 10-q is typically used."
Lets reference Macabacus. First of all to answer your question about the target burning cash prior to deal close would not happen because there any material change to the business would impact the deal closing so they wont do anything to kill the deal. Also it should be backed up in the purchase agreement . To answer question one. I would say a big no need to project balance sheet :One ,because of the stated reason above, two the complication of breaking yr one financial does not justify the infinitesima difference in the model. 3 months is not a whole lot to change in the balance sheet( unlike income statement ) for a transaction about to happen because I would not expect a material difference in the way the business is run. And if there is a material difference they would tell you and you can make adjustment to the model. So dont project. I believe I have answered question 2 above. I personally dont think it would affect the accuracy that much but it depends on the timing , the industry etc. It should not in general. Hope this helps :)
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