Hey guys,
This is straight out of the Vault guide to PE. It's the paper LBO example they give, but I kind of don't get it and would really appreciate the help. Right now, I'm practicing LBOs and modelling them, so its important I understand the fundamentals. Here it is:
Paper LBO example
You buy a retail company for 5.0x. You raised 40/60 debt to equity; the debt costs 10 percent. Next year, the company is projected to generate $100 million in revenue with a 40 percent EBITDA margin. Revenue is expected to increase by $50 million every year and margins are estimated to stay flat. Working capital stays the same every year. Capital expenditures are 20 percent of sales. The depreciation is $20 million every year. The tax rate is 40 percent. You’d like to exit in five years. Does this look like a good investment?
When PE says they a company at 5.0x, they usually mean total price/forward year one EBITDA. The forward year one EBITDA is $100 million of revenue x 40 percent EBITDA margin or $60 million.The acquisition price is $60 million x 5.0 = $300 million. Your capital mix was 40/60 debt to equity so the beginning debt value is $120 million, and beginning equity value is $180 million.Now you must calculate the FCF for every year on the paper that is enclosed in the resume portfolio you brought with you to the interview.
If you go to page 99 on this link, you will see the statement:
http://www.scribd.com/doc/63330616/Vault-Guide-to…
Okay, so I get that part, the assumptions and getting down to FCF. But here is where I get lost when it goes on to say:
Ending FYI EBITDA = $100
Exit Multiple = 5.0x
Ending TEV = $700 (how do we get to 700? Shouldn't it be 500?)
Beginning Debt = $120
Cash = 45
Ending Debt = $75
Ending EV = 625
Beginning EV =180
Approximate EV Multiple = 3.4x
Please ask questions, if needed. I really need to understand this example, so I'm ready for paper LBOs. Thanks all!
If you follow their layout, ending EBITDA is the assumed 5 year exit after you enter in year 2 (forward EBITDA of 60m) so you get to an EBITDA of 140 in the last year which gives you an EV of 700m (tbh not sure where this FY1 100 EBITTDA is coming from). If you take all the cash you have generated and use that as a net debt you basically end with 75m in debt. you take that out of the ultimate year EV and get your implied equity value (625) which over the 180 you have initially put into the company is ~3.5x (slight rounding errors here and there but fine)
Ok thanks...yeah I don't know where that 100 is coming from? Anyways, from that step, how would you go about estimating IRR? Would you just put 180 over 625 and get ~29%, or would there be a better way to estimate IRR? Thanks so much for all your help -- really appreciate it.
tbh what you would do in the interview is estimate the IRR, if you go from your cash on cash multiple of 3.5x the formula that yields you the 28% IRR is 3.5x^(1/5)-1 but that is not easy to calculate in your head. as a rule of thumb know what IRR you get for a 2.0x (15%) multiple, 2.5x (20%), 3.0x (25%), 3.5x (29%/30%) for 5 years (norm investment horizon etc.) and then tell them that it should be somewhere around that.
Thanks so much!
$100M of revenue at 40% EBITDA margin ... and you got $60M of EBITDA?
its the one year forward EBITDA which is 60m at 40% margin for 150m sales
yeah but he already said $100M was the forward year revenue projection
dayaaam -- how would you do it?
well not sure how detailed you want to get here, but the question simply asks is this a good investment?
Think about your big levers in an LBO - it comes down to your EBITDA expansion, exit multiple and how much debt you can pay down.
Your revenue is growing at $50M per year, that's a pretty awesome growth rate. Even if margins stay flat, you should already know this will be a good outcome. Over 5 years, revenue will increase $250M, which means you're revenue is around $350M, apply a 40% margin, and you get an EBITDA of $140M, but for round numbers sake lets use $150M exit EBITDA.
You could get away with some multiple degradation, but let's say you exit at 5x forward EBITDA...your exit TEV is $750M. If the company is doing $40M forward EBITDA and you're entering at a 5x, that's a $200M entry valuation, so even before taking into the change in capital structure, returns are looking good.
I'm not going to get into the FCF calcs, you can obviously do that, but from the getgo FCF assumptions are reasonable to pay down some debt. Debt isn't too bad at 10%, no WC investment, capex is a little high (just halve EBITDA each year), remeber your tax rate is applied to a lower number given interest and D&A (although not sure why they assume D&A stays flat when capex is increasing so much...) anwyays, should be enough to pay down maybe half your debt, assuming a $200M entry TEV / $80M of debt.
I haven't looked at the vault guide, but that's how I would simply do it. Remember, when you're doing a paper LBO in front of an interviewer, you have more like 5-10 minutes, not 30 minutes, to write it out and explain it, so make sure you capture all the big themes.
So I did a very rough and simplified model (using the assumptions above only). Does anyone know where I can host it for you to download and look at? I'm practising this stuff myself so it would be good to have extra eyes on it, and to add to the above discussion.
Curlyarmstrong -- just put in mediafire or any other quick upload site and send me the link? Thanks!
Thanks for sharing.
Daayam -- how did you get 80M in debt? and 10% debt? Where did that come from? I am still new to this , so looking for a more detailed explanation. I appreciate your time and effort. Thanks!
$100M forward yr revenue at 40% EBITDA margin = $40M forward EBITDA. They say 5x entry multiple so that's $200M entry TEV, split 40/60 debt/equity equals $80M of debt.
The 10% is the interest rate, which they mentioned. Are you doing this for a banking interview or are you in banking doing this for a PE interview? If you're in banking, you should know this already. If you're in college, they don't grill you on this in banking interviews.
btw I looked at the vault guide and this is why you need to be careful using vault..
It says "The forward year one EBITDA is $100 million of revenue x 40 percent EBITDA margin or $60 million" $100M x .40 does not equal $60M...
Best way to practice LBO modeling: either ask more senior analysts for materials they used or pull up a 10-K on a company you know and build out an LBO model yourself. Make sure to ask for help and that you understand conceptually how everything works, not just memorize what links to what.
To me, that looks go curly! Can someone else verify it and tell me if that is correct? Thanks!
http://www.interviewprivateequity.com/paper-lbo-model-example-how-to-do…
This will teach you everything you need to know.
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