PE Interview question - Help!

I got this question in an interview, I was wondering how you would answer it.

There's two companies - let's say apple and blackberry. Apple has a higher valuation than Blackberry and it may have a higher return.

If you're looking at this from a LBO perspective, how would you determine which one to buy? What would you look at pertaining to cash flows? Any other considerations you would make?

Very straightforward, but open ended question. Everyone's thoughts?

I've got another interview this week, so I'd like to learn how to improve on my answers and etc. Thanks everyone!

 

It is impossible to answer this question since Blackberry is not a company but rather a product.

You're born, you take shit. You get out in the world, you take more shit. You climb a little higher, you take less shit. Till one day you're up in the rarefied atmosphere and you've forgotten what shit even looks like. Welcome to the layer cake, son.
 

The three most key factors to look at in doing an LBO are:

Stable cash flows (so you don't default or bust covenants or miss interest payment hurdles) Underused debt capacity (adds more value when you lever the shit out of the company) Relatively cheap purchase price (self-explanatory)

You could probably also add in some of the LBO model IRR drivers such as:

Optimal leverage ratio Predicted EBITDA growth (assuming that the sponsor would be able to operationally improve cash flows) Exit multiples (RIM and Apple are in (slightly) somewhat different industries, so perhaps exit multiples for pure mobile and computing companies will change in 5-6 years) Current interest rates (and availability of funds)

I think bad management might also be something to look for, because once you go hostile and buy it out, you're able to add value to the company by replacing management, something that's relatively difficult in public companies without BoD support, but I'm not sure on that one.

Hope this helps!

 

I would state what you know about the companies - the size is important here because you can't LBO apple. Who will give you 4 turns of debt on a $300 billion company? That's too much, so immediately I would just take it off the table.

The EBITDA multiple is huge as well - APPL is trading at 13x EBITDA....that's a bit steep, and IRR and returns are greatly diminished because you can't lever it up as a % of the total transaction...

RIMM is trading at 5.6x - not bad. You'd have to pay a premium no matter which public company you're buying, but you might be able to get there with RIMM. However, not knowing too much, you'd want to consider the prospects of the company. Is their product declining? Can you improve margins? What about revenue growth? Can you pay down the debt with the cash flows.

This one looks pretty straight-forward at least from a numbers perspective: RIMM would be much easier to LBO.

 
Best Response

The comment above about the companies being too big to LBO are valid but I'll assume it isn't a trick question.

Both companies are "good" companies, but I think RIMM is the better candidate.

If I were looking at Apple I'd be very weary of buying because of the risk of "calling the top." The company is on an incredible run of growth, homerun products, etc and its future cash flows are likely to be overestimated/overvalued because of the growth rate the company has seen and its "brand cachet." Apple is also managed by a visible and popular executive who may be near the end of his career (Steve Jobs). Things could go poorly if margins drop or consumers turn to the next hot thing.

RIMM is almost the opposite. They have an incredibly popular product that has great marketshare and a strong brand, but they've had some missteps in the past few years (things like a patent lawsuits) and have lost their edge to competitors (including Apple). Their stock has paid the price for it. Blackberries and RIMM aren't going anywhere, but the company trades at ~10x earnings versus ~20x for Apple. RIMM has upside if things like market share loss can get turned around and sustainable cash flows to service debt if things stay the same.

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

Just to piggy back on what Kenny Powers said, I would make it a point to highlight the difficulties (impossibilities) of going after a company like Apple. While RIM is gradually losing market share, value, etc. Apple is going through the roof in a lot of respects and an LBO at this stage would be damn near impossible.

If I had asked people what they wanted, they would have said faster horses - Henry Ford
 

Thanks for the help guys! Much appreciated. Very helpful.

But what if I were to replace RIM and Apple and just say company A and B. And lets say it's a fund with $1bn of capital to contribute. Company A's purchase price is $300mm, Company B is $800mm. If I put together a LBO model, A gets me a IRR of 20% and B gets me something higher (let's say 26%).

Logically speaking, you would go with deals that give you a higher return... but with a larger deal, it becomes harder to finance with more debt, and also if it's the majority of your fund, you're putting all your eggs in one basket. I know the examples I'm providing probably don't have the same magnitude of say buying Apple (so perhaps the difficulty of getting funding for purchases with $500MM difference may not be that of RIM vs. Apple), but in such an instance, would you consider Company A over B for size reasons? Or would you essentially look at the model you've constructed on B (the higher IRR and more costly investment) and further test out sensitivities to see how attributes (e.g., purchase price, exit multiples, leverage used, revenue growth %, operating margins...) change to drop to the same 20% IRR?

I know how to put together LBO models and all... but I feel like I'm missing a lot of practical or big picture details like some of the things you guys have mentioned in your answers.

 
Vz:
Thanks for the help guys! Much appreciated. Very helpful.

but in such an instance, would you consider Company A over B for size reasons? Or would you essentially look at the model you've constructed on B (the higher IRR and more costly investment) and further test out sensitivities to see how attributes (e.g., purchase price, exit multiples, leverage used, revenue growth %, operating margins...) change to drop to the same 20% IRR? .

Absolutely, IRR is not meaningful if you can't actual execute the transaction.

 

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If I had asked people what they wanted, they would have said faster horses - Henry Ford

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