I had a phone screen with a BB bank today. Got this question:
Your debt is 6x EBITDA, and you are selling an asset that is worth 4x EBITDA. You will use the asset sale proceeds to pay down debt. What happens to your debt/EBITDA ratio?
Apparently it increases, but I don't know why. It seems like you're reducing your debt by 2/3, so for some reason your EBITDA must decrease by more than 2/3? Or does this not make any sense and I just misheard what he said?
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Think assets on B/S. Also, 6/4
[quote=SonnyZH]Think assets on B/S. Also, 6/4
think in fractions ya jabroni
Just make up some numbers.
Total Debt $1,200 -- 6x EBITDA means EBITDA $200 you are selling an asset at 4x EBITDA. so say EBITDA is $25m for that asset, therefore proceeds = $100m
Debt is then $1,200 - $100 = $1,100 EBITDA = $200 - $25 = $175
Debt / EBITDA now 6.3x
Ok.
Unsure what you are saying in your 3rd line- EBITDA is $25m for that asset?
i don't think it is fair to make an assumption of the degree to which EBITDA is reduced after the asset sale. the more appropriate way is to ask the interviewer how much EBITDA would go down after this asset sale. while assets represent future revenues, the company in question might face default issues, especially with a leverage ratio as high as 6x. this is particularly high even for sponsor-backed companies.
it is entirely possible that the company is selling the asset in a fire sale, where the EBITDA decrease would offset the debt reduction, producing higher leverage ratios that initially. if that is not the case, then EBITDA wouldn't decrease enough and the leverage ratios would be less than 6x. just wanted to point out that without an EBITDA bridge, you don't know how much EBITDA this asset contributes.
or i could be totally wrong. haha
Is this for summer interviews??
Maintain a 6x leverage ratio, you have to drop debt by 6 times the amount that you drop EBITDA. in this case, you're dropping EBITDA by a certain amount but you're dropping debt by only 4 times that amount from the sale proceeds. As a result, your leverage goes up.
Also- don't you need to know the book value of the asset in order to solve this problem?
Are you sure that's all the info you're given? I think you need more info...?
OP: "Did I hear it right?"
Nope.
^ The conclusion I am drawing as well.
Maybe I was supposed to ask the right questions to get the necessary info to solve it-obviously did not do that.
So, Company is at 6x EBITDA
You are selling an asset (a subsidiary) for 4x it's EBITDA.
You can make up whatever numbers you like, but Debt/EBITDA goes up.
Company EBITDA (before) $200m 6x leverage Company Debt = $1,200
Asset (subsidiary) -- make up a number -- $25m EBITDA sells for 4x EBITDA, and used for debt paydown sells for $100m, debt down $100m
So total EBITDA = $200m - $25m sold = $175m Company Debt goes from $1,200 minus the proceeds of $100m = $1,100
new Debt / EBITDA = $1,100 / $175 = 6.3x
I'm not sure you understand the concept of EBITDA....(or I don't)
Read the question the OP was given.
Grosse is right. End of story. I'm shocked this has triggered so much discussion.
double post.
I almost feel bad saying this, but this is just kind of common sense, you don't need to do a single calculation. If you have some overall multiple (whatever that is, in this case of debt and ebitda), and you remove a chunk of it that is at a lower multiple, your overall multiple will go up. It's just business logic! Although to be fair, I would never have gotten that right when I was in college. Then again I wasn't a business major.
^That makes sense when thinking of it as a subsidiary I guess? This came up after walking him through an LBO
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@grosse
Yeah, that makes sense if it's a subsidiary since they have their own financial statements, but can someone explain how an O&G company can sell assets to pay off debt will increase Debt/EBITDA (ability to pay off debt)? If a company is paying off debt, why would it hurt their credit? What if the asset doesn't have that high of a return, but you can sell it for a high price? When the asset yield is unknown (affect to EBITDA), how is it possible to know what happens to the ratio?
In the colorful world of finance lingo, a subsidiary can also be referred to as an 'asset'. If something is referred to as having an EBITDA probably safe to assume it's not a giant red bean bag chair. More like a divestiture.
I'm skeptical of the OP's information- feel like they would have been a bit more explicit if they were referring to a subsidiary.
Treating it as a subsidiary makes it easier to think about, but it doesn't really make a difference in the answer, you can just think of a bean bag chair's EBITDA as the revenue you get from charging bros to sit on it minus the costs of cleaning off all the grime and stains that accumulate. Although I agree that it's a poorly worded question. But what do you expect, when you have a bunch of sleep-deprived banker bros doing broscience all day accuracy and clarity isn't necessarily the name of the game.
There's nothing wrong with the question. Here's the info:
The TOTAL COMPANY'S Leverage Ratio (Debt / EBITDA) = 6x
They are selling an ASSET. This means that they are only selling a certain portion of the EBITDA contribution which this ASSET makes. In the previous example (which is a very good example) the $25MM is an assumption that we made saying that's how much the ASSET contributes in EBITDA.
If the ASSET is sold at a 4x multiple, that means you're getting $100 for it in proceeds. Therefore the resulting COMPANY has $1100 left in Debt and $175 left in EBITDA.
The questions is perfectly fine.
@BTbanker
Whether it's a subsidiary or a facility, lumber mill, widget factory doesn't matter.
You are selling an asset that produces EBITDA.
By selling at a lower multiple than the whole company trades for, your negative impact (reduction) on EBITDA is greater than the impact on debt.
My example - EBITDA goes down 12.5%, Debt goes down only 8.3%.
You can use whatever numbers you like, but GoingConcern has it right. I was trying to illustrate with numbers.
The extreme example - debt $1,200, EBITDA $200m you sell ALL OF YOUR ASSETS at 4x EBITDA.
All of your assets produce $200m, so you just sold them for $800m. Debt only goes down to $400m.
Debt/EBITDA now $400/$0 (well, you found $1 on the ground). $400/$1 = debt to EBITDA of 400x.
@grosse
What if the asset doesn't have that high of a return, but you can sell it for a high price?
example - EBITDA goes down by 5%, Debt goes down by 10%
When you don't know the affect the asset has on EBITDA, how is it possible to know what happens to the ratio?
I'm not sure I agree with that answer either...why are you assigning separate EBITDA for the asset that is being sold? Generally I assume there is one EBITDA for a company, or it might be broken down by business line with each business having a separate EBITDA, but the question comes down to this: Does EBITDA for the company as a whole change by selling that asset? When I originally read the question I thought 'no', but the examples and calculations everyone is using assumes yes. Under my interpretation of the question, if EBITDA stays the same before and after the sale, but you are decreasing debt by SOME level, doesn't matter how big or small, while keeping EBITDA constant. Therefore: debt to EBITDA will decrease.
You know there that the Asset is generating EBITDA because the questions says your selling it at a 4x EBITDA multiple....if it generates 0 EBITDA that would make no sense. 99% of the time, when we talk about "Assets" in our group, we're talking about operational assets that generate revenue, which therefore generates EBITDA. I work in the Energy group so an easy example would be an oil well. Each well generates a certain amount of revenue and has a certain amount of cash costs so each well essentially generates a certain amount of EBITDA. Therefore, after you sell that asset you don't get the EBITDA anymore so your total EBITDA goes down
You are on a party bus with your frat which has a ratio of 6 bros to 1 chick The front part of the bus has a ratio of 4 bros to 1 chick, but they get puked on and they leave.
What happens to your ratio of bros to chicks? It just went up.
You got rid of 4 bros which is sounds great for the ratio, but you also got rid of one girl and you had very few to begin with.
The impact on girls (EBITDA) is greater than the impact on bros (debt).
@BT Your question of asset productivity is like saying "well, how hot was the chick that just left"? Doesn't matter.
Listen to grosse
lol this is great
this is great
That's a great question. My initial answer before reading this post definitely was not correct.
you probably could have helped yourself by asking some probing questions, but the intuition is basic:
in this example, Debt = asset sale price in conceptual terms, in that the asset sale price represents debt paying power. so if the aggregate Debt/EBITDA for the whole company is 6x, and you remove a portion of the EBITDA at a rate of 4x Debt/EBITDA, 4x EBITDA will have a higher (than 6x) multiple of debt associated with it.
you have a glass of kool-aid that you're magically able to disaggregate. you remove some of the kool-aid, but the liquid you remove is flavored at a lower concentration than the aggregate batch (magic!), so you're left with some overly sweet kool-aid.
you're cutting down the company's debt, but you're doing it at a discount to your company's 6x multiple, so your multiple is getting worse. if you sold an asset that had an 8x multiple, you would be improving your remaining Debt/EBITDA.
just tell your interviewer that it depends. The asset you are selling might have negative ebitda for all you know (newspaper assets).
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