Type of capex in cash flow

For capex it's nice to separate into maintenance vs. growth. Maintenance is similar to upkeep and should be around D&A while growth represents new (re-)investment into the business operations.

For a good LBO candidate we would obviously want predictable high cash flow. So we'd want low capex. But does that mean we would like to have low maintenance or growth capex? If you had 2 businesses where one had higher % of capex as growth vs maintenance which would you rather buy, all else equal?

When calculating levered FCF for a LBO which capex figure do we use?
LFCF = Net income + d&a - capex - change in NWC

What about unlevered FCF in a DCF?

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Comments (6)

Most Helpful
Aug 5, 2020 - 7:55am

This is a simple question with a complicated answer. Theoretically, if all else is equal it doesn't matter whether you have a business with higher growth or maintenance capex, as your earnings/FCF/entry & exit multiple are all the same.

However, it's obviously more nuanced in reality and there's no clear answer to which type of business is preferable. Intuitively, you'd want lower maintenance capex, particularly in the context of the traditional LBO, because growth capex is more discretionary in nature which effectively means that you can put more leverage on the business if you plan on reducing growth capex to a minimum, amplifying returns. You can't do that with maintenance capex, at least not to the same extent and particularly not in the mid/long term if you don't want to put yourself out of business.

That being said, it really depends on the returns you get on your growth capex. Theoretically speaking, if the high maintenance capex business earns such a high ROI on its growth capex that it drives its earnings/cash flow and, in turn, equity value and return (assuming same exit multiple) beyond that of the low maintenance capex business, it is actually preferable in the context of an LBO.

Aug 5, 2020 - 2:45pm
lvrup:

Theoretically speaking, if the high maintenance capex business earns such a high ROI on its growth capex that it drives its earnings/cash flow and, in turn, equity value and return (assuming same exit multiple) beyond that of the low maintenance capex business, it is actually preferable in the context of an LBO.

This is the only relevant part of your answer: it depends on the RONIC.

Ceteris paribus you want low maintenance capex (basically lumpy opex that is capitalised). High growth capex should mean that those investments yield a return that is satisfactory to you or you would not pursue those investments.

Aug 6, 2020 - 4:10am

I find the second paragraph especially a bit farfetched. More leverage because higher proportion of your budgeted capex is growth capex does not seem very realistic to me. To financiers capex = capex in my experience especially since most growth capex will require some time to produce cash again so in short run there is no difference for them.

To summarize: maintenance capex has 0 incremental value to the business (negative actually), while growth capex should only be in your budget if it adds value. Therefore answer should be more clear-cut imo.

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