Value creation deconstruction in LBOs
Hi guys,
One question I have encountered in the past is to analyze the value creation of an LBO.
My first thought on this was to deconstruct the IRR or MOIC to see how each individual value driver (I would say the main ones are a) multiple expansion, b) operational improvements like margin growth or sales growth, and c) leverage).
I was looking at a case where all these factors were present, and built toggles for each one so I could see how much each of them contributed to my total IRR/MOIC. However, I could not get the sum of each scenario to equal my base case IRR (where all toggles were switched on). I have a few questions:
1) Is it mathematical possible to deconstruct an IRR or MOIC to see exactly how much comes from each of these drivers
2) I guess I am kind of answering my first question, but am I right in saying that these drivers cannot be assessed on a standalone basis (especially leverage), since it is the combination of these drivers that create the IRR (e.g. leverage can boost your return if your business grows sufficiently, but with no growth it can drag your IRR below what the business would be able to generate unlevered).
Look forward to hearing your thoughts!
Deconstruct Value creation as follows: Value creation defined as Exit equity less entry equity.
(1) Revenue growth: (Exit Revenue-Entry revenue)entry EBITDA marginentry multiple (2) Gross margin: (Exit gross margin-entry gross margin)exit revenueentry multiple (3) Opex margin: (Exit opex as % sales -entry opex as % sales)exit revenueentry multiple (A) SUM OF THESE = YOUR EBITDA uplift as a value driver
(B) Deleverage: Exit net debt-entry net debt (C) Multiple Change: Exit EBITDA * (Exit multiple - entry multiple) (D) Less Transaction Costs
A+B+C-D = total value creation -- and should equal Exit equity value less entry equity value (may need to use some round functions here depending on how complex the model (to like 7 decimal places or so -- any more and the calcs are done wrong)
Hope helpful
Would (A) = (Exit EBITDA - Entry EBITDA)*entry multiple?
But you are just breaking it out to see the individual effect of the 3 operating factors?
Would argue to include a cash generation factor. Especially in (primarily) equity-financed deals, your ability to generate cash/have dividend recaps can impact your bottom line IRR substantially. (Or, to put it differently exit - entry net debt does not take into account intermittent cash payouts.)
Understand the general logic behind this and really appreciate the breakdown - this comment does a good job of taking the basic concepts explained by multiplexpansion and breaking down the "EBITDA growth" component of LBO drivers.
Wanted to clarify something that I was initially fuzzy on. The value driver from (1) is relatively intuitive (how much incremental revenue are you producing, how much of that accretes to your pre-operational improvement margins, and what "value" does this add using your pre-multiple expansion EBITDA multiple). (2) and (3) seemed a bit off to me because I initially thought that comparing the gross margin and OpEx % of Rev differentials * exit revenue with an EBITDA multiple would not be looking at TEV on an "apples to apples" basis. In other words, how does it make sense to take an increase in operating income and multiply that by the entry EBITDA multiple? We still need to affect it by your OpEx to get EBITDA contribution from that uplift.
From my understanding, (2) and (3) are calculated as incremental "value" components that are being driven by an increase in margins. They together make up any change in EBITDA margin and therefore don't need to be affected prior to applying a multiple. Seems pretty obvious when I say it now but I spent some time playing around with numbers until everything clicked. Hope this helps clarify things for anyone else reading this, and again great post overall.
Exactly -- its very often helpful to see this next level of detail of what is driving EBITDA growth (i.e. is all your growth coming from GM uplifts would be a concern to me for example -- i.e. your smashing up pricing)
Would it be easier if you calculate the leverage by taking the total value creation + transaction cost - EBITDA growth and multiples expansion?
Awesome - SB'ed. Probably the best LBO overview I've seen on this site IMO
It should come out to exactly the same answer -- but usually better to always calculte off the actual drivers (ie in this case opening and clsoing net debt difference) so then you can check if everything is working
Doing it as a plug like this will mean that you could miss an error in one of the other calcs
Bookmarked
@moneypants3 - Great, illustrative response.
Two comments: (i) I would argue that (B) should read - "entry net debt minus exit net debt" (ii) I would clarify that (D) includes financing fees
You should also take out management equity/options as the last bucket.
great overview - Just like to ask though, is it common for Deleveraging to contribute to majority of the Value Creation? Its been what I've found in most LBOs
Would be great if there were any real-life examples to illustrate
Depends on the business type -- is it a growth business or a stable cashflow generative business which can be more "Open" to financial engineering
Notionaly ebitda growth should be the main driver of uplift, as you have the multiplier effect. (EBITDA * Multiple for exit)
Notionally if you have a dollar of excess cashflow which you can invest in capex to expand ebitda, or pay down debt, you should put it into ebitda growth
How would you add changing participation in this calculation? Say we start at 32% and go to 35%. Do you have to adjust somewhere for the beginning and ending %?
nvm ignore this.
To revive an old thread, why is revenue growth value creation multiplied by entry EBITDA margin while margin expansion is multiple by exit revenue? You'd think both would be at entry or both at exit instinctively.
The way I understand it the formulas are as follows:
(Exit Rev. - Entry Rev.) x Entry EBITDA Margin x Entry EV / EBITDA (Exit Margin - Entry Margin) x Exit Rev. x Entry EV / EBITDA
go to:
multipleexpansion.com
Click "Archives" --> go to 2017
There's a really solid Excel template in there that breaks down value creation in an LBO
Just want to leave a big thank you to big monkeys who contributed to this post.
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