Leveraged Buy-Outs (LBOs): Components of an LBO model
Leveraged Buy-Outs (LBOs): Components of an LBO model
May 27th 2020, Uden/ The Netherlands
Consultant & Trainer: Joris Kersten
Joris (1980) is an independent Corporate Finance consultant with his firm “Kersten Corporate Finance” at Uden (The Netherlands).
He provides consulting and deal making in Mergers & Acquisitions (M&As) of medium sized companies in The Netherlands.
Moreover, he provides training in “Business Valuation” and “Financial Modelling” at leading “bulge bracket” investment banks in New York, London and Hong Kong.
In addition, he provides training in Corporate Finance at Universities and at Corporations all over the world (e.g. Mongolia, Surinam, Kuwait, Peru, Luxembourg, Saudi Arabia, Dubai, The Netherlands, Belgium etc.).
At last, he writes blogs on LinkedIn on Corporate Finance, almost 60 of his (free) blogs can be found at the end of this one (and on his LinkedIn page under “articles”).
NEW: 100% Online training “Certificate Investment Management”
On September 1st 2020 you can start (100% online) with obtaining your “Certificate Investment Management” given out by “Kersten Corporate Finance” in The Netherlands.
In 19 webinars (19 topics) of about 3 hours each, I will teach you the key elements of “investment management”. And this in 6 main themes.
After the webinars you practice with cases and exercises yourself, including questions from past CFA exams (level 1, 2 and 3). In the cases and exercises I will also teach you to actively use “Microsoft Excel” since this is an important tool in Corporate Finance.
The correct answers of the cases and exercises are also presented to you by webinars, worked out in detail. This in order to check your own work.
When you have finished the 19 webinars and have practised with the exercises and cases (all online), then there is an online exam to take (whenever you feel ready).
And when you pass the exam then you will receive the “Certificate Investment Management” of “Kersten Corporate Finance”. (pass = grade above 5.5 on a scale of 10)
Your name, and certificate number, will then be mentioned in the register on www.joriskersten.nl.
So for example your employer can then verify that you obtained the “Certificate Investment Management” of “Kersten Corporate Finance”.
Level training:
Participants get from a "foundation" level to "intermediate" level. This takes about 1 month to 3 months, depending on your own speed.
Foreknowledge needed for the training: A basic understanding of the Profit & Loss statement, cash flow statement and balance sheet. Moreover, a basic understanding of Microsoft excel.
The “course manual” with all info and conditions of the training will be available in the week of June 8th 2020.
And registration & subscription will also start in the week of June 8th 2020.
The 19 topics of the webinars, divided over 6 main themes are:
Theme 1: Key elements of investments
1) Asset classes and financial instruments. 2) Securities markets. 3) Mutual funds and other investment companies.
Theme 2: Portfolio theory
4) Risk, return and the historical record. 5) Efficient diversification. 6) Capital asset pricing model and arbitrage pricing theory. 7) Efficient market hypothesis.
Theme 3: Debt securities
8) Bond prices and yields. 9) Managing bond portfolios.
Theme 4: Security analysis
10) Macroeconomic and industry analysis. 11) Equity valuation. 12) Financial Statement Analysis.
Theme 5: Derivative markets
13) Option markets. 14) Option valuation. 15) Future markets and risk management.
Theme 6: Active investment management.
16) Evaluating investment performance. 17) International diversification. 18) Hedge funds. 19) Taxes, inflation and investment strategy.
The “course manual” with all info and conditions of the training will be available in the week of June 8th 2020.
Open (real life) training programs
The open training programs of Joris Kersten in The Netherlands take place at the dates below.
And for registration just write an email ([email protected]) or look at www.joriskersten.nl.
· 17, 18, 19, 20 and 22, 23 June 2020: 6 days - Business Valuation & Deal Structuring. Location: Uden/ The Netherlands;
· 24, 25, 26, 27 and 29, 30 June 2020: 6 days - Business Valuation & Deal Structuring. Location: Uden/ The Netherlands;
· 19, 20, 21, 22 and 23 July 2020: 5 days – Training with Certificate in Investment Banking. Location: Dubai/ United Arab Emirates;
· 16, 17, 18, 19 and 20 August 2020: 5 days – Training Master Financial Modelling Specialist. Location: Riyadh/ Saudi Arabia;
· 28, 29, 30, 31 October 2020 + 2, 3 November 2020: 6 days - Business Valuation & Deal Structuring. Location: Amsterdam Zuidas/ The Netherlands;
· 16, 17, 18, 19 November 2020: 4 days - Financial Modelling in Excel. Location: Amsterdam Zuidas/ The Netherlands.
Leveraged Buy-Outs (LBOs)
This is a sequence of blogs on so called “Leveraged Buy-Outs” (LBOs).
In a number of blogs I will describe what LBOs are and how they are structured.
Topics that will come back are:
· The advantage of leverage;
· The parties involved in LBOs;
· Financial modelling for LBOs;
· Building the LBO analysis;
· What price can you pay for the target in an acquisition;
· Debt analysis;
· Returns analysis and sensitivity analysis.
I have written a blog in the past already on the “financial modelling” of LBOs.
In case you have not read it yet, and when you are interested, I will give you the link here:
Leveraged Buyout (LBO) Analysis (older blog):
https://www.dhirubhai.net/pulse/leveraged-buyouts-lbos-joris-kersten-msc-bsc-rab/
For this sequence of blogs, I have used the book below as a source.
I really recommend you to read to book when you are interested in this topic, since it discusses LBOs within a practical setting and in a very clear way! ??
· Source blog: Leveraged Buyouts: A practical introductory guide to LBOs (2012). Author: David Pilger. Publisher: Harriman House Great Britain.
Sequence on: Leveraged Buy-Outs (LBOs)
The first article in this sequence (May 18th 2020) was an introduction to the topic.
And in the second article in this sequence (May 19th 2020) I discussed the debt components of an LBO: Term loans and high-yield bonds.
In case you have not read these articles yet, and when you are interested, I will give you the links below:
Article 1: Leveraged Buyouts (LBOs): Key mechanics of LBOs
https://www.dhirubhai.net/pulse/leveraged-buyouts-lbos-key-mechanics-joris-kersten-msc-bsc-rab/
Article 2: Leveraged Buy-Outs (LBOs): Term Loans, High-Yield Bonds and Financial Modelling
In this 3rd blog in this sequence I will talk about the components of an LBO model!
Financial statements
The analysis of financial statements in LBOs can be broken down in two parts:
1. Historical financial statements;
2. Forecasted financial statements.
The historical part of the financial statements comes from the current, and historical, annual or quarterly financial statements of a company.
This information can be found in the annual or quarterly financial statements of a company.
And for example in the US these reports are filed with the SEC (Securities & Exchange Commission) and are called 10-K and 10-Q.
(Source used: David Pilger, 2012)
Income statements
When building an LBO-model we first focus on the income statement, also called P&L (profit & loss statement).
In general we base ourselves on the historical income statements and then we make forecasts.
And with the forecasts we start with “revenue” and then we look at the “expenses”, also called “operating costs”.
In general cost assumptions are made as a percentage of revenue. This also enables us to make multiple "operating scenarios" in excel.
Concerning the forecasts, the forecasts of “revenues” are the most important ones.
Since if revenues decrease, the company can only cut costs.
However, these costs can only be reduced to a certain point.
Therefore when building an LBO model, close attention needs to be paid to estimating revenues of a potential buy-out target.
Since only revenues can lead to a strong and steady cash flow!!
This is very important in an LBO due the large amounts of debt involved, and corresponding mandatory interest and principal payments.
In addition, good analysis of the “operating costs” is also very important. Because potential uncovered reductions can increase the value of the company at the exit.
Since here you might remember that the value of a company is often calculated as a “multiple on EBTIDA”, so revenues minus operating costs.
In other words, every dollar saved in the costs, will result in 8 dollars "enterprise value" (e.g. EBITDA factor 8).
So this is good for the IRR (internal rate of return) of the LBO.
(Source used: David Pilger, 2012)
Balance sheets
A balance sheet (BS) is only a snapshot of a company’s financial position.
Within an LBO, the major lines from the BS on the left hand side are “cash” and other “current assets”.
On the right hand side, the major lines are the “current liabilities”, “interest bearing liabilities” and also “equity”.
Especially the "liability side" of the BS gets a lot of attention in an LBO model.
This because an analyst needs to assess the suggested “capital structure” closely.
Moreover, the “interest” in the P&L is an effect again of the debt on the balance sheet.
And “interest” is modelled from the “beginning balance” of the debt on the balance sheet.
You can also model “interest” from the “average yearly debt” or “debt at the end of the year”. But then you have to deal with so called “circularities” in your model.
You can do this, but you significantly increase the complexity of your model with "circularities".
I have written about these “circular references” in "financial modelling" before. In case you like to read this previous article, I will give you the link:
Article: Financial Modelling in Excel: Circular references, interest calculations and iterations
https://www.dhirubhai.net/pulse/financial-modelling-excel-circular-references-kersten-msc-bsc-rab/
(Source used: David Pilger, 2012)
Cash flow statement
The cash flow statement strips out any non-cash expenses such as depreciation and amortisation.
And it includes money spend on “capital expenditures” and changes in “net working capital”.
This cash flow is also extremely important in an LBO model, because this “cash” is used to service the debt of an LBO with:
1. Interest payments;
2. Paying down principle on the debt.
So the cash flows from the company’s operations are estimated from the estimations made on the:
1. Future P&Ls, and,
2. Future balance sheets.
And again, these “cash outcomes” are so important, because it enables us to determine what the amount of cash available is, to pay down the debt.
(Source used: David Pilger, 2012)
Debt sweep
In an LBO model the “debt sweep” is used in combination with the cash flow statement.
Since we like to take a look at the “debt schedule” in relation to “available cash”.
Cash available to pay down “existing debt” is calculated based on:
1. Net income;
2. After adding back non-cash charges;
3. And after adjustments for “capital expenditures”;
4. And after adjustments for “net working capital”.
The resulting number of cash is used within a “dept sweep” to pay back debt to the maximum.
So basically with a “debt sweep” switched on your model “throws” all the cash available back to the debt holders based on "seniority" (e.g. revolver, term loan A, term loan B etc).
Obviously, the debt sweep on your “revolver” (revolving credit facility) can also “pull” more debt in case of “negative cash” from you cash flow statements.
So in general, with an LBO model/ analysis we “switch on” the debt sweep.
As mentioned, herewith debt is paid back to the maximum.
And this has an effect again on the debt on your balance sheet.
Which affects interest payments in your P&Ls and cash flow statements.
Which affects debt levels again, and so on and so on!
(Source used: David Pilger, 2012)
Ratio analysis
When your LBO model in excel is working well then we want to measure performance and the financial health of the company.
With an LBO model ratios that are very important are:
1. Return on assets and return on equity to assess the leverage effect;
2. Capital structure and leverage (debt to equity) in order to check “reasonable” debt levels over the years;
3. Credit statistics like “EBITDA/ interest expenses” and “EBITDA/ total debt” in order to check “reasonable” debt levels over the years.
Basically within an LBO the trick is to have a good return (IRR) with realistic “credit statistics” (EBITDA/ total debt) over the years.
(Source used: David Pilger, 2012)
The upcoming blog on LBOs will be on:
· Further LBO analysis;
· Detailed steps in building an LBO model (in Microsoft Excel).
Stay tuned!
Source
For this sequence of blogs, I have used the book below as a source.
I really recommend you to read to book when you are interested in this topic, since it discusses LBOs within a practical setting and in a very clear way! ??
· Source blog: Leveraged Buyouts: A practical introductory guide to LBOs (2012). Author: David Pilger. Publisher: Harriman House Great Britain.
Under here you can find the links to my previous free articles (almost 60) on business valuation.
Earlier blogs on “net debt” (cash & debt free)
Article 1: Valuation: Introduction to "net debt" (cash & debt free)
https://www.dhirubhai.net/pulse/valuation-introduction-net-debt-cash-free-joris-kersten-msc-bsc-rab/
Article 2: Valuation: Net debt (cash & debt free)
https://www.dhirubhai.net/pulse/valuation-net-debt-cash-free-joris-kersten-msc-bsc-rab/
Article 3: Valuation: Adjusted net debt – Cash like items
https://www.dhirubhai.net/pulse/valuation-adjusted-net-debt-cash-like-items-kersten-msc-bsc-rab/
Article 4: Valuation: Adjusted net debt – Debt like items
https://www.dhirubhai.net/pulse/valuation-adjusted-net-debt-like-items-joris-kersten-msc-bsc-rab/
Earlier blogs on “valuation of banks”
Article 1: Valuation of Banks: Business models of Banks
https://www.dhirubhai.net/pulse/valuation-banks-business-models-joris-kersten-msc-bsc-rab/
Article 2: Bank Valuation: Financial Statements of Banks (part 1)
https://www.dhirubhai.net/pulse/bank-valuation-financial-statements-banks-part-1-joris/
Earlier blogs on “Valuation of Oil & Gas Companies”
Article 1: Valuating Oil & Gas Companies: The Oil Industry
https://www.dhirubhai.net/pulse/valuating-oil-gas-companies-industry-joris-kersten-msc-bsc-rab/
Article 2: Valuating Oil & Gas Companies: The Oil Industry – Part 2
https://www.dhirubhai.net/pulse/valuating-oil-gas-companies-industry-part-2-kersten-msc-bsc-rab/
Earlier blogs on “Leveraged Buy-Outs (LBOs)”
Article 1: Leveraged Buyouts (LBOs): Key mechanics of LBOs
https://www.dhirubhai.net/pulse/leveraged-buyouts-lbos-key-mechanics-joris-kersten-msc-bsc-rab/
Article 2: Leveraged Buy-Outs (LBOs): Term Loans, High-Yield Bonds and Financial Modelling
Earlier blogs on “Debt & Leverage”
Article 1: Debt: Ratio “debt/ GDP” in the US, The Netherlands, Germany and Japan
https://www.dhirubhai.net/pulse/debt-ratio-gdp-us-netherlands-germany-japan-kersten-msc-bsc-rab/
Article 2: Debt: Why global debt increased over the last 100 years
https://www.dhirubhai.net/pulse/debt-why-global-increased-over-last-100-years-kersten-msc-bsc-rab/
Article 3: Debt of companies: Leverage, Private Equity, Solvency and Bankruptcy
https://www.dhirubhai.net/pulse/debt-companies-leverage-private-equity-solvency-kersten-msc-bsc-rab/
Earlier blogs on “Weighted Average Cost of Capital (WACC) – step by step”
Article 1: Capital Market History Lessons – Corporate Finance (part 1)
https://www.dhirubhai.net/pulse/capital-market-history-lessons-corporate-finance-part-joris/
Earlier blogs on Financial Modelling
Article 1: Financial Modelling in Excel: Circular references, interest calculations and iterations
https://www.dhirubhai.net/pulse/financial-modelling-excel-circular-references-kersten-msc-bsc-rab/
Article 2: Excel basics for Finance: SUM, MAX, MIN, AVERAGE, IF, cell referencing, named ranges
https://www.dhirubhai.net/pulse/excel-basics-finance-sum-max-min-average-cell-named-joris/
Article 3: Excel for Valuation: COUNTIF, VLOOKUP, INDEX and MATCH
https://www.dhirubhai.net/pulse/excel-valuation-countif-vlookup-index-match-kersten-msc-bsc-rab/
Article 4: Excel for Business Valuation: OFFSET, FORECAST and CHOOSE
https://www.dhirubhai.net/pulse/excel-business-valuation-offset-forecast-choose/
Article 5: Excel for Business Valuation: NPV, IRR, PMT and EOMONTH
https://www.dhirubhai.net/pulse/excel-business-valuation-npv-irr-pmt-eomonth-kersten-msc-bsc-rab/
Article 6: Excel for Business Valuation: Custom Formatting, Conditional Formatting and Sparklines
https://www.dhirubhai.net/pulse/excel-business-valuation-custom-formatting-sparklines-joris/
Earlier blogs on “various topics”
Article 1: Financing a M&A transaction: An introduction
https://www.dhirubhai.net/pulse/financing-ma-transaction-introduction-joris-kersten-msc-bsc-rab/
Article 2: Valuation: How to adjust for “Operating Lease” (under Dutch GAAP)
https://www.dhirubhai.net/pulse/valuation-how-adjust-operating-lease-under-dutch-gaap-joris/
Article 3: M&A closing mechanisms: Locked Box & Completion Accounts
https://www.dhirubhai.net/pulse/ma-closing-mechanisms-locked-box-completion-accounts-joris/
Article 4: Scoping a financial model built primarily for business valuation:
https://www.dhirubhai.net/pulse/scoping-financial-model-built-primarily-business-joris/
Article 5: Consolidation of M&A targets and Purchase Price Allocation (PPA)
https://www.dhirubhai.net/pulse/consolidation-ma-targets-purchase-price-allocation-joris/
Article 6: Economics: Do economies have to grow to maintain the same level of prosperity ???
https://www.dhirubhai.net/pulse/economics-do-economies-have-grow-maintain-same-level-joris/
Earlier blogs on “bonds”
Article 1: Bonds - An introduction
https://www.dhirubhai.net/pulse/corporate-finance-bonds-introduction-joris-kersten-msc-bsc-rab/
Article 2: Bonds & Bond Markets
https://www.dhirubhai.net/pulse/bonds-bond-markets-corporate-finance-joris-kersten-msc-bsc-rab/
Article 3: Bonds, Rating Agencies and Credit Ratings
https://www.dhirubhai.net/pulse/bonds-rating-agencies-credit-ratings-joris-kersten-msc-bsc-rab/
Earlier blogs on “Valuation & funding of start-ups”
Article 1: Valuation & funding of start-ups - Funding rounds
https://www.dhirubhai.net/pulse/valuation-funding-startups-rounds-joris-kersten-msc-bsc-rab/
Article 2: Startup valuation: Pre-money and post-money valuation
https://www.dhirubhai.net/pulse/startup-valuation-pre-money-post-money-joris-kersten-msc-bsc-rab/
Article 3: Valuation methods for Startups (early stage) – Part 1
https://www.dhirubhai.net/pulse/valuation-methods-startups-early-stage-part-1-kersten-msc-bsc-rab/
Article 4: Valuation methods for Startups (early stage) – Part 2
https://www.dhirubhai.net/pulse/valuation-methods-startups-early-stage-part-2-kersten-msc-bsc-rab/
Article 5: Startups in Silicon Valley: The beginning – Part 1
https://www.dhirubhai.net/pulse/startups-silicon-valley-beginning-part-1-joris-kersten-msc-bsc-rab/
Article 6: Startup Funding & Convertible Debt (part 1)
https://www.dhirubhai.net/pulse/startup-funding-convertible-debt-part-1-joris-kersten-msc-bsc-rab/
Earlier blogs on “Mergers & Acquisitions (M&As)” and “M&A transactions”
Article 1: M&A Transactions: Share Deals, Asset Deals and Legal Mergers and Divisions
https://www.dhirubhai.net/pulse/ma-transactions-share-deals-asset-legal-mergers-kersten-msc-bsc-rab/
Earlier blogs on “Business valuation to Enterprise Value”
From June until August I have written the following blogs on valuation:
1) Leveraged Buyout (LBO) Analysis:
https://www.dhirubhai.net/pulse/leveraged-buyouts-lbos-joris-kersten-msc-bsc-rab/
2) M&A Analysis – Accretion/ Dilution:
https://www.dhirubhai.net/pulse/ma-model-accretion-dilution-joris-kersten-msc-bsc-rab/
3) Discounted Cash Flow Valuation:
https://www.dhirubhai.net/pulse/discounted-cash-flow-valuation-dcf-joris-kersten-msc-bsc-rab/
4) Valuation Multiples 1 – Comparable Companies Analysis:
https://www.dhirubhai.net/pulse/valuation-multiples-1-comparable-companies-analysis-joris
5) Excel Shortcuts & Business Valuation:
https://www.dhirubhai.net/pulse/excel-shortcuts-business-valuation-joris-kersten-msc-bsc-rab
6) Valuation Multiples 2 – Precedent Transaction Analysis:
https://www.dhirubhai.net/pulse/valuation-multiples-2-precedent-transaction-kersten-msc-bsc-rab
Earlier blogs on “Investment Management”
Article 1: Investment Management: Securitization, Subprime Loans and Collateralised Debt Obligations
https://www.dhirubhai.net/pulse/investment-management-securitization-subprime-loans-joris/
Earlier blogs on “Energy Transition”
Article 1: Energy transition: Introduction to Sustainable/ Renewable Energy
Article 2: Energy transition: Energy mix of The Netherlands & Goals for co2 reduction
https://www.dhirubhai.net/pulse/energy-transition-mix-netherlands-goals-co2-reduction-joris/
Earlier blogs on Wall Street
Article 1: Wall Street – A general introduction
https://www.dhirubhai.net/pulse/wall-street-general-introduction-joris-kersten-msc-bsc-rab/
Article 2: Wall Street – The Federal Reserve banking system
https://www.dhirubhai.net/pulse/wall-street-federal-reserve-banking-system-kersten-msc-bsc-rab/
Earlier blogs on the “cost of capital”
Article 1: Valuation & Betas (CAPM)
https://www.dhirubhai.net/pulse/valuation-betas-capm-joris-kersten-msc-bsc-rab/
Article 2: Valuation & Equity Market Risk Premium (CAPM)
https://www.dhirubhai.net/pulse/valuation-equity-market-risk-premium-capm-joris-kersten-msc-bsc-rab/
Article 3: Is the Capital Asset Pricing Model dead ? (CAPM)
https://www.dhirubhai.net/pulse/capital-asset-pricing-model-dead-capm-joris-kersten-msc-bsc-rab/
Article 4: Valuation & the cost of debt (WACC)
https://www.dhirubhai.net/pulse/valuation-cost-debt-wacc-joris-kersten-msc-bsc-rab/
Article 5: Valuation & Capital Structure (WACC)
https://www.dhirubhai.net/pulse/valuation-capital-structure-wacc-joris-kersten-msc-bsc-rab/
Article 6: International WACC & Country Risk – Part 1
https://www.dhirubhai.net/pulse/valuation-international-wacc-country-risk-part-1-joris/
Article 7: International WACC – Part 2
https://www.dhirubhai.net/pulse/valuation-international-wacc-part-2-joris-kersten-msc-bsc-rab/
Article 8: Present Values, Real Options, the Dot.com Bubble
https://www.dhirubhai.net/pulse/valuation-present-values-real-options-dotcom-bubble-joris/
Article 9: Valuation: Different DCF & WACC techniques
https://www.dhirubhai.net/pulse/valuation-different-dcf-wacc-techniques-joris-kersten-msc-bsc-rab/
Article 10: Valuation of a company abroad
https://www.dhirubhai.net/pulse/valuation-company-abroad-joris-kersten-msc-bsc-rab/
Article 11: Valuation: Illiquidity discounts, control premiums and minority discounts
https://www.dhirubhai.net/pulse/valuation-illiquidity-discounts-control-premiums-joris/
Article 12: Valuation: Small firm premiums
https://www.dhirubhai.net/pulse/valuation-small-firm-premiums-joris-kersten-msc-bsc-rab/
Earlier blogs on Financial Due Diligence
Blogs on this topic coming soon
Earlier blogs on Derivatives
Blogs on this topic coming soon
Earlier blogs on Distressed M&A and distressed Valuation
Blogs on this topic coming soon
Earlier blogs on Debt crises
Blogs on this topic coming soon
Earlier blogs on How inflation works
Blogs on this topic coming soon
Earlier blogs on Tax and tax evasion
Blogs on this topic coming soon
Earlier blogs on Financial modelling in excel: step by step model building
Blogs on this topic coming soon
Earlier blogs on Hedge funds
Blogs on this topic coming soon
Earlier blogs on Central banking and the supply of money (quantitative easing)
Blogs on this topic coming soon
Earlier blogs on Advanced Valuation
Blogs on this topic coming soon
Earlier blogs on Finance for Non Financials
Blogs on this topic coming soon
In case you like to see back certain topics within my blogs, please email your suggestions and I will take them into account: [email protected]
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4 年Congratulations and thanks for this reading Joris Kersten, MSc BSc RAB