GOOD LBO candidates
- Strong and stable cash flow
- not very large expenses in the middle of years
cost reduction possibilites - management team
- synergies
cost synergies
–downsizing, reducing employment, combining the
revenue synergies
–cross reference and cross sell with a company
why is levering up as much as possible not the best option?
good bc increases returns
what is the impact of an increase in deferred revenue on the 3 financial statements
Deferred revenue is
why do you subtract out cash when finding the enterprise value
bc it is a non-operating asset
- -cash on hand is just going to discount the
- -excess cash is what we are subtracting
wallet effect if wallet costs $20 you pay $20. But if buy $20 wallet and it has $10 in it…you paid $20 but really only payed $10
Can Enterprise value ever be negative?? YES if have lots of cash
–bc only thing you subtract out
can equity value be negative?
–NO bc $ shares and price per share can never
enterprise value
market cap (equity value) + net debt --subtract cash from market cap and add back minority interest, preferred stock and total debt
How do you find terminal value in the DCF equation
Using either the Multiples method or Gordon Growth method
Multiples
- -apply an exit multiple to the company’s Year 5 EBITDA, EBIT or Free Cash Flow
- -exit multiple - refers to the terminal multiple at which any given project will be exited. The most commonly used multiple is EV / EBITDA - The actual exit multiple simply refers to the return of investment. If an investor is investing $100 and sells his investment in the future for $300, this is an exit multiple of 3x
- -THESE VALUES ARE BASED ON COMPARABLE COMPANIES -
Gordon Growth
–Estimate its value based on its growth rate into perpetuity.
The formula for Terminal Value using Gordon Growth is: Terminal Value = Year 5 Free Cash Flow * (1 + Growth Rate) / (Discount Rate – Growth Rate).
–Use WACC for discount rate and GDP for growth rate
What would an increase in the tax rate do to your valuation?
it depends. In the FCF formula you subtract you taxes…so an increase in tax rate would decrease your FCF left over for all capital investors, which would decrease the value
–BUT an increase in tax rate also provides a larger tax shield when estimating the WACC (cost of capital to the firm) - it would decrease the cost of capital and therefore increase the value of the firm
How is goodwill represented?
Goodwill is the difference between the value the buyer has paid and the fair market value of the company
–You calculate the number by subtracting the book value of a company from its equity purchase price.
How do you value a company?
you can either take its intrinsic value or its relative value
INTRINSIC
–DCF - estimate projected FCF and terminal value then discount both by WACC - which will give enterprise value (if used unlettered FCF). and subtract net debt to find equity value
–divide equity value by diluted shares outstanding and find equity value per share
Relative
- -comps and precedent transactions
- -determining a comparable peer group – companies that are in the same industry with similar operational, growth, risk, and return on capital characteristics
- -Calculate appropriate industry multiples
- -Apply the median of these multiples on the relevant operating metric of the target company to arrive at a valuation (common multiples - EV/Rev, EV/EBITDA, P/E)
Increase profitability in LBO - 3 levers
- Deal lever - purchase price and exit price (pay less for purchase price and make exit price high)
- financial levers - debt % and diff. types of debt
- –want to use the cheapest debt (Term loan) - operation lever
- -optimizing SG&A - MARGIN EXPANSION
- -and keep margin steady
LBO steps!!
- make assumptions about purchase price and revenue growth - find numbers
- then find sources - to fund it
- adjust balance sheet - just added debt to balance sheet
- project out all financial statements (debt payment included)
- find the exit price - find price that will give you IRR
- -then want
