Overview of Leveraged Buyouts
Overview of Leveraged Buyouts
An LBO is the acquisition of a company or division of a company using debt for a majority of the purchase price and equity for the remainder.
The buyer (the LBO Sponsor or Equity Sponsor) borrows the debt portion of the purchase price, typically through public or private bonds and bank loans issued by the company, and contributes the equity portion typically through a private fund Debt is serviced and repaid with the company’s operating cash flows a b The buyer later sells all or a portion of the company and realizes a return on its initial equity investment – Sale of Sponsor equity typically through a) an initial public offering or b) a sale to a strategic buyer or another LBO firm The LBO transaction focus is on cash flows generated by operations and the use of the cash to pay down debt, thereby increasing equity value Additionally, improvements in operating performance can increase value Assuming the enterprise value remains unchanged, as debt is repaid, value reverts to the equity holders, thereby generating equity returns
Return on Equity: A Practical Example
1,000,000 1,000,000 750,000 Assume a home is purchased today for $1,000,000. The purchase is financed with $250,000 of equity and $750,000 of debt. Over the next five years, enough rent is generated to repay $500,000 of debt, in addition to paying interest expense. Assuming the value of the home remains at $1,000,000 five years later, the equity stake in the home has grown to $750,000 5 1,000,000 250,000 750,000 Assuming this home is sold at the end of the fifth year for $1,000,000, $250,000 of the proceeds must be used to repay the remaining debt, which leaves the owner with $750,000. The return on the equity investment can then be calculated using the following IRR formula: 250,000 500,000 750,000
Goals of LBO Analysis
LBO analysis is primarily designed to address three fundamental goals
Determining the enterprise value of a company by measuring a company’s ability to generate sufficient cash flows to meet required equity returns while complying with leverage parameters -Determining what price a potential buyer could pay for a company Calculating financial ratios and other measurements to determine the balance sheet and credit impact of an LBO -Ratios and current credit conditions will determine mix of debt / equity and financing terms Evaluating the feasibility of an LBO given the credit characteristics of a business and understanding how much debt a company’s cash flows can service -“ ”= - “Dose it work” =Will a buyer get reasonable returns given financial projections and leverage assumption in the model
Characteristics of a Good LBO Candidate
LBO A good LBO candidate will demonstrate many, if not all, of the following characteristics (Business Specific) (Strong management team) Steady and predictable cash flow (moderate growth can be anticipated) Opportunities for immediate rationalization (e.g., working capital, synergies with other portfolio companies, hidden assets) (Minimal required capital expenditures) (Limited working capital requirements) (Divestible assets over time) (Industry Specific) (High market share) (Margins will not likely be pressured) (Industry with high barriers to entry) (Low cyclicality of industry) (Viable exit strategy)
Citigroup’s Role In The Process
(Citigroup Viewpoint) (Private Equity Viewpoint) (Create equity value) (Looking for upside to the business) (Find add-on acquisitions) (Create an aggressive financing structure that can be effectively syndicated to the market) (Limit downside) (Some financing remains on Citigroup’s balance sheet) (Other roles in (Use as much leverage as possible to minimize initial equity...