LBO training by JobSearchDigest.com and IBtraining.com

1. and
present
A Summary of
Leveraged Buyout
(LBO) Models

2. About JobSearchDigest.com
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Copyright 2009

3. About The Investment Banking Institute
 Core financial, technical and modeling skills.
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 Visit www.ibtraining.com for additional details.
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4. Table of Contents
I. Uses for An LBO Model
II. Components of LBO Model
III. IRR Analysis
IV. Q&A
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5. Uses for an LBO Model
 An LBO Model is an analysis used by private equity
firms (financial sponsors) to evaluate an acquisition
 The goal of an LBO is to acquire a company by
financing the purchase with as much debt as cash flow
and debt markets will support
 The more debt available, the smaller an equity
investment the financial sponsor has to make
 The higher the leverage, the higher the expected IRR
for the financial sponsor or private equity firm
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6. Uses for an LBO Model (cont’d)
 The goal of an LBO model is to establish expected
internal rates of return (“IRR”) for the acquisition
that reflects:
 Purchase price assumptions and the cash needed
 Capitalization assumptions: leverage, debt tranches, equity
investments
 Base case financial projections for balance sheet, cash flow
and income statement
 Model should include sensitivity functions for a
range of:
 purchase prices,
 capitalization structures,
 operating assumptions
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7. Uses for an LBO Model (cont’d)
 Private Equity Firms / Financial Sponsors usually have
a required rate of return hurdle
 Expected transaction IRR must meet or exceed hurdle rate
 PE firms required rates of return usually range from 15% to
30% (18% - 25% typical)
 The IRR analysis is strongly driven by the amount of
leverage
 With higher leverage, less equity, and higher IRR
 Often the goal is to leverage up the Company based on cash
flow and the debt markets
 More leverage increases risk, as cash flows will pay interest
and debt service
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8. Uses for an LBO Model (cont’d)
 Leverage is largely determined by the debt markets
 Until mid-2007, the debt markets were experiencing
excess liquidity
 Lenders were allowing higher leverage
 In 2005-2007 leveraged at 4.0–6.0x recent EBITDA
 Higher levels allowed higher prices yet still attain
the required IRR
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9. Uses for an LBO Model (cont’d)
 Leverage is comprised of some combination
of:
 Senior secured loans
 Junior loans/bonds
 Mezzanine debt, or “hybrid” securities
 Lenders may require the financial sponsor to
have a minimum equity investment
 Minimum equity contribution is typically around
20% - 25% of total capitalization
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10. Uses for an LBO Model (cont’d)
 Not Just for Buyers
 The LBO Model is also used by lenders
 Lenders like to see expected leverage and debt
service coverage ratios based upon Company’s
projected:
– income statement,
– balance sheet,
– cash flow
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11. Pop Quiz
 The goal of an LBO model is to establish
expected internal rates of return (“IRR”)
using a financial model that reflects:
 a. Purchase price assumptions and uses of cash
 b. Capitalization assumptions and sources of cash
 c. Base case financial projections with
assumptions
 d. All the above.
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12. Pop Quiz
 The goal of an LBO model is to establish
expected internal rates of return (“IRR”)
using a financial model that reflects:
 a. Purchase price assumptions and uses of cash
 b. Capitalization assumptions and sources of cash
 c. Base case financial projections with
assumptions
 d. All the above.
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13. I. Uses for An LBO Model
II. Components of LBO Model
III. IRR Analysis
IV. Q&A
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14. Components of LBO Model
 Typical LBO Model will contain, at a minimum, the
following items:
 Purchase price assumptions
 Uses of Cash Schedule
 Sources of Cash Schedule
 Capital Structure Alternatives
 Pro Forma Balance Sheet
 Integrated Financial Model
 IRR Analyses
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15. Purchase Price Calculation and Considerations
 Determination of the purchase price typically
involves a full-scale valuation of the company:
 Comparable Companies Analysis
 Precedent Transactions Analysis
 Discounted Cash Flow Analysis
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16. Sources and Uses of Cash
 Total Uses is the amount of cash necessary to
complete the transaction
 Total Sources is capital required to complete the
transaction
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17. Sources and Uses of Cash (cont’d)
 The Sources of Cash schedule is comprised of the capitalization
assumptions
 An example of a Sources and Uses of Cash Schedule (millions $):
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18. Capital Structure Alternatives
 Debt may be comprised of different securities
usually provided by different lenders
 Revolver / Term loan (senior secured loans)
– Usually provided by typical commercial banks
– Have lower interest rates
 Junior loans can be provided by public markets
(high yield issue) and private placements
 Often, the most junior piece on debt will have
equity warrants attached
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19. Capital Structure Alternatives (cont’d)
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20. Proforma Balance Sheet
 Proforma balance sheet gives effect for the transaction
 Adjusts the historical balance sheet for the new sources
of debt and equity as well as any transaction-related
adjustments:
 Write-ups or write-downs
 All financing fees incurred can be capitalized and amortized
 Any Goodwill created by the transaction
 The buyer typically assumes all of the normal-course
short term liabilities
 The “old debt” is typically eliminated
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21. Proforma Balance Sheet (cont’d)
 Proforma Balance Sheet example (assets):
Proforma Balance Sheet
($ in millions)
Historical Financing/ Proforma
Balance Sheet Dec. 31 Transaction Dec. 31
Assets 2008 Adjustments 2008
Cash $0.0 $0.0 $0.0
Accounts Receivable $16.0 0.0 16.0
Inventory $10.0 0.0 10.0
Other Current Assets $1.0 0.0 1.0
Total Current Assets $27.0 $0.0 $27.0
Gross PP&E $323.2 $0.0 $323.2
Cumulative Depreciation $45.0 0.0 45.0
Net PP&E $278.2 $0.0 $278.2
Amortizable Intangibles $0.0 $8.0 $8.0
Goodwill 5.0 65.2 70.2
Total Assets $310.2 $73.2 $383.4
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22. Proforma Balance Sheet (cont’d)
 Liabilities Balance Sheet
Historical
Dec. 31
Financing/
Transaction
Proforma
Dec. 31
& Equity Liabilities 2008 Adjustments 2008
Accounts Payable $11.0 $0.0 $11.0
Accrued Liabilities $2.4 0.0 $2.4
Other Current Liabilities $0.0 0.0 0.0
Total Current Liabilities $13.4 $0.0 $13.4
Existing Debt
Revolving Credit Facility $40.8 ($40.8) $0.0
Term Loan $100.0 ($100.0) $0.0
Unsecured Debt $50.0 ($50.0) $0.0
New Debt
Revolving Credit Facility $0.0 $0.0 $0.0
Term Loan 0.0 $120.0 $120.0
Senior Bonds 0.0 $90.0 $90.0
Unsecured Debt 0.0 $60.0 $60.0
Other Liabilities $2.0 $0.0 $2.0
Total Liabilities $206.2 $79.2 $285.4
Shareholders Equity
Retained Earnings $94.0 ($100.0) ($6.0)
Common Stock 10.0 $94.0 104.0
Total Shareholders Equity $104.0 ($6.0) $98.0
Total Liabilities and Equity $310.2 $73.2 $383.4
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23. Financial Statement Projections
 An LBO model must also include forecasted income
statement, balance sheet, cash flow and debt
schedule
 This allows us to forecast performance of the
company on a post-LBO basis to see:
 How well the company is able to service the increased debt;
 How profitable the company can be following the LBO; and
 How the company might be valued at the end of the
anticipated holding period
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24. Pop Quiz
 Which of the following is not included in total
uses of cash?
 a. purchase price
 b. transaction fees
 c. debt service
 d. other required cash payments in the transaction
 e. none
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25. Pop Quiz
 Which of the following is not included in total
uses of cash?
 a. purchase price
 b. transaction fees
 c. debt service
 d. other required cash payments in the transaction
 e. none
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26. I. Uses for An LBO Model
II. Components of LBO Model
III. IRR Analysis
IV. Q&A
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27. IRR Analysis
 The IRR analysis accounts for:
 Cash flows from the financial sponsor into the
company
 Cash flows to the financial sponsor during the
holding period
 Net proceeds to the sponsor following the sale of
the company (aka “exit”)
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28. IRR Analysis (cont’d)
 Example of exit value calculation:
SALE OF COMPANY A IN 2013
Closing Date 31-Dec-13
2012 EBITDA $76.6
EBITDA Multiple 6.0x
Transaction Value $459.5
Less: Total Debt (190.5)
Plus: Cash Balance 0.0
Less: Transaction Fees (1) (6.6)
Equity Value $262.4
% Equity to Sponsor 95.0%
Equity to Sponsor $249.3
% Equity to Unsecured Lender 5.0%
Equity to Unsecured Lender $13.1
(1) Assumes 1% of Purchase Price for Investment Banking Fees, plus $2 million in legal and other expenses.
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29. IRR Analysis for Financial Sponsors
 Example of IRR analysis for financial sponsor:
IRR to Financial Sponsor 12/31/08 12/31/09 12/31/10 12/31/11 12/31/12 12/31/13
Initial Equity Investment ($104.0) $0.0 $0.0 $0.0 $0.0 $0.0
Dividends 0.0 0.0 0.0 0.0 0.0 0.0
Proceeds at Sale 0.0 0.0 0.0 0.0 0.0 249.3
Total Cash Flows to Sponsor ($104.0) $0.0 $0.0 $0.0 $0.0 $249.3
IRR Calculation 19.1%
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30. Pop Quiz
 The IRR analysis accounts for:
 a. Cash flows from the financial sponsor into
the company
 b. Cash flows to the financial sponsor during
the holding period
 c. Net proceeds to the sponsor following the
sale of the company
 d. All of the above
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31. Pop Quiz
 The IRR analysis accounts for:
 a. Cash flows from the financial sponsor into
the company
 b. Cash flows to the financial sponsor during
the holding period
 c. Net proceeds to the sponsor following the
sale of the company
 d. All of the above
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32. I. Uses for An LBO Model
II. Construction of LBO Model
III. IRR Analysis
IV. Q&A
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33. Q&A
Q: When is the LBO considered an
appropriate method over other
financing options?
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34. Q&A
Q: How have current market
conditions affected the LBO
model?
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35. Q&A
Q: Common pitfalls and how to avoid?
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36. Q&A
Q: Best tools and resources for LBO
modeling?
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37. Q&A
Q: Is there a difference modeling an
LBO for a private company vs.
public company?
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38. and
Thank You.

39. About Investment Banking Institute
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40. About Investment Banking Institute
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Copyright 2009

41. Investment Banking Institute Student Testimonial
I am so thankful for the class I took at the Investment Banking Institute. It was both
an enriching knowledge vault and a confidence booster!
Your walkthrough of the DCF calculations was an excellent refresher. While I still
remember bits and pieces of how DCF works from my on-campus interviews back in
college and work at JP Morgan, your presentation helped to consolidate everything
in my mind. I also appreciate how you tied things back to an estimate of the
company's stock price at the end -- I actually once got an interview question on that
exact topic! The details and examples of the LBO modeling were extremely helpful,
and the encouragement you gave students throughout the class was equally
invaluable.
A huge thank-you for your insight into current market conditions, and on how the
subprime crisis actually unfolded. Although I manage to gain exposure to
macroeconomic and market valuation issues at work every day at JP Morgan, it was
your engaging, concise teaching method and holistic approach to the course that
put everything in perspective for me.
I will definitely recommend your course to my future classmates at Harvard Business
School as I am sure they will benefit tremendously from it.
Thank you very much.
Anthony, Boston
Copyright 2009

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