For full text article go to: https://www.educorporatebridge.com/lbo/lbo-analysis/ LBO analysis and the concept involved in it are indeed interesting. The entire process is robust and includes important steps in analysis, returns, applications etc.

1. LBO Analysis
-by edu CBA

2. LBO Analysis Concept
•
Consider that the concept of leveraged buyout is very similar
to buying a house.
•
Suppose you want to buy a big house what will you do?
•
Due to rising real estate prices, definitely it is not possible to
do the entire down payment.
•
Then what do you do? Yes, ofcourse you go for a loan.
•
And most of the times it forms a major part of the entire
process. Similar is the concept in LBO analysis.

3. If we break down it to simple terms, in an LBO,
the “down payment” is called Equity (cash)
and the “mortgage” is called Debt.
In Leverage Buyout, the
acquisition of another company
is significantly by borrowed
money (bonds or loans) to meet
the cost of acquisition.

4. Steps involved in LBO Analysis
•
In the first step of LBO analysis we need to take care of some
transaction assumptions. Analyzing the purchase price and
financing of the deal are some important steps here.
•
With this information, then a table of Sources and Uses can be
created Uses reflects the amount of money required to
effectuate the transaction. The Sources tells us from where the
money is coming.
•
Next we make the changes in the existing balance sheet of the
company to reflect the transaction and the new capital
structure. This process leads to the construction of the
“Proforma” balance sheet. At this step intangible assets like
the goodwill and capitalized financing fees are likely to be
created.

5. •
The third and the crucial step is to create an integrated cash flow model
for the company. Here, the company’s income statement, balance sheet
and cash flow statement are projected for a period of time (five years
mostly). The balance sheet has to be projected based on the newly
created proforma balance sheet. While projecting the debt and interest,
post-transaction debt must be considered.
•
Once the model is created, assumptions about the private equity firm’s
exit from its investment can be made. A general assumption is that the
company will be sold after five years at the same implied EBITDA
multiple at which the company was purchased. There is a reason why we
calculate the sale value of the company. It allows us to also calculate the
value of the private equity firm’s equity stake which we can then use to
analyze its internal rate of return (IRR).

6. Sources of funds in LBO Analysis
• Revolving credit facility
• Bank Debt
• Mezzanine debt
• Subordinated or High-Yield
Notes
• Seller Notes
• Common Equity

7. Key
characteristics of
a LBO candidate
•
Mature industry and the company.
•
Clean balance sheet with no or low amount of outstanding debt.
•
Strong management team and potential cost-cutting measures.
•
Low working capital requirement and steady cash flows.
•
Low future capital expenditure requirements
•
Feasible exit options.
•
Strong competitive advantages and market position
•
Possibility of selling some under performing or non-core assets

8. Returns in LBO analysis
•
In Leverage buyout the financial buyers evaluate investment
opportunities by analyzing expected internal rates of return (IRRs), which
measure returns on invested equity.
•
Historically, financial sponsors’ hurdle rate, which is the minimum required
rate, have been in excess of 30%, but may be as low as 15-20% for
particular deals under adverse economic conditions.
•
Sponsors also measure the success of an LBO investment using a metric
called “cash on cash”.
•
Typical LBO investments return range between 2x – 5x cash-on-cash. If an
investment returns 2x cash on cash, the sponsor is said to have “doubled its
money”.

9. Exit Multiples

10. Applications of the LBO Analysis
•
LBO analysis helps in determining the purchase price of the
prospective Company or business.
•
It helps in developing a view of the leverage and equity
characteristics of the transaction.
•
Calculate the minimum valuation for a company since, in the
absence of strategic buyers, an LBO firm should be a willing
buyer at a price that delivers an expected equity return that
meets the firm’s hurdle rate.

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