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LBO Financial Model
C H A P T E R
17
LBO Financial Model O U T L I N E Determining Cash Flow Available for Debt Service and Debt Sources
Calculate Acquisition Multiples 382 Determine Target’s Capitalization Postacquisition383 Determine Cash Flow Available for Debt Service 385 Calculate Credit Ratios 388 Calculate the Equity Value, Internal Rate of Return and Multiple of Investment on Projected Exit Date 388
371
Determining Financial Sponsor Internal Rate of Return 373 Determining Purchase Price and Sale Price373 Leveraged Buyout Analysis Example Forecast Revenue, Margins, D&A, CapEx, Working Capital, Interest Rate, and Tax Rate
374 374
Leveraged Buyout Analysis Postcredit Crisis390
The material in this chapter should be cross-referenced with the following case: Toys “R” Us LBO. As previously discussed, targets for leveraged buyout (LBO) transactions are typically companies in mature industries that have stable and growing cash flow that can be used to service large debt obligations and, potentially, pay dividends to the financial buyers. In addition, targets usually have low capital expenditures, low leverage, and assets that can be used as collateral for debt or sold. Financial buyers generally target an exit event within 3–7 years, which is usually accomplished through either an initial public offering (IPO) or M&A sale to a strategic buyer or, sometimes, to another financial buyer. Financial buyers have historically targeted an internal rate of return (IRR) on their investments of above 20%. The possibility of achieving a high return is augmented by purchasing a company at the lowest possible price using the maximum amount of leverage that is available and, correspondingly, minimizing the equity contribution. Management of the target company will be asked to grow the company’s market share and improve margins, creating growth in free cash flow. Sometimes, as a result of operating improvements, the company can achieve an enterprise value/EBITDA multiple expansion (see Chapter 4), but this is unusual. To realize a target IRR return for a private equity investor, Investment Banks, Hedge Funds, and Private Equity, Third Edition http://dx.doi.org/10.1016/B978-0-12-804723-1.00017-7
369
© 2018 Elsevier Inc. All rights reserved.
370
17. LBO FINANCIAL MODEL
the company must grow cash flow to pay down debt over the holding period (resulting in an increase in equity), and then a sale must be accomplished in the future at a multiple of the increased cash flow level (see Exhibit 17.1). Exhibit 17.2 shows three potential ways to achieve IRR returns by deleveraging, improving margins, and/or through multiple expansion.
EXH I BIT 17.1 LEVERAGED B UY O UT O B J E CTI V E : PAY D OW N D EBT DURING HOLDING P E RI O D Initial: Acquired for 8.0x LTM EBITDA of $125.0
Future: Sold for 8.0x LTM EBITDA of $137.5 Future
$1,100
Initial
$1,000 $350
$650
Equity Equity
$725
Debt
$375
Debt
Source: Training the Street, Inc.
EXH I BIT 17.2 LEVERAGED B UY O UT: THRE E WAY S TO CREATE RETURNS Assume the Target company was acquired for 8.0x LTM EBITDA of $125.0
1. Deleveraging
2. Deleverage & Improve Margins
3. Deleverage, Improve Margins& Multiple Expansion
Sources of Funds Total Debt
$650.0
$650.0
$650.0
350.0
350.0
350.0
$1,000.0
$1,000.0
$1,000.0
$167.6
$212.3
$212.3
125.0
164.5
164.5
8.0x
8.0x
9.0x
Transaction Value
1,000.0
1,316.0
1,480.5
+/-Net Debt
1
(482.4)
(437.7)
(437.7)
Equity Value
$517.6
$878.2
$1,042.8
8.1%
20.2%
24.4%
Total Equity Total Year 5 Assumptions
Cumulative Excess Cash to Repay Debt Projected EBITDA
Assumed Exit Multiple
IRR Returns (5-YrExit)
Note 1: Total Debt - Cumulative Excess Cash to Repay Debt = Net Debt Source: Training the Street, Inc.
Determining Cash Flow Available for Debt Service and Debt Sources
371
An LBO analysis includes cash flow projections, terminal value projections (the price at which a financial buyer thinks the company can be sold in 3–7 years) and present value determination (the price that a financial buyer will pay for a company today), and the analysis solves for the IRR of the investment (the discount rate applied). LBO models require an assumption of a minimum IRR required by financial buyers, based on risks associated with the investment and market conditions. The model solves for the purchase price that creates this targeted IRR. Basically, the LBO analysis answers the question: What is the highest purchase price that can be paid for a company to earn a compound annual rate of return that meets the investor’s risk-adjusted return requirement? The LBO analysis considers whether there is enough projected cash flow to operate the company and also pay debt principal and interest payments. In addition, the analysis determines if there is sufficient cash flow to pay dividends at some point to the private equity investor. An ability to retire debt and pay dividends results in a higher IRR.
DETERMINING CASH FLOW AVAILABLE FOR DEBT SERVICE AND DEBT SOURCES The starting point in an LBO analysis is to determine the cash flow available to service a target company’s future debt obligations. This can be done by starting with a determination of net income; adding depreciation and amortization; and then either adding or subtracting amounts for changes in deferred taxes, other noncash charges, and changes in net working capital. The result is cash flow from operations, which should be reduced by capital expenditures to create cash flow available for debt service (see Exhibit 17.3). When cash flow available for debt service has been calculated, the total debt available to purchase the target can be determined through discussion with investment bankers who will advise regarding the market’s tolerance for debt, given the cash flow and risk characteristics of the target company and the target company’s industry (see Exhibit 17.4). Bankers and their financial sponsor clients sometimes scale back the amount of debt they attempt to secure if associated risks seem too high. When the maximum appropriate amount of debt to finance an acquisition is determined, investment bankers and the financial sponsor can then determine the sources of debt, which include senior credit facilities, second lien loans, high-yield debt, and mezzanine financing (see Exhibits 17.5 and 17.6).
EXH I BI T 1 7 .3 DETERMINING CA S H F L OW AVA I L A B L E F O R D EBT SERVICE Net Income + Depreciation and amortization +/– Changes in deferred taxes +/– Other non-cash changes +/– Changes in net working capital = Cash flow from operations – Capital expenditures = Cash flow available for debt service
II. HEDGE FUNDS AND PRIVATE EQUITY
372
17. LBO FINANCIAL MODEL
EXH I BIT 17.4 WHAT DETERM I NE S D E B T CA PA CI TY ? Industry Risk • • • • •
Growth rate and size Cyclicality Barriers to entry Capital intensity Relative strength of suppliers and customers • Rate of technological change/ threat of substitution • Environmental issues • Regulatory risk
Company Risk
Structural Risk
• • • •
Competitive position Historical performance Achievability of projections Depth and quality of management • Qualitative: Information quality Ownership support
• Quantitative Size Leverage Coverage • Security (second way out) • Sources of repayment Are assumptions credible? • Valuation/equitycushion • Comparable transactions • Other successful LBOs in that industry • Growth capability given leverage constraints
Source: Training the Street, Inc.
EXH I BIT 17.5 TY PICAL CAP I TA L S TRUCTURE • Senior credit facility • Revolver • Term loans • Second lien loans • High-yield debt • Senior notes • Senior subordinated notes • Mezzanine/Payment-in-Kind/warrants/preferred stock • Common equity
Source: Training the Street, Inc.
EXH I BIT 17.6 COMMON F IN A NCI NG PA RA M E TE RS • Key credit statistics: • Total debt/EBITDA • Senior bank debt/EBITDA • EBITDA/interest coverage • EBITDA—CapEx/interest coverage • Bank debt payoff • Equity contribution
• Typical range:1 • 3.5–5.5× • 2.5–3.5× • >2.0× • >1.6× • 6–8 years • At least 20%–35%
• Factors affecting credit statistics: • EBITDA determination • Maintenance versus growth in CapEx • Average versus peak working capital requirements • Off-balance sheet financing
Note 1: These ranges applied prior to the credit crisis, which started during the second half of 2007. Subsequently, market conditions worsened, resulting in lower debt ratios, higher interest coverage ratios, and higher equity contribution requirements. For a few duringAND 2006 to mid-2007, total debt/EBITDA multiples reached 8×. II. transactions HEDGE FUNDS PRIVATE EQUITY Source: Training the Street, Inc.
373
Determining Purchase Price and Sale Price
EXH I BI T 1 7 .7 COMPARIS ON OF I NTE RNA L RATE O F RE TURN ( I RR) V ER SUS MULTIPLE OF IN V E S TM E NT Initial Equity Invested
Investment Holding Period
IRR
Value of Equity at Exit
Profit
Multiple of Investment
$1,000
2 years
30%
$1,690
$690
1.69x
$1,000
4 years
25%
$2,441
$1,441
2.44x
$1,000
6 years
20%
$2,986
$1,986
2.99x
DETERMINING FINANCIAL SPONSOR INTERNAL RATE OF RETURN The next step in an LBO analysis is to calculate the IRR. This is done by determining the equity portion of the purchase price, dividend payments to be made, if any, during the investment horizon, and the expected market value of the equity on the exit date. Usually, a range of purchase prices is considered along with a corresponding equity investment amount (which is determined after calculating the maximum debt amount available for the purchase, as described above). The equity amount must, in combination with the projected cash flow and the final projected equity value on the exit date (factoring in the risks associated with cash flow and equity exit value projections), create an IRR that is acceptable to the financial sponsor. If the resulting IRR is below an acceptable level, the financial sponsor must either lower the purchase price or lower the equity contribution, while increasing the debt component of the purchase price, subject to the additional debt being accessible. In other words, this is an iterative process, which sometimes requires the financial sponsor to either reduce their minimum IRR level, or give up the investment opportunity, depending on the price expectations of the target company and pricing from competing buyers. The IRR accepted by the financial sponsor depends on the risk of the investment: lower risk investments allow lower IRR targets and higher risk investments require higher IRR targets. Ultimately, financial sponsors are principally focused on the profitability of an investment, its risk, and the time it takes to exit the investment. They consider the multiple of the expected equity at the time of exit relative to the initial equity invested and attempt to strike a balance between maximizing IRR and maximizing the total cash amount taken out of the investment when the exit is achieved. For example, even if an IRR of 30% is achievable after 2 years, a sponsor may choose a 25% IRR alternative based on an exit in 4 years if the “profit” of the transaction (equity value at exit—equity invested at inception = profit) is substantially higher in the 4-year exit alternative (see Exhibit 17.7). By holding the investment for 4 years, the sponsor gives up IRR, but increases the multiple of investment from 1.69× to 2.44×. The IRR give-up is caused principally by investor’s desire to remain invested based on their aversion to new risks and costs associated with redeployment of funds and financial buyer interest in achieving high multiples of investment (which creates an effective marketing metric for future fundraising).
DETERMINING PURCHASE PRICE AND SALE PRICE Financial sponsors generally determine a purchase price for a target based on a multiple of enterprise value to EBITDA. In consultation with investment bankers, they determine purchase price multiples that strategic buyers might apply to an acquisition and then decide if they are
374
17. LBO FINANCIAL MODEL
able to offer a higher multiple based on their targeted IRR (normally, financial buyers cannot pay as high a multiple as strategic buyers can because they lack synergies, but leverage can level the playing field). The IRR, in turn, is determined largely based on the amount of debt financing available and the cash flow available for debt service. The decision regarding a purchase price is therefore based on an iterative process. Financial sponsors usually project a future sale price based on the same multiple used in the initial purchase price determination if an M&A sale is considered the most likely exit strategy. Sometimes, however, a comparable company multiple is used if the ultimate sale is expected to be initiated through an IPO. In addition, the sale multiple could be increased if positive changes in the industry or in management are expected, or decreased if negative changes are expected. See Chapter 4 for a more complete discussion of valuation multiples.
LEVERAGED BUYOUT ANALYSIS EXAMPLE A simplified example of an LBO analysis is provided below based on the acquisition of Toys “R” Us (Toys) by a consortium of buyers consisting of KKR, Bain Capital, and Vornado Realty Trust during 2005. This consortium will be referred to as “KKR.”
Forecast Revenue, Margins, D&A, CapEx, Working Capital, Interest Rate, and Tax Rate The LBO analysis starts with a review of the target company’s financial statements. See Toys financial statements in Exhibits 17.8–17.10. KKR would have completed a summary similar to Exhibit 17.11 to determine historical sales growth and margins. They would have then performed due diligence to determine the likelihood that Toys would be able to continue producing similar (or better) margins and sales growth. KKR would also have completed a forecast of Toys’ balance sheet, income statement, and cash flow statement for their expected investment horizon in an effort to determine cash flow projections that would be utilized to establish the future value of the company. This future value would be calculated by multiplying projected EBITDA on the date of a future sale by the expected enterprise value/EBITDA multiple that would be relevant at that time. As part of the creation of future expected balance sheets, income statements, and cash flow statements, KKR would have made assumptions regarding growth in revenues. When these projections are made, other parts of the income statement (including cost of goods sold; selling, general and administrative expenses; and depreciation and amortization) are expected to remain constant (or to decline slightly) as a percentage of revenues (see Exhibit 17.12). For CapEx, it is commonly assumed that annual CapEx is equal to annual depreciation to keep the asset base constant.1 However, KKR may have decided to improve Toys’ asset base by increasing CapEx above depreciation or, they might have decided to decelerate CapEx, allowing Toys’ asset base to reduce. Although working capital can be set at a percentage of revenues, KKR probably calculated working capital based on individual balance sheet items, with changes in Toys’ working capital resulting from the projected balance sheet (see Exhibit 17.13). Toys FYE 2005 federal tax rate of 35% (state and local taxes might increase the tax rate to as much as 38%) was used as 1 To
account for inflation, however, CapEx is often projected to increase at a higher rate than depreciation so that the real value of physical capital like plant and equipment does not decline. II. HEDGE FUNDS AND PRIVATE EQUITY
375
Leveraged Buyout Analysis Example
a base from, which KKR could project future tax rates (which could be constant, increasing or decreasing, depending on known and future expected tax developments). The interest rate assumption used for Toys was higher than the company’s historical rate to reflect higher leverage and correspondingly higher risk to lenders (see Exhibit 17.14).
EXH I BI T 1 7 .8 CONSOLIDATED F I NA NCI A L RE S ULTS ( $ I N M I LL IONS, EXCEPT PER S HA RE D ATA ) ȱȱȱ ȱ
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376
17. LBO FINANCIAL MODEL
EXH I BIT 17.9 CONS OLIDAT E D B A L A NCE S HE E T ( $ I N MILLIONS ) For the Year Ended 1/31/2004
1/29/2005
ASSETS $1,432
$1,250
Short-term inves tments
C ash and c ash equivalents
571
953
Accounts and other rec eivables
146
153
2,094
1,884
Merc handis e inventories N et property ass ets held f or s ale
163
7
Current portion of derivative ass ets
162
1
Prepaid expenses and other current assets Total c urrent ass ets
161
159
$4,729
$4,407
$2,165
$2,393
Property, plant, and equipment R eal estate, net Other, net Total PP&E Goodwill, net D erivative ass ets
2,274
1,946
$4,439
$4,339
348
353
77
43
D eferred tax ass et
399
426
Other ass ets
273
200
$10,265
$9,768
Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Short-term borrowings Accounts payable
$0
$0
1,022
1,023
Accrued expenses and other current liabilities
866
881
Inc ome taxes payable
319
245
Current portion of long-term debt Total c urrent liabilities Long-term debt D eferred inc ome taxes D erivative liabilities
657
452
$2,864
$2,601
2,349
1,860
538
485
26
16
D eferred rent liability
280
269
Other liabilities
225
212
Minority interest in T oysrus.c om Total liabilities
9
0
$6,291
$5,443
Stockholders’ equity C ommon stock
$30
$30
Additional paid-in c apital
407
405
5,308
5,560
R etained earnings Accumulated other c omprehensive loss
(64)
(7)
0
(5)
Treas ur y shares, at c ost
(1,707)
(1,658)
Total stoc kholders’ equity
$3,974
$4,325
$10,265
$9,768
R estricted stoc k
Total liabilities and stockholders’ equity
377
Leveraged Buyout Analysis Example
EXH I BI T 1 7 .10 CONSOLIDATED S TATE M E NT O F CA S H F L OW ( $ I N M I LL IONS) ȱȱȱ ŘȦŗȦŘŖŖř
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ȱȱȱȱȱȱȱȱȱȱ DZ ȱȱ£ £ȱȱȱ ȱȱ¡ ¢ȱȱȱ¢ǯ ȱȬȱ Ȭȱȱȱȱȱȱ
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II. HEDGE FUNDS AND PRIVATE EQUITY
ǻǞŗŞŘǼ
For the Year Ended 2/1/2003
% of Total
1/31/2004
% of Total
378
EX H I B IT 1 7 .11 F INANCIA L P E RF O RM A NCE B Y S E G M E NT ( $ I N M I L L I O N S ) For the Year Ended 1/29/2005
% of Total
NET SALES BY SEGMENT
2/1/2003
1/31/2004
1/29/2005
GROWTH BY SEGMENT (%) $6,755
59.8
$6,326
55.9
$6,104
55.0
–6.4
–3.5
Toys “R” Us —International
2,161
19.1
2,470
21.8
2,739
24.7
14.3
10.9
Babies “R” Us
1,595
14.1
1,738
15.4
1,863
16.8
9.0
7.2
340
3.0
371
3.3
366
3.3
9.1
–1.3
Toys “R” Us —U.S.
Toysrus.com Kids “R” Us Consolidated net sales
454
4.0
415
3.7
28
0.3
–8.6
–93.3
$11,305
100.0
$11,320
100.0
$11,100
100.0
0.1
–1.9
MARGIN BY SEGMENT (%) $256
49.4
$70
20.4
$4
0.9
3.8
1.1
Toys “R” Us —International
158
30.5
166
48.4
220
51.9
7.3
6.7
8.0
Babies “R” Us
169
32.6
192
56.0
224
52.8
10.6
11.0
12.0
Toysrus.com
(37)
–7.1
(18)
–5.2
1
0.2
–10.9
–4.9
0.3
Kids “R” Us
(28)
–5.4
(67)
–19.5
(25)
–5.9
–6.2
–16.1
–89.3
100.0
$343
100.0
$424
100.0
4.6
3.0
3.8
3.9
1.9
2.7
Toys “R” Us —U.S.
Segment operating earnings
$518
Corporate/other expenses
(75)
Restructuring charges Reported operating earnings
0
(63)
(4)
$443
$217
$304
(63)
(116)
ADJUSTED EBITDA BY SEGMENT Toys “R” Us —U.S. Toys “R” Us —International
0.1
MARGIN BY SEGMENT (%) $447
55.1
$264
39.3
$322
37.4
6.6
4.2
5.3
210
25.9
227
33.8
295
34.3
9.7
9.2
10.8 14.1
Babies “R” Us
197
24.3
223
33.2
262
30.5
12.4
12.8
Toysrus.com
(33)
–4.1
(16)
–2.4
1
0.1
–9.7
–4.3
0.3
Kids “R” Us Adjusted segment EBITDA
(10)
–1.2
(27)
–4.0
(20)
–2.3
–2.2
–6.5
–71.4
$811
100.0
$671
100.0
$860
100.0
7.2
5.9
7.7
Corporate/other expenses
(75)
6.9
5.7
7.0
Add-back: other D&A Consolidated adjusted EBITDA
(63)
(116)
46
40
36
$782
$648
$780
Note 1: Includes markdowns of $49 million and accelerated depreciation of $24 million in 2003 related to the closing of all stores. Note 2: Includes corporate expenses, the operating results of Toy Box, and the equity in net earnings of Toys “R”— UsJapan. Increase in amount is due to ourstrategic review expenses and Sarbanes-Oxley Section 404 compliance totaling $29 million. In addition, we incurred charges of $8 million relating to our 2004 restructuring of the Company’s corporate headquarters operations, and a $19 million increase in incentive compensation costs. $118 million net add-back in FY 2005. Source: Toys “R” Us FYE 2005 10-K Filing
17. LBO FINANCIAL MODEL
II. HEDGE FUNDS AND PRIVATE EQUITY
OPERATING EARNINGS BY SEGMENT
EXH I BI T 17.1 2 INCOME S TATE M E NT ( $ I N M I L L I O NS ) Base Case For the FYE January 31 Consolidated Net Sales Growth COGS & SG&A by Segment Margin EBITDA by Segment Margin
Consolidated EBITDA Growth Margin
Actual 2004 2005 $11,320.0 $11,100.0 0.1% -1.9%
2006 $10,875.2 -2.0%
2007 $10,456.3 -3.9%
2008 $10,405.8 -0.5%
2009 $10,741.8 3.2%
Projected 2010 2011 $11,140.9 $11,554.9 3.7% 3.7%
2012 $11,984.2 3.7%
2013 $12,429.4 3.7%
2014 $12,891.2 3.7%
2015 $13,370.2 3.7%
$10,494.0 92.8%
$10,649.0 $10,240.0 94.1% 92.3%
$9,986.4 91.8%
$9,569.5 91.5%
$9,501.9 91.3%
$9,799.4 91.2%
$10,155.5 91.2%
$10,532.8 91.2%
$10,924.1 91.2%
$11,330.0 91.2%
$11,750.9 91.2%
$12,187.5 91.2%
$811.0 7.2%
$671.0 5.9%
$860.0 7.7%
$888.7 8.2%
$886.9 8.5%
$903.9 8.7%
$942.5 8.8%
$985.5 8.8%
$1,022.1 8.8%
$1,060.1 8.8%
$1,099.4 8.8%
$1,140.3 8.8%
$1,182.7 8.8%
29.0 0.3%
23.0 0.2%
80.0 0.7%
27.9 0.3%
26.8 0.3%
26.7 0.3%
27.6 0.3%
28.6 0.3%
29.6 0.3%
30.7 0.3%
31.9 0.3%
33.1 0.3%
34.3 0.3%
$782.0
$780.0 20.4% 7.0%
$860.8 10.4% 7.9%
$860.0 -0.1% 8.2%
$877.2 2.0% 8.4%
$914.9 4.3% 8.5%
$956.9 4.6% 8.6%
$992.4 3.7% 8.6%
$1,029.3 3.7% 8.6%
$1,067.6 3.7% 8.6%
$1,107.2 3.7% 8.6%
$1,148.4 3.7% 8.6%
6.9%
$648.0 -17.1% 5.7%
D&A by Segment Margin
293.0 2.6%
328.0 2.9%
318.0 2.9%
304.4 2.8%
288.5 2.8%
284.6 2.7%
293.2 2.7%
303.8 2.7%
315.1 2.7%
326.8 2.7%
339.0 2.7%
351.5 2.7%
364.6 2.7%
Other D&A Margin
46.0 0.4%
40.0 0.4%
36.0 0.3%
35.3 0.3%
33.9 0.3%
33.7 0.3%
34.8 0.3%
36.1 0.3%
37.5 0.3%
38.9 0.3%
40.3 0.3%
41.8 0.3%
43.4 0.3%
0.0 $443.0
63.0 $217.0 -51.0% 1.9%
4.0 $422.0 94.5% 3.8%
0.0 $521.1 23.5% 4.8%
0.0 $537.6 3.2% 5.1%
0.0 $558.9 4.0% 5.4%
0.0 $586.8 5.0% 5.5%
0.0 $616.9 5.1% 5.5%
0.0 $639.9 3.7% 5.5%
0.0 $663.6 3.7% 5.5%
0.0 $688.3 3.7% 5.5%
0.0 $713.9 3.7% 5.5%
0.0 $740.4 3.7% 5.5%
$139.0 47.3 209.0 90.0 64.0 $549.2
$116.8 50.8 209.0 90.0 64.0 $530.5
$100.3 54.3 209.0 90.0 64.0 $517.5
$88.2 57.8 209.0 90.0 64.0 $509.0
$74.1 61.3 209.0 90.0 64.0 $498.3
$57.8 64.8 209.0 90.0 64.0 $485.6
$39.4 66.5 209.0 90.0 64.0 $468.9
$18.7 66.5 209.0 90.0 64.0 $448.2
$3.9 54.5 209.0 90.0 64.0 $421.4
$0.0 22.5 209.0 90.0 64.0 $385.5
Restructuring Charges Consolidated EBIT Growth Margin Interest Expense Assumed Debt Senior Secured Credit Facility Unsecured Bridge Loan Secured European Bridge Loan Mortgage Loan Agreements Total Interest Expense Interest Income on Cash Balance
3.9%
40.5
46.8
53.0
59.2
65.5
71.7
77.9
77.9
77.9
77.9
Pre-Tax Income Use of NOLs Taxes 35.0% Net Income Growth Margin
$12.4 0.0 4.3 $8.1 0.1%
$53.9 0.0 18.9 $35.0 334.2% 0.3%
$94.3 0.0 33.0 $61.3 75.1% 0.6%
$137.1 0.0 48.0 $89.1 45.3% 0.8%
$184.1 0.0 64.4 $119.6 34.3% 1.1%
$226.0 0.0 79.1 $146.9 22.8% 1.3%
$272.7 0.0 95.4 $177.3 20.7% 1.5%
$318.0 0.0 111.3 $206.7 16.6% 1.7%
$370.4 0.0 129.7 $240.8 16.5% 1.9%
$432.8 0.0 151.5 $281.3 16.8% 2.1%
Proceeds from Store Sales (After-Tax)
217.7
185.8
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0 $225.8
0.0 $220.8
0.0 $61.3
0.0 $89.1
0.0 $119.6
0.0 $146.9
0.0 $177.3
0.0 $206.7
0.0 $240.8
0.0 $281.3
Dividends Retained Earnings
Leveraged Buyout Analysis Example
II. HEDGE FUNDS AND PRIVATE EQUITY
Corporate / Other Expenses Margin
2003 $11,305.0
379
380
EX H I BI T 17.13 B ALANCE S HEET ($ I N M I L L I O NS ) Base Case For the FYE January 31
ASSETS Cash and Cash Equivalents Accounts and Other Receivables Merchandise Inventories Other Current Assets Total Current Assets
2003
Actual 2004
2005
2006
2007
2008
2009
Projected 2010
2011
2012
2013
2014
2015
$1,247.0 149.9 1,837.3 163.6 $3,397.9
$1,247.0 144.1 1,760.6 157.3 $3,309.1
$1,247.0 143.4 1,748.2 156.6 $3,295.2
$1,247.0 148.1 1,802.9 161.6 $3,359.6
$1,247.0 153.6 1,868.4 167.6 $3,436.6
$1,247.0 159.3 1,937.9 173.8 $3,518.0
$1,247.0 165.2 2,009.9 180.3 $3,602.4
$1,247.0 171.3 2,084.5 187.0 $3,689.9
$1,247.0 177.7 2,162.0 193.9 $3,780.6
$1,247.0 184.3 2,242.3 201.2 $3,874.8
Net, PP&E
4,339.0
$4,216.8
$4,103.5
$3,993.3
$3,880.0
$3,762.9
$3,641.4
$3,515.4
$3,384.8
$3,249.2
$3,108.6
Goodwill, net New Goodwill Other Assets
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
$11,143.0
$10,967.7
$10,765.6
$10,641.5
$10,592.7
$10,552.5
$10,512.4
$10,470.8
$10,427.6
$10,382.8
$10,336.4
Accounts Payable Accrued Expenses & Other Current Liabilities
$1,023.0 1,126.0
$997.7 1,098.1
$956.0 1,052.3
$949.3 1,044.8
$979.0 1,077.5
$1,014.6 1,116.7
$1,052.2 1,158.2
$1,091.3 1,201.2
$1,131.9 1,245.9
$1,173.9 1,292.1
$1,217.6 1,340.2
Total Current Liabilities
$2,149.0
$2,095.8
$2,008.3
$1,994.1
$2,056.5
$2,131.3
$2,210.4
$2,292.6
$2,377.7
$2,466.1
$2,557.7
Assumed Debt Senior Secured Credit Facility Unsecured Bridge Loan Secured European Bridge Loan Mortgage Loan Agreements Total Debt
$2,312.0 700.0 1,900.0 1,000.0 800.0 $6,712.0
$1,964.1 700.0 1,900.0 1,000.0 800.0 $6,364.1
$1,628.7 700.0 1,900.0 1,000.0 800.0 $6,028.7
$1,457.4 700.0 1,900.0 1,000.0 800.0 $5,857.4
$1,257.1 700.0 1,900.0 1,000.0 800.0 $5,657.1
$1,022.6 700.0 1,900.0 1,000.0 800.0 $5,422.6
$756.4 700.0 1,900.0 1,000.0 800.0 $5,156.4
$455.4 700.0 1,900.0 1,000.0 800.0 $4,855.4
$120.3 700.0 1,900.0 1,000.0 800.0 $4,520.3
$0.0 446.4 1,900.0 1,000.0 800.0 $4,146.4
$0.0 27.0 1,900.0 1,000.0 800.0 $3,727.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
Total Liabilities
$9,843.0
$9,441.9
$9,019.0
$8,833.5
$8,695.6
$8,535.8
$8,348.8
$8,129.9
$7,880.1
$7,594.5
$7,266.7
Stockholders' Equity New Preferred Stock Sponsor Equity Retained Earnings Total Stockholders' Equity
$0.0 1,300.0 0.0 $1,300.0
$0.0 1,300.0 225.8 $1,525.8
$0.0 1,300.0 446.6 $1,746.6
$0.0 1,300.0 508.0 $1,808.0
$0.0 1,300.0 597.1 $1,897.1
$0.0 1,300.0 716.7 $2,016.7
$0.0 1,300.0 863.6 $2,163.6
$0.0 1,300.0 1,040.9 $2,340.9
$0.0 1,300.0 1,247.6 $2,547.6
$0.0 1,300.0 1,488.4 $2,788.4
$0.0 1,300.0 1,769.7 $3,069.7
$11,143.0
$10,967.7
$10,765.6
$10,641.5
$10,592.7
$10,552.5
$10,512.4
$10,470.8
$10,427.6
$10,382.8
$10,336.4
$0.000
$0.000
$0.000
$0.000
$0.000
$0.000
$0.000
$0.000
$0.000
$0.000
$0.000
Total Assets LIABILITIES & STOCKHOLDERS' EQUITY
Deferred Income Taxes Other Liabilities
Total Liabilities & Stockholders' Equity Check
17. LBO FINANCIAL MODEL
$1,247.0 153.0 1,884.0 167.0 $3,451.0
EX H I BI T 17.14 INTEREST RATE AN D W O RKI NG CA P I TA L A S S UM P TI O NS ( $ I N M I LLI ONS) Base Case For the FYE January 31
Interest Rate Assumptions LIBOR
2003
Actual 2004
2007
2008
2009
Projected 2010
2011
2012
2013
2014
2015
2.75%
3.25%
3.75%
4.25%
4.75%
5.25%
5.75%
6.00%
6.00%
6.00%
6.00%
3.25%
3.75%
4.25%
4.75%
5.25%
5.75%
6.25%
6.25%
6.25%
6.25%
LIBOR Spread Fixed Rate 6.50% 3.50% 11.00% 9.00% 8.00%
6.50% 6.75% 11.00% 9.00% 8.00%
6.50% 7.25% 11.00% 9.00% 8.00%
6.50% 7.75% 11.00% 9.00% 8.00%
6.50% 8.25% 11.00% 9.00% 8.00%
6.50% 8.75% 11.00% 9.00% 8.00%
6.50% 9.25% 11.00% 9.00% 8.00%
6.50% 9.50% 11.00% 9.00% 8.00%
6.50% 9.50% 11.00% 9.00% 8.00%
6.50% 9.50% 11.00% 9.00% 8.00%
6.50% 9.50% 11.00% 9.00% 8.00%
$146.0 4.7
$153.0 5.0
$149.9 5.0
$144.1 5.0
$143.4 5.0
$148.1 5.0
$153.6 5.0
$159.3 5.0
$165.2 5.0
$171.3 5.0
$177.7 5.0
$184.3 5.0
$2,094.0 5.1
$1,884.0 5.4
$1,837.3 5.4
$1,760.6 5.4
$1,748.2 5.4
$1,802.9 5.4
$1,868.4 5.4
$1,937.9 5.4
$2,009.9 5.4
$2,084.5 5.4
$2,162.0 5.4
$2,242.3 5.4
$486.0 15.7
$167.0 5.5
$163.6 5.5
$157.3 5.5
$156.6 5.5
$161.6 5.5
$167.6 5.5
$173.8 5.5
$180.3 5.5
$187.0 5.5
$193.9 5.5
$201.2 5.5
Accounts Payable Days Outstanding
$1,022.0 35.0
$1,023.0 36.5
$997.7 36.5
$956.0 36.5
$949.3 36.5
$979.0 36.5
$1,014.6 36.5
$1,052.2 36.5
$1,091.3 36.5
$1,131.9 36.5
$1,173.9 36.5
$1,217.6 36.5
Accrued Expenses & Other
$1,185.0
$1,126.0
$1,098.1
$1,052.3
$1,044.8
$1,077.5
$1,116.7
$1,158.2
$1,201.2
$1,245.9
$1,292.1
$1,340.2
Merchandise Inventories Turns Other Current Assets Days Outstanding
Current Liabilities Days Outstanding Total Current Assets Total Current Liabilities Working Capital
40.6
40.1
40.1
40.1
40.1
40.1
40.1
40.1
40.1
40.1
40.1
40.1
$2,726.0 2,207.0 $519.0
$2,204.0 2,149.0 $55.0
$2,150.9 2,095.8 $55.1
$2,062.1 2,008.3 $53.8
$2,048.2 1,994.1 $54.1
$2,112.6 2,056.5 $56.1
$2,189.6 2,131.3 $58.4
$2,271.0 2,210.4 $60.5
$2,355.4 2,292.6 $62.8
$2,442.9 2,377.7 $65.1
$2,533.6 2,466.1 $67.5
$2,627.8 2,557.7 $70.0
($7.0)
$3.1
$5.8
$0.7
($4.6)
($5.5)
($5.7)
($5.9)
($6.1)
($6.4)
($6.6)
(Increase) / Decrease in Merchandise Inventories
210.0
46.7
76.7
12.4
(54.7)
(65.5)
(69.4)
(72.0)
(74.7)
(77.4)
(80.3)
(Increase) / Decrease in Other Current Assets Increase / (Decrease) in Accounts Payable Increase / (Decrease) in Accrued Expenses & Other Current Liabilities (Increase in) Reduction of Working Capital
319.0 1.0 (59.0)
3.4 (25.3) (27.9)
6.3 (41.7) (45.9)
0.8 (6.7) (7.4)
(5.1) 29.7 32.7
(6.0) 35.6 39.2
(6.2) 37.7 41.5
(6.5) 39.1 43.0
(6.7) 40.5 44.6
(6.9) 42.1 46.3
(7.2) 43.6 48.0
($0.1)
$1.3
($0.3)
($2.0)
($2.3)
($2.2)
($2.2)
($2.3)
($2.4)
($2.5)
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
(Increase) / Decrease in Long-Term Assets Increase / (Decrease) in Long-Term Liabilities
$464.0
381
(Increase) / Decrease in Accounts and Other Receivables
Leveraged Buyout Analysis Example
Workings Capital Assumptions Accounts and Other Receivables Days Outstanding
2006
2.75%
Interest Earned on Cash Cash Interest Rate on Debt Assumed Debt Senior Secured Credit Facility Unsecured Bridge Loan Secured European Bridge Loan Mortgage Loan Agreements
2005
382
17. LBO FINANCIAL MODEL
Calculate Acquisition Multiples On March 17, 2005, Toys announced that it had reached a definitive agreement to sell the entire company to KKR for $26.75 per share in a $7.7-billion transaction, including all transaction fees. The purchase price represented a total transaction value (enterprise value + transaction fees) that was 9.9× Toys’ FYE 2005 EBITDA and an enterprise value that was 9.4× Toys’ FYE 2005 EBITDA. The equity amount contributed by KKR was $1.3 billion (see Exhibits 17.15 and 17.16). KKR’s purchase price was a 63% premium to Toys’ share price on the day before the company announced it was exploring a sale of the global toy business. KKR may have decided to offer a high premium based on an analysis of comparable transactions that included acquisition premiums and because of Toys’ significant real estate holdings (which KKR may have felt was not fully valued by the market). Regardless, KKR would have completed financial projections that showed growth in cash flow over their investment horizon. Multiples applied against cash flow on the projected future sale date would create a final equity amount, which when compared with the initial KKR equity contribution, would result in an IRR that was acceptable to KKR.
EXH I BIT 17.1 5 TRANSACTI O N S UM M A RY ǻǞȱȱǼ
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EXH I BIT 17.1 6 SOURCES AND US E S ( $ I N M I L L I O NS ) Sources Cash on balance sheet Senior secured credit facility Unsecured bridge loan
Uses $956 700 1900
Purchase of common stock Purchase of stock options and restricted stock Settlement of equity security interests
II. HEDGE FUNDS AND PRIVATE EQUITY
$5900 227 114
Leveraged Buyout Analysis Example
383
EXH I BI T 1 7 .16 S OURCES AND US E S ( $ I N M I L L I O NS ) —co n t' d Sources
Uses
Secured European bridge loan Mortgage loan agreements Sponsor equity Total
1000 800 1300 $6656
Purchase of all warrants Transaction fees Severance and bonus payments Total
17 362 36 $6656
Summary of Fees Advisory fees and expenses Financing fees Sponsor fees Others Total
$78 135 81 68 $362
Note: Senior secured credit facility has $2.0 billion of availability. This exhibit reflects actual sources and uses for the Toys transaction that closed on July 21, 2005: the $956 million cash used is included in the model, which assumes (for simplicity) a closing on January 29, 2005 (see Exhibit 17.18). Source: Toys “R” Us, Form 10-Q, July 30, 2005.
Determine Target’s Capitalization Postacquisition Postacquisition, Toys had a capitalization of: (1) $2.3 billion of assumed existing debt plus $4.4 billion of new debt for a total of $6.7 billion in debt (see Exhibit 17.17), and (2) $1.3 billion of equity. As a result, equity represented only 16.3% of postacquisition Toys capitalization, and debt represented 83.7% of capitalization. This compares to a preacquisition equity and debt of approximately 65% and 35%, respectively. As a result, Toys’ capitalization became significantly more leveraged based on the LBO transaction (see Exhibit 17.18).
EXH I BI T 1 7 .17 LEVERAGE SUM M A RY ( $ I N M I L L I O NS ) > s Z' E>z^/^
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ϳ͘Ϭdž
EŽƚĞ͗dŚĞŵŽĚĞůĂƐƐƵŵĞƐƚƌĂŶƐĂĐƟŽŶĐůŽƐĞĚŽŶ &z :ĂŶƵĂƌLJϮϵ͕ϮϬϬϱ͘ ĐƚƵĂůĚĞĂůĐůŽƐĞĚŽŶ:ƵůLJϮϭ͕ϮϬϬϱ͘
II. HEDGE FUNDS AND PRIVATE EQUITY
384
17. LBO FINANCIAL MODEL
EXH I BI T 17.1 8 CONS OLIDAT E D B A L A NCE S HE E T @ TRA N SACTION CLOS E ǻǞȱȱǼ ȱȱȱ ȱȱȱ ȱ ȱȱ ȱȱ
ȱȱȱȱȱ ŗȦřŗȦŘŖŖŚ ŗȦŘşȦŘŖŖś
ǞŘǰŖŖř ŗŚŜ ŘǰŖşŚ ŚŞŜ ǞŚǰŝŘş
ǞŘǰŘŖř ŗśř ŗǰŞŞŚ ŗŜŝ ǞŚǰŚŖŝ
ǞŚǰŚřş
ǞŚǰřřş
řŚŞ Ŗ ŝŚş
řśř Ŗ ŜŜş
ǻřśřǼ ŘǰŜŞŚ
Ŗ ŘǰŜŞŚ ŜŜş
ǞŗŖǰŘŜś
ǞşǰŝŜŞ
Ǟŗǰřŝś
ǞŗŗǰŗŚř
ȱǭȱ ȇȱ ȱ¢ ŗǰŖŘŘ ȱ¡ȱǭȱȱȱ ŗǰŗŞś ȱȱ ǞŘǰŘŖŝ
ŗǰŖŘř ŗǰŗŘŜ ǞŘǰŗŚş
ǞŖ
ŗǰŖŘř ŗǰŗŘŜ ǞŘǰŗŚş
řǰŖŖŜ Ŗ Ŗ Ŗ Ŗ řǰŖŖŜ
ŘǰřŗŘ Ŗ Ŗ Ŗ Ŗ ŘǰřŗŘ
ŝŖŖ ŗǰşŖŖ ŗǰŖŖŖ ŞŖŖ ŚǰŚŖŖ
ŘǰřŗŘ ŝŖŖ ŗǰşŖŖ ŗǰŖŖŖ ŞŖŖ ŜǰŝŗŘ
śřŞ śŚŖ
ŚŞś Śşŝ
ȱ
ǞŜǰŘşŗ
ǞśǰŚŚř
ǞŚǰŚŖŖ
ǞşǰŞŚř
ȇȱ¢ ȱȱ ȱ¢ ȱ ȱȇȱ¢
ǞŖ Ŗ řǰşŝŚ ǞřǰşŝŚ
ǞŖ Ŗ ŚǰřŘś ǞŚǰřŘś
ŗǰřŖŖ ǻŚǰřŘśǼ ǻǞřǰŖŘśǼ
ǞŖ ŗǰřŖŖ Ŗ ǞŗǰřŖŖ
ǰȱǭ ǰȱ ȱ ȱ ȱ
ȱ ȱȱȱ¢ ȱȱ ȱȱȱ ȱȱ ȱ ȱ ȱ¡ ȱ
ǻǞşśŜǼ
ȱȱȓȱ
ǻǞşśŜǼ
ǞŗǰŘŚŝ ŗśř ŗǰŞŞŚ ŗŜŝ ǞřǰŚśŗ ǞŚǰřřş
ŚŞś Śşŝ
ȱȱǭȱȇȱ¢ ǞŗŖǰŘŜś ǞşǰŝŜŞ Ǟŗǰřŝś DZȱȱȱȱȬȱǯȱȱȱȱȱȱȱ ¢ȱŘşǰȱŘŖŖśǯȱ ȱȱȱȱ ¢ȱŘŗǰȱŘŖŖśǯ DZȱȱ ȱ ¢ȱȱȱǻ ǯȱǼ ǞŜǰŜśŜ ȱȱȱ řǰşŝŘ ȱ ǞŘǰŜŞŚ DZȱȱȱȱȱȱȱȱȬȱ
II. HEDGE FUNDS AND PRIVATE EQUITY
ǞŗŗǰŗŚř
Leveraged Buyout Analysis Example
385
Determine Cash Flow Available for Debt Service KKR determined the cash flow available for debt service by subtracting CapEx from projected EBITDA and then making adjustments based on changes in working capital and other long-term assets and liabilities and payment of cash taxes. In addition, because KKR expected to receive cash from the future sale of stores, the projected after-tax proceeds of these sales increased cash. The result was a forecast of cash available for debt service through 2015 (see Exhibit 17.19). This amount was then reduced to reflect interest expense netted against interest income to create cash available for debt repayment. Normally, this cash is used to pay down debt and, in the case of Toys, the Exhibit suggests that the $2.3 billion of debt assumed on the date of acquisition is paid off first, and then the senior secured credit facility receives partial repayment. The end result of using available cash flow to retire debt is the reduction in total debt over time and improvement in debt/EBITDA ratios (see Exhibits 17.19 and 17.20). The gradual reduction in debt combined with the increase in EBITDA creates a growth in equity for a financial sponsor, enabling the sponsor to achieve its targeted IRR (see Exhibit 17.1). The Toys’ projected cash flow statement (Exhibit 17.19) shows that there should be $347.9 million in cash available during 2006 to repay a portion of the debt assumed at the time of the acquisition.2 Payment of this debt reduces total debt from $6.712 billion in 2005 to $6.364 billion in 2006 (see Exhibit 17.20). This total debt amount continues to decrease from debt repayment through 2010, when it reaches $5.423 billion (net debt of $4.176 billion). LBO models typically assume that all excess cash is used to pay down debt. This is because the financial sponsor usually thinks that this is the best use for excess cash. However, if there is a compelling investment opportunity, or if the sponsor wants the company to pay a large dividend, this cash can be diverted, unless lenders include loan covenants that prevent or minimize dividends and other large cash payments (which they usually do).
2 Sometimes,
a range of cash flows is projected since it is increasingly difficult to be precise the further out in time the projection continues. A variable cash flow projection will reveal alternative IRR outcomes and the riskiness of the debt brought onto the balance sheet.
II. HEDGE FUNDS AND PRIVATE EQUITY
386
E X HI BI T 17.19 CASH FLOW STATE M E NT ( $ I N M I L L I O NS ) ȱ ȱȱȱ ¢ȱřŗ
ŘŖŖŝ ǞŞŜŖǯŖ ŘŖşǯŗ ǞŜśŖǯş
ŘŖŖŞ ǞŞŝŝǯŘ ŘŖŞǯŗ ǞŜŜşǯŗ
ŘŖŖş ǞşŗŚǯş ŘŗŚǯŞ ǞŝŖŖǯŗ
ŘŖŗŖ ŘŖŗŗ ǞşśŜǯş ǞşşŘǯŚ ŘŘŘǯŞ Řřŗǯŗ ǞŝřŚǯŗ ǞŝŜŗǯř
ǻ ǼȱȦȱȱȱȱ ǻ ǼȱȦȱȱȱȱȱ ȱȦȱǻǼȱȱȱȱ ȱ¡ ȱȱȱȱȱ¡ȱȱȱ ȱȱȦȱǻǼȱȱ
ǻǞŖǯŗǼ ŖǯŖ ŖǯŖ ǻŚǯřǼ ŖǯŖ ǻǞŚǯŚǼ
Ǟŗǯř ŖǯŖ ŖǯŖ ǻŗŞǯşǼ ŖǯŖ ǻǞŗŝǯŜǼ
ǻǞŖǯřǼ ŖǯŖ ŖǯŖ ǻřřǯŖǼ ŖǯŖ ǻǞřřǯřǼ
ǻǞŘǯŖǼ ŖǯŖ ŖǯŖ ǻŚŞǯŖǼ ŖǯŖ ǻǞśŖǯŖǼ
ǻǞŘǯřǼ ŖǯŖ ŖǯŖ ǻŜŚǯŚǼ ŖǯŖ ǻǞŜŜǯŝǼ
ȱȱȱȱǻȬ¡Ǽ
Řŗŝǯŝ
ŗŞśǯŞ
ŖǯŖ
ŖǯŖ
ŖǯŖ
ŖǯŖ
ŖǯŖ
ŖǯŖ
ŖǯŖ
ŖǯŖ
ȱȱȱȱ
ǞŞśŜǯŜ
ǞŞŗşǯŗ
ǞŜřśǯŞ
ǞŜśŖǯŗ
ǞŜŜŝǯŚ
ǞŜŞŖǯŗ
ǞŜşŗǯş
ǞŝŖśǯř
Ǟŝŗŝǯř
ǞŝŘŝǯŖ
ȱ ȱ¡ ȱ ȱȱȱ ȱȱȱȱ£ȱȦȱ¢
ǞśŚşǯŘ ŚŖǯś ǞřŚŝǯş
ǞśřŖǯś ŚŜǯŞ ǞřřśǯŚ
Ǟśŗŝǯś śřǯŖ Ǟŗŝŗǯř
ǞśŖşǯŖ śşǯŘ ǞŘŖŖǯŚ
ǞŚşŞǯř Ŝśǯś ǞŘřŚǯś
ǞŚŞśǯŜ ŝŗǯŝ ǞŘŜŜǯŘ
ǞŚŜŞǯş ŝŝǯş ǞřŖŗǯŖ
ǞŚŚŞǯŘ ŝŝǯş Ǟřřśǯŗ
ǞŚŘŗǯŚ ŝŝǯş Ǟřŝřǯş
ǞřŞśǯś ŝŝǯş ǞŚŗşǯŚ
ȱȱ¢ ȱȱȱ¢ȱ¢
ǻǞřŚŝǯşǼ ǞŖǯŖ
ǻǞřřśǯŚǼ ǞŖǯŖ
ǻǞŗŝŗǯřǼ ǞŖǯŖ
ǻǞŘŖŖǯŚǼ ǞŖǯŖ
ǻǞŘřŚǯśǼ ǞŖǯŖ
ǻǞŘŜŜǯŘǼ ǞŖǯŖ
ǻǞřŖŗǯŖǼ ǞŖǯŖ
ǻǞřřśǯŗǼ ǞŖǯŖ
ǻǞŗŘŖǯřǼ ǻǞŘśřǯŜǼ
ǞŖǯŖ ǻǞŚŗşǯŚǼ
ȱ ȱ¡ ȱȬȱ¡
ŘŖŖŚ
ŘŖŖś
¡ȱȱȱȱȱȱ¢ȱ¢ ȱȱ ȱȱ ȱ ȱȱȦȱ ȱȱȦȱ ȱȦȱ ȱ¡ ǻ Ȭ¡ǼȱȦȱ ȱ¡ ¡ȱȱ¢ ȱ ȱȱ ȱ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ŞǯŜŗ¡ ŝǯŖŗ¡
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ǻǞŘǯŘǼ ŖǯŖ ŖǯŖ ǻŝşǯŗǼ ŖǯŖ ǻǞŞŗǯřǼ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ŘŖŗŘ ǞŗǰŖŘşǯř Řřşǯŝ ǞŝŞşǯŜ
ŘŖŗř ǞŗǰŖŜŝǯŜ ŘŚŞǯŜ ǞŞŗşǯŖ
ŘŖŗŚ ǞŗǰŗŖŝǯŘ ŘśŝǯŞ ǞŞŚşǯŚ
ŘŖŗś ǞŗǰŗŚŞǯŚ ŘŜŝǯŚ ǞŞŞŗǯŖ
ǻǞŘǯŘǼ ŖǯŖ ŖǯŖ ǻşśǯŚǼ ŖǯŖ ǻǞşŝǯŝǼ
ǻǞŘǯřǼ ŖǯŖ ŖǯŖ ǻŗŗŗǯřǼ ŖǯŖ ǻǞŗŗřǯŜǼ
ǻǞŘǯŚǼ ŖǯŖ ŖǯŖ ǻŗŘşǯŝǼ ŖǯŖ ǻǞŗřŘǯŗǼ
ǻǞŘǯśǼ ŖǯŖ ŖǯŖ ǻŗśŗǯśǼ ŖǯŖ ǻǞŗśŚǯŖǼ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
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ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
17. LBO FINANCIAL MODEL
ŘŖŖŜ ǞŞŜŖǯŞ Řŗŝǯś ǞŜŚřǯř
ŘŖŖř
EXH I BIT 17.2 0 RETURNS S UM M A RY ( $ I N M I L L I O NS ) ȱ ŘŖŖś ǞŝŞŖǯŖ ŘŖǯŚƖ ŝǯŖƖ
ŘŖŖŝ ǞŞŜŖǯŖ ȬŖǯŗƖ ŞǯŘƖ
¡
ǞŘŗŝǯś
ǞŘŖşǯŗ
ȱ ȱ¡
ǞśŚşǯŘ ǞŜǰřŜŚ ŗǰŘŚŝ Ǟśǰŗŗŝ
ȱ ȱȱȱ ȱȱȱ II. HEDGE FUNDS AND PRIVATE EQUITY
ȱ ȱȱȱ ȱ
ǞŜǰŝŗŘ ŗǰŘŚŝ ǞśǰŚŜś
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ŞǯŜŗ¡ ŝǯŖŗ¡
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ŘŖŖŞ ǞŞŝŝǯŘ ŘǯŖƖ ŞǯŚƖ
ŘŖŖş ǞşŗŚǯş ŚǯřƖ ŞǯśƖ
ŘŖŗŖ ǞşśŜǯş ŚǯŜƖ ŞǯŜƖ
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Ǟśŗŝǯś
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ǞŜǰŖŘş ŗǰŘŚŝ ǞŚǰŝŞŘ
ǞśǰŞśŝ ŗǰŘŚŝ ǞŚǰŜŗŖ
ǞśǰŜśŝ ŗǰŘŚŝ ǞŚǰŚŗŖ
ǞśǰŚŘř ŗǰŘŚŝ ǞŚǰŗŝŜ
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ŗřǯŖƖ ŗŜǯŞƖ ŘŖǯŘƖ ŘřǯŘƖ ŘŜǯŖƖ ŘŞǯśƖ řŖǯŞƖ
ǞŗǰŗŖŖǯŚ ŗǰśřŗǯŖ ŗǰşŜŗǯŜ ŘǰřşŘǯŘ ŘǰŞŘŘǯŞ řǰŘśřǯŚ řǰŜŞŚǯŖ
Ȧ ŗŚǯśƖ ŗŞǯŚƖ ŘŗǯŞƖ ŘŚǯŞƖ ŘŝǯŜƖ řŖǯŘƖ řŘǯśƖ
ȇŖśȬȇŗŖ ŚǯŘƖ
Leveraged Buyout Analysis Example
ŘŖŖŜ ǞŞŜŖǯŞ ŗŖǯŚƖ ŝǯşƖ
ǞŗǰŗŞŗǯŚ ŗǰŜŗŘǯŖ ŘǰŖŚŘǯŜ ŘǰŚŝřǯŘ ŘǰşŖřǯŞ řǰřřŚǯŚ řǰŝŜśǯŖ
387
388
17. LBO FINANCIAL MODEL
Calculate Credit Ratios Lenders in an LBO transaction take considerable risks based on their exposure to highly leveraged companies such as Toys. As a result, they require controls on the company’s total amount of debt and on the cash flow available to pay interest when due. As a condition for lending, therefore, two different kinds of credit ratios are imposed by lenders: leverage ratios and coverage ratios. Leverage ratios limit the amount of total debt and net debt that the target company is allowed to undertake relative to EBITDA. In the Toys transaction, postacquisition total debt/ EBITDA during 2005 was 8.61×. Net debt/EBITDA during 2005 was 7.01× (see Exhibit 17.20). Note that these ratios are forecast to reduce each year based on the repayment of debt until 2010, when total debt/EBITDA is 5.67× and net debt/EBITDA is 4.36×. Coverage ratios require the company to produce cash flow in excess of annual interest payments. For example, EBITDA must exceed interest payments due in any year by a certain ratio. In the Toys transaction, EBITDA/interest expense during 2006 was 1.57×. (EBITDACapEx)/interest expense was 1.17× during 2006. Through the repayment of debt, these ratios are forecast to improve each year until 2010, when EBITDA/interest expense increases to 1.92× and (EBITDA-CapEx)/interest expense increases to 1.47×.
Calculate the Equity Value, Internal Rate of Return and Multiple of Investment on Projected Exit Date To calculate equity value, IRR, and multiple of investment on the projected exit date, start with EBITDA on the projected exit date year (2010 in the Toys case—see Exhibit 17.21) and multiply that EBITDA by a range of enterprise value/EBITDA multiples that might apply as of the exit date. This creates an expected enterprise value. After the enterprise value alternatives are determined, equity value as of the exit date can be calculated by subtracting debt and adding cash. A further step sometimes involves determining the equity value of options held by nonsponsor holders (such as management) and reducing the equity value for the sponsor by this amount.
II. HEDGE FUNDS AND PRIVATE EQUITY
EXH I BI T 17.2 1 RETURNS S UMM A RY ( $ I N M I L L I O NS ) ȱ ȱ¡ȱ
ŘŖŗŖȱ ǞşśŜǯşȱ
ǞŜǰŜşŞǯřȱ ŝǰŗŝŜǯŝȱ ŝǰŜśśǯŗȱ ŞǰŗřřǯŜȱ ŞǰŜŗŘǯŖȱ şǰŖşŖǯśȱ şǰśŜŞǯşȱ
DZ ǻǞśǰŚŘŘǯŜǼ ǻǞśǰŚŘŘǯŜǼ ǻǞśǰŚŘŘǯŜǼ ǻǞśǰŚŘŘǯŜǼ ǻǞśǰŚŘŘǯŜǼ ǻǞśǰŚŘŘǯŜǼ ǻǞśǰŚŘŘǯŜǼ
DZ ǞŗǰŘŚŝǯŖȱ ǞŗǰŘŚŝǯŖȱ ǞŗǰŘŚŝǯŖȱ ǞŗǰŘŚŝǯŖȱ ǞŗǰŘŚŝǯŖȱ ǞŗǰŘŚŝǯŖȱ ǞŗǰŘŚŝǯŖȱ
ǻǞŚǰŗŝśǯŜǼ ǻǞŚǰŗŝśǯŜǼ ǻǞŚǰŗŝśǯŜǼ ǻǞŚǰŗŝśǯŜǼ ǻǞŚǰŗŝśǯŜǼ ǻǞŚǰŗŝśǯŜǼ ǻǞŚǰŗŝśǯŜǼ
¢ ǞŘǰśŘŘǯŝȱ ǞřǰŖŖŗǯŗȱ ǞřǰŚŝşǯŜȱ ǞřǰşśŞǯŖȱ ǞŚǰŚřŜǯśȱ ǞŚǰşŗŚǯşȱ ǞśǰřşřǯŚȱ
ȱ ŝǯŖŖȱ¡ȱ ŝǯśŖȱ¡ȱ ŞǯŖŖȱ¡ȱ ŞǯśŖȱ¡ȱ şǯŖŖȱ¡ȱ şǯśŖȱ¡ȱ ŗŖǯŖŖȱ¡ȱ
ŘŖŖś ǻǞŗǰřŖŖǯŖǼ ǻŗǰřŖŖǯŖǼ ǻŗǰřŖŖǯŖǼ ǻŗǰřŖŖǯŖǼ ǻŗǰřŖŖǯŖǼ ǻŗǰřŖŖǯŖǼ ǻŗǰřŖŖǯŖǼ
ŘŖŖŜ ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ȱȱ ȱ ȱ ŘŖŖś ŘŖŖŜ ŝǯŖŖȱ¡ȱ ǻǞŗǰŘŗşǯŖǼ ǞŖǯŖȱ ŝǯśŖȱ¡ȱ ǻŗǰŘŗşǯŖǼ ŖǯŖȱ ŞǯŖŖȱ¡ȱ ǻŗǰŘŗşǯŖǼ ŖǯŖȱ ŞǯśŖȱ¡ȱ ǻŗǰŘŗşǯŖǼ ŖǯŖȱ şǯŖŖȱ¡ȱ ǻŗǰŘŗşǯŖǼ ŖǯŖȱ şǯśŖȱ¡ȱ ǻŗǰŘŗşǯŖǼ ŖǯŖȱ ŗŖǯŖŖȱ¡ȱ ǻŗǰŘŗşǯŖǼ ŖǯŖȱ
ŘŖŖŝ ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ŘŖŖŞ ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ŘŖŖş ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ŘŖŗŖ ǞŘǰŚŖŖǯŚȱ ŘǰŞřŗǯŖȱ řǰŘŜŗǯŜȱ řǰŜşŘǯŘȱ ŚǰŗŘŘǯŞȱ ŚǰśśřǯŚȱ ŚǰşŞŚǯŖȱ
ŘŖŖŝ ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ŘŖŖŞ ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ŘŖŖş ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ŘŖŗŖ ǞŘǰŚŖŖǯŚȱ ŘǰŞřŗǯŖȱ řǰŘŜŗǯŜȱ řǰŜşŘǯŘȱ ŚǰŗŘŘǯŞȱ ŚǰśśřǯŚȱ ŚǰşŞŚǯŖȱ
ŗřǯŖƖ ŗŜǯŞƖ ŘŖǯŘƖ ŘřǯŘƖ ŘŜǯŖƖ ŘŞǯśƖ řŖǯŞƖ
ǞŗǰŗŖŖǯŚȱ ŗǰśřŗǯŖȱ ŗǰşŜŗǯŜȱ ŘǰřşŘǯŘȱ ŘǰŞŘŘǯŞȱ řǰŘśřǯŚȱ řǰŜŞŚǯŖȱ
ȱ ȱ ŗŚǯśƖ ǞŗǰŗŞŗǯŚȱ ŗŞǯŚƖ ŗǰŜŗŘǯŖȱ ŘŗǯŞƖ ŘǰŖŚŘǯŜȱ ŘŚǯŞƖ ŘǰŚŝřǯŘȱ ŘŝǯŜƖ ŘǰşŖřǯŞȱ řŖǯŘƖ řǰřřŚǯŚȱ řŘǯśƖ řǰŝŜśǯŖȱ
ȱȱ ȱȱ ȱ ¢ȱ ǞŗŘŘǯřȱ ǞŘǰŚŖŖǯŚȱ ŗŝŖǯŗȱ ŘǰŞřŗǯŖȱ ŘŗŞǯŖȱ řǰŘŜŗǯŜȱ ŘŜśǯŞȱ řǰŜşŘǯŘȱ řŗřǯŜȱ ŚǰŗŘŘǯŞȱ ŚǰśśřǯŚȱ řŜŗǯśȱ ŚŖşǯřȱ ŚǰşŞŚǯŖȱ
Leveraged Buyout Analysis Example
II. HEDGE FUNDS AND PRIVATE EQUITY
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389
390
17. LBO FINANCIAL MODEL
The most relevant multiple to use in forecasting the exit equity value for the sponsor depends on who the expected buyer is on the exit date (IPO sale, or M&A sale to a strategic buyer or to another financial sponsor) and the multiple used to value the investment on the original acquisition date. Generally, sponsors use the same multiple for entering and exiting an investment, but this depends on the facts and circumstances of the investment. After a range of equity values is determined, the IRR of the investment can be calculated based on the number of years the investment is expected to be held and the entry and exit equity values derived from the analysis. The IRR is the discount rate which causes the present value of the future cash flow (including the equity value on the exit date) to equal the equity investment at time zero. This IRR can be calculated on most financial calculators by including the time horizon (n), which was 5 years in the Toys case, the original investment (PV), which was -$1.3 billion (without fees) for Toys and the exit equity value (FV), which, assuming a 9.0× multiple, was $4.12 billion for Toys. Assuming no interim dividend payments (PMT), solving for the IRR (i) based on the 9× multiple results in an IRR of 26%. In Exhibit 17.21, the original equity investment by KKR in Toys during 2005 was $1.3 billion. Assuming a 5-year holding period (an exit during 2010), the sponsor’s equity value at exit ranges from $2.4 billion to just under $5.0 billion, depending on the enterprise value/ EBITDA multiple used. Since the 2005 multiple (excluding fees) was 9.4×, it is reasonable to assume an exit multiple of between 9.0× and 9.5×, which suggests that the IRR for KKR in the Toys transaction may have been expected to be between 26.0% and 28.5%. Including fees, the expected return may have been 26.7%–30.2%. If an exit multiple of 9.0× had been used, the expected exit equity value would have been $4.12 billion, producing a gain of $2.82 billion (not including initial fees) since the original equity investment was $1.3 billion. As a result, the expected multiple of investment would have been $4.12 billion/$1.3 billion = 3.17 times (equity exit value/entry equity value).
LEVERAGED BUYOUT ANALYSIS POSTCREDIT CRISIS Although when KKR initiated the Toys LBO the expected IRRs may have been 26%, or higher, and expected multiple of investment at 3.17 times, or higher, there was considerable risk associated with this transaction. It is likely, therefore, that KKR completed several “stress test” scenarios that projected worsening credit, real estate, and retailing markets. Based on this risk-adjusted analysis, they may have expected lower returns. Indeed, in the postcredit crisis environment, returns for most financial sponsors were significantly diminished. This happened, in part, because creditors were unwilling to provide as much leverage in support of LBO transactions (and the cost of leverage increased). With less leverage available, financial sponsors were required to commit more up-front equity, which reduced returns. In addition, because of a massive inflow of new private equity funding that came from investors during 2006–08, there was significantly more competition for acquisition targets, which also resulted in a reduction in returns. Since 2009, many sponsors have accepted IRRs substantially below 25%, and sometimes as low as 10%–15%, while other sponsors have decided to seek returns from nontraditional sources.
II. HEDGE FUNDS AND PRIVATE EQUITY
Leveraged Buyout Analysis Postcredit Crisis
391
KKR had Toys file a registration statement during 2010 in relation to a potential IPO, but the offering was delayed that year, and again in 2011 and 2012, with the registration formally withdrawn during 2013. In each year, Toys cited market conditions for not launching an offering, and so 10 years after the original purchase by KKR and its partners, there was still no exit for the investment group.
II. HEDGE FUNDS AND PRIVATE EQUITY
17
LBO Financial Model O U T L I N E Determining Cash Flow Available for Debt Service and Debt Sources
Calculate Acquisition Multiples 382 Determine Target’s Capitalization Postacquisition383 Determine Cash Flow Available for Debt Service 385 Calculate Credit Ratios 388 Calculate the Equity Value, Internal Rate of Return and Multiple of Investment on Projected Exit Date 388
371
Determining Financial Sponsor Internal Rate of Return 373 Determining Purchase Price and Sale Price373 Leveraged Buyout Analysis Example Forecast Revenue, Margins, D&A, CapEx, Working Capital, Interest Rate, and Tax Rate
374 374
Leveraged Buyout Analysis Postcredit Crisis390
The material in this chapter should be cross-referenced with the following case: Toys “R” Us LBO. As previously discussed, targets for leveraged buyout (LBO) transactions are typically companies in mature industries that have stable and growing cash flow that can be used to service large debt obligations and, potentially, pay dividends to the financial buyers. In addition, targets usually have low capital expenditures, low leverage, and assets that can be used as collateral for debt or sold. Financial buyers generally target an exit event within 3–7 years, which is usually accomplished through either an initial public offering (IPO) or M&A sale to a strategic buyer or, sometimes, to another financial buyer. Financial buyers have historically targeted an internal rate of return (IRR) on their investments of above 20%. The possibility of achieving a high return is augmented by purchasing a company at the lowest possible price using the maximum amount of leverage that is available and, correspondingly, minimizing the equity contribution. Management of the target company will be asked to grow the company’s market share and improve margins, creating growth in free cash flow. Sometimes, as a result of operating improvements, the company can achieve an enterprise value/EBITDA multiple expansion (see Chapter 4), but this is unusual. To realize a target IRR return for a private equity investor, Investment Banks, Hedge Funds, and Private Equity, Third Edition http://dx.doi.org/10.1016/B978-0-12-804723-1.00017-7
369
© 2018 Elsevier Inc. All rights reserved.
370
17. LBO FINANCIAL MODEL
the company must grow cash flow to pay down debt over the holding period (resulting in an increase in equity), and then a sale must be accomplished in the future at a multiple of the increased cash flow level (see Exhibit 17.1). Exhibit 17.2 shows three potential ways to achieve IRR returns by deleveraging, improving margins, and/or through multiple expansion.
EXH I BIT 17.1 LEVERAGED B UY O UT O B J E CTI V E : PAY D OW N D EBT DURING HOLDING P E RI O D Initial: Acquired for 8.0x LTM EBITDA of $125.0
Future: Sold for 8.0x LTM EBITDA of $137.5 Future
$1,100
Initial
$1,000 $350
$650
Equity Equity
$725
Debt
$375
Debt
Source: Training the Street, Inc.
EXH I BIT 17.2 LEVERAGED B UY O UT: THRE E WAY S TO CREATE RETURNS Assume the Target company was acquired for 8.0x LTM EBITDA of $125.0
1. Deleveraging
2. Deleverage & Improve Margins
3. Deleverage, Improve Margins& Multiple Expansion
Sources of Funds Total Debt
$650.0
$650.0
$650.0
350.0
350.0
350.0
$1,000.0
$1,000.0
$1,000.0
$167.6
$212.3
$212.3
125.0
164.5
164.5
8.0x
8.0x
9.0x
Transaction Value
1,000.0
1,316.0
1,480.5
+/-Net Debt
1
(482.4)
(437.7)
(437.7)
Equity Value
$517.6
$878.2
$1,042.8
8.1%
20.2%
24.4%
Total Equity Total Year 5 Assumptions
Cumulative Excess Cash to Repay Debt Projected EBITDA
Assumed Exit Multiple
IRR Returns (5-YrExit)
Note 1: Total Debt - Cumulative Excess Cash to Repay Debt = Net Debt Source: Training the Street, Inc.
Determining Cash Flow Available for Debt Service and Debt Sources
371
An LBO analysis includes cash flow projections, terminal value projections (the price at which a financial buyer thinks the company can be sold in 3–7 years) and present value determination (the price that a financial buyer will pay for a company today), and the analysis solves for the IRR of the investment (the discount rate applied). LBO models require an assumption of a minimum IRR required by financial buyers, based on risks associated with the investment and market conditions. The model solves for the purchase price that creates this targeted IRR. Basically, the LBO analysis answers the question: What is the highest purchase price that can be paid for a company to earn a compound annual rate of return that meets the investor’s risk-adjusted return requirement? The LBO analysis considers whether there is enough projected cash flow to operate the company and also pay debt principal and interest payments. In addition, the analysis determines if there is sufficient cash flow to pay dividends at some point to the private equity investor. An ability to retire debt and pay dividends results in a higher IRR.
DETERMINING CASH FLOW AVAILABLE FOR DEBT SERVICE AND DEBT SOURCES The starting point in an LBO analysis is to determine the cash flow available to service a target company’s future debt obligations. This can be done by starting with a determination of net income; adding depreciation and amortization; and then either adding or subtracting amounts for changes in deferred taxes, other noncash charges, and changes in net working capital. The result is cash flow from operations, which should be reduced by capital expenditures to create cash flow available for debt service (see Exhibit 17.3). When cash flow available for debt service has been calculated, the total debt available to purchase the target can be determined through discussion with investment bankers who will advise regarding the market’s tolerance for debt, given the cash flow and risk characteristics of the target company and the target company’s industry (see Exhibit 17.4). Bankers and their financial sponsor clients sometimes scale back the amount of debt they attempt to secure if associated risks seem too high. When the maximum appropriate amount of debt to finance an acquisition is determined, investment bankers and the financial sponsor can then determine the sources of debt, which include senior credit facilities, second lien loans, high-yield debt, and mezzanine financing (see Exhibits 17.5 and 17.6).
EXH I BI T 1 7 .3 DETERMINING CA S H F L OW AVA I L A B L E F O R D EBT SERVICE Net Income + Depreciation and amortization +/– Changes in deferred taxes +/– Other non-cash changes +/– Changes in net working capital = Cash flow from operations – Capital expenditures = Cash flow available for debt service
II. HEDGE FUNDS AND PRIVATE EQUITY
372
17. LBO FINANCIAL MODEL
EXH I BIT 17.4 WHAT DETERM I NE S D E B T CA PA CI TY ? Industry Risk • • • • •
Growth rate and size Cyclicality Barriers to entry Capital intensity Relative strength of suppliers and customers • Rate of technological change/ threat of substitution • Environmental issues • Regulatory risk
Company Risk
Structural Risk
• • • •
Competitive position Historical performance Achievability of projections Depth and quality of management • Qualitative: Information quality Ownership support
• Quantitative Size Leverage Coverage • Security (second way out) • Sources of repayment Are assumptions credible? • Valuation/equitycushion • Comparable transactions • Other successful LBOs in that industry • Growth capability given leverage constraints
Source: Training the Street, Inc.
EXH I BIT 17.5 TY PICAL CAP I TA L S TRUCTURE • Senior credit facility • Revolver • Term loans • Second lien loans • High-yield debt • Senior notes • Senior subordinated notes • Mezzanine/Payment-in-Kind/warrants/preferred stock • Common equity
Source: Training the Street, Inc.
EXH I BIT 17.6 COMMON F IN A NCI NG PA RA M E TE RS • Key credit statistics: • Total debt/EBITDA • Senior bank debt/EBITDA • EBITDA/interest coverage • EBITDA—CapEx/interest coverage • Bank debt payoff • Equity contribution
• Typical range:1 • 3.5–5.5× • 2.5–3.5× • >2.0× • >1.6× • 6–8 years • At least 20%–35%
• Factors affecting credit statistics: • EBITDA determination • Maintenance versus growth in CapEx • Average versus peak working capital requirements • Off-balance sheet financing
Note 1: These ranges applied prior to the credit crisis, which started during the second half of 2007. Subsequently, market conditions worsened, resulting in lower debt ratios, higher interest coverage ratios, and higher equity contribution requirements. For a few duringAND 2006 to mid-2007, total debt/EBITDA multiples reached 8×. II. transactions HEDGE FUNDS PRIVATE EQUITY Source: Training the Street, Inc.
373
Determining Purchase Price and Sale Price
EXH I BI T 1 7 .7 COMPARIS ON OF I NTE RNA L RATE O F RE TURN ( I RR) V ER SUS MULTIPLE OF IN V E S TM E NT Initial Equity Invested
Investment Holding Period
IRR
Value of Equity at Exit
Profit
Multiple of Investment
$1,000
2 years
30%
$1,690
$690
1.69x
$1,000
4 years
25%
$2,441
$1,441
2.44x
$1,000
6 years
20%
$2,986
$1,986
2.99x
DETERMINING FINANCIAL SPONSOR INTERNAL RATE OF RETURN The next step in an LBO analysis is to calculate the IRR. This is done by determining the equity portion of the purchase price, dividend payments to be made, if any, during the investment horizon, and the expected market value of the equity on the exit date. Usually, a range of purchase prices is considered along with a corresponding equity investment amount (which is determined after calculating the maximum debt amount available for the purchase, as described above). The equity amount must, in combination with the projected cash flow and the final projected equity value on the exit date (factoring in the risks associated with cash flow and equity exit value projections), create an IRR that is acceptable to the financial sponsor. If the resulting IRR is below an acceptable level, the financial sponsor must either lower the purchase price or lower the equity contribution, while increasing the debt component of the purchase price, subject to the additional debt being accessible. In other words, this is an iterative process, which sometimes requires the financial sponsor to either reduce their minimum IRR level, or give up the investment opportunity, depending on the price expectations of the target company and pricing from competing buyers. The IRR accepted by the financial sponsor depends on the risk of the investment: lower risk investments allow lower IRR targets and higher risk investments require higher IRR targets. Ultimately, financial sponsors are principally focused on the profitability of an investment, its risk, and the time it takes to exit the investment. They consider the multiple of the expected equity at the time of exit relative to the initial equity invested and attempt to strike a balance between maximizing IRR and maximizing the total cash amount taken out of the investment when the exit is achieved. For example, even if an IRR of 30% is achievable after 2 years, a sponsor may choose a 25% IRR alternative based on an exit in 4 years if the “profit” of the transaction (equity value at exit—equity invested at inception = profit) is substantially higher in the 4-year exit alternative (see Exhibit 17.7). By holding the investment for 4 years, the sponsor gives up IRR, but increases the multiple of investment from 1.69× to 2.44×. The IRR give-up is caused principally by investor’s desire to remain invested based on their aversion to new risks and costs associated with redeployment of funds and financial buyer interest in achieving high multiples of investment (which creates an effective marketing metric for future fundraising).
DETERMINING PURCHASE PRICE AND SALE PRICE Financial sponsors generally determine a purchase price for a target based on a multiple of enterprise value to EBITDA. In consultation with investment bankers, they determine purchase price multiples that strategic buyers might apply to an acquisition and then decide if they are
374
17. LBO FINANCIAL MODEL
able to offer a higher multiple based on their targeted IRR (normally, financial buyers cannot pay as high a multiple as strategic buyers can because they lack synergies, but leverage can level the playing field). The IRR, in turn, is determined largely based on the amount of debt financing available and the cash flow available for debt service. The decision regarding a purchase price is therefore based on an iterative process. Financial sponsors usually project a future sale price based on the same multiple used in the initial purchase price determination if an M&A sale is considered the most likely exit strategy. Sometimes, however, a comparable company multiple is used if the ultimate sale is expected to be initiated through an IPO. In addition, the sale multiple could be increased if positive changes in the industry or in management are expected, or decreased if negative changes are expected. See Chapter 4 for a more complete discussion of valuation multiples.
LEVERAGED BUYOUT ANALYSIS EXAMPLE A simplified example of an LBO analysis is provided below based on the acquisition of Toys “R” Us (Toys) by a consortium of buyers consisting of KKR, Bain Capital, and Vornado Realty Trust during 2005. This consortium will be referred to as “KKR.”
Forecast Revenue, Margins, D&A, CapEx, Working Capital, Interest Rate, and Tax Rate The LBO analysis starts with a review of the target company’s financial statements. See Toys financial statements in Exhibits 17.8–17.10. KKR would have completed a summary similar to Exhibit 17.11 to determine historical sales growth and margins. They would have then performed due diligence to determine the likelihood that Toys would be able to continue producing similar (or better) margins and sales growth. KKR would also have completed a forecast of Toys’ balance sheet, income statement, and cash flow statement for their expected investment horizon in an effort to determine cash flow projections that would be utilized to establish the future value of the company. This future value would be calculated by multiplying projected EBITDA on the date of a future sale by the expected enterprise value/EBITDA multiple that would be relevant at that time. As part of the creation of future expected balance sheets, income statements, and cash flow statements, KKR would have made assumptions regarding growth in revenues. When these projections are made, other parts of the income statement (including cost of goods sold; selling, general and administrative expenses; and depreciation and amortization) are expected to remain constant (or to decline slightly) as a percentage of revenues (see Exhibit 17.12). For CapEx, it is commonly assumed that annual CapEx is equal to annual depreciation to keep the asset base constant.1 However, KKR may have decided to improve Toys’ asset base by increasing CapEx above depreciation or, they might have decided to decelerate CapEx, allowing Toys’ asset base to reduce. Although working capital can be set at a percentage of revenues, KKR probably calculated working capital based on individual balance sheet items, with changes in Toys’ working capital resulting from the projected balance sheet (see Exhibit 17.13). Toys FYE 2005 federal tax rate of 35% (state and local taxes might increase the tax rate to as much as 38%) was used as 1 To
account for inflation, however, CapEx is often projected to increase at a higher rate than depreciation so that the real value of physical capital like plant and equipment does not decline. II. HEDGE FUNDS AND PRIVATE EQUITY
375
Leveraged Buyout Analysis Example
a base from, which KKR could project future tax rates (which could be constant, increasing or decreasing, depending on known and future expected tax developments). The interest rate assumption used for Toys was higher than the company’s historical rate to reflect higher leverage and correspondingly higher risk to lenders (see Exhibit 17.14).
EXH I BI T 1 7 .8 CONSOLIDATED F I NA NCI A L RE S ULTS ( $ I N M I LL IONS, EXCEPT PER S HA RE D ATA ) ȱȱȱ ȱ
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376
17. LBO FINANCIAL MODEL
EXH I BIT 17.9 CONS OLIDAT E D B A L A NCE S HE E T ( $ I N MILLIONS ) For the Year Ended 1/31/2004
1/29/2005
ASSETS $1,432
$1,250
Short-term inves tments
C ash and c ash equivalents
571
953
Accounts and other rec eivables
146
153
2,094
1,884
Merc handis e inventories N et property ass ets held f or s ale
163
7
Current portion of derivative ass ets
162
1
Prepaid expenses and other current assets Total c urrent ass ets
161
159
$4,729
$4,407
$2,165
$2,393
Property, plant, and equipment R eal estate, net Other, net Total PP&E Goodwill, net D erivative ass ets
2,274
1,946
$4,439
$4,339
348
353
77
43
D eferred tax ass et
399
426
Other ass ets
273
200
$10,265
$9,768
Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Short-term borrowings Accounts payable
$0
$0
1,022
1,023
Accrued expenses and other current liabilities
866
881
Inc ome taxes payable
319
245
Current portion of long-term debt Total c urrent liabilities Long-term debt D eferred inc ome taxes D erivative liabilities
657
452
$2,864
$2,601
2,349
1,860
538
485
26
16
D eferred rent liability
280
269
Other liabilities
225
212
Minority interest in T oysrus.c om Total liabilities
9
0
$6,291
$5,443
Stockholders’ equity C ommon stock
$30
$30
Additional paid-in c apital
407
405
5,308
5,560
R etained earnings Accumulated other c omprehensive loss
(64)
(7)
0
(5)
Treas ur y shares, at c ost
(1,707)
(1,658)
Total stoc kholders’ equity
$3,974
$4,325
$10,265
$9,768
R estricted stoc k
Total liabilities and stockholders’ equity
377
Leveraged Buyout Analysis Example
EXH I BI T 1 7 .10 CONSOLIDATED S TATE M E NT O F CA S H F L OW ( $ I N M I LL IONS) ȱȱȱ ŘȦŗȦŘŖŖř
ŗȦřŗȦŘŖŖŚ
ŗȦŘşȦŘŖŖś
ȱȱ ȱ ȱ
ǞŘŗřȱ
ǞŜřȱ
ǞŘśŘȱ
Ǟřřşȱ
ǞřŜŞȱ
ǞřśŚȱ
Ŗȱ
Ŗȱ
şşȱ
Řŝȱ
ǻŚŖǼ
ǻŗŚǼ
ǻŞǼ
ǻŜǼ
ǻşǼ
ŗȱ
Řȱ
Ŗȱ
Ŝřȱ
Śȱ
ȱȱȱȱȱȱȱȱȱȱ DZ ȱȱ£ £ȱȱȱ ȱȱ¡ ¢ȱȱȱ¢ǯ ȱȬȱ Ȭȱȱȱȱȱȱ
ŝȱ
ȱȱȱȱȱDZ ȱȱȱ
Şȱ
ŜŘȱ
ǻśǼ
ŗřřȱ
ŘŘŗȱ
ȱ
ǻŗŖŖǼ
ȱ¡ȱȱȱȱ
ǻŗŗŞǼ
ŘŞȱ
ŝŜȱ
ŗŖşȱ
ŗŗŝȱ
ǻŚśǼ
ȱ¢ǰȱȱ¡ǰȱȱȱ ȱ¡ȱ¢ ȱȱȱ¢ȱȱ
ŚŞȱ
ǻśřǼ
ǻŝŚǼ
Ǟśŝśȱ
ǞŞŖŗȱ
ǞŝŚŜȱ
ǻǞřşśǼ
ǻǞŘŜŘǼ
ǻǞŘŜşǼ
ȱȱȱ ȱ ȱ¡ǰȱ ȱȱȱȱę¡ȱ
Ŗȱ
Ŗȱ
ŘŗŜȱ
ȱȱȱ¢ǰȱ ǯ
Ŗȱ
Ŗȱ
ǻŚŘǼ
ȱȱ Ȭȱȱȱ ȱȱȱȱȱ
Ŗȱ ǻǞřşśǼ
ǻśŝŘǼ
ǻřŞŘǼ
ǻǞŞřŚǼ
ǻǞŚŝŝǼ
ȱȱȱ ȱ Ȭȱ ǰȱ Ȭȱ Ȭȱȱ¢
ǞŖȱ
ǞŖȱ
śŚŞȱ
ŝşŘȱ
ǻŗŚŗǼ
ǻřŝŖǼ
ǞŖȱ Ŗȱ ǻśŖřǼ
ȦǻǼȱȱȱ
ǻŜŖǼ
ŜŖȱ
Ŗȱ
ȱȱȱȱȱȱȱȱȱ
ŘŜŜȱ
Ŗȱ
Ŗȱ
Ŗȱ
Ŗȱ
ȱȱǻȱǼȦȱ¢ȱęȱ
ȱȱ¡ȱȱȱ
ǞŜŗřȱ
ǞŚŞŘȱ
ěȱȱ¡ȱȱȱȱȱȱȱ
ǻǞśřǼ
ǻǞŚŖǼ
Řŝȱ ǻǞŚŝŜǼ ǞŘśȱ
ȱȱ ȱ ǻǼȦȱȱ¢ ȱȱ¢ ȱȱ¢
ǞŝŚŖȱ
ǞŚŖşȱ
ŘŞřȱ
ŗǰŖŘřȱ
ŗǰŚřŘȱ
ǞŗǰŖŘřȱ
ǞŗǰŚřŘȱ
ǞŗǰŘśŖȱ
II. HEDGE FUNDS AND PRIVATE EQUITY
ǻǞŗŞŘǼ
For the Year Ended 2/1/2003
% of Total
1/31/2004
% of Total
378
EX H I B IT 1 7 .11 F INANCIA L P E RF O RM A NCE B Y S E G M E NT ( $ I N M I L L I O N S ) For the Year Ended 1/29/2005
% of Total
NET SALES BY SEGMENT
2/1/2003
1/31/2004
1/29/2005
GROWTH BY SEGMENT (%) $6,755
59.8
$6,326
55.9
$6,104
55.0
–6.4
–3.5
Toys “R” Us —International
2,161
19.1
2,470
21.8
2,739
24.7
14.3
10.9
Babies “R” Us
1,595
14.1
1,738
15.4
1,863
16.8
9.0
7.2
340
3.0
371
3.3
366
3.3
9.1
–1.3
Toys “R” Us —U.S.
Toysrus.com Kids “R” Us Consolidated net sales
454
4.0
415
3.7
28
0.3
–8.6
–93.3
$11,305
100.0
$11,320
100.0
$11,100
100.0
0.1
–1.9
MARGIN BY SEGMENT (%) $256
49.4
$70
20.4
$4
0.9
3.8
1.1
Toys “R” Us —International
158
30.5
166
48.4
220
51.9
7.3
6.7
8.0
Babies “R” Us
169
32.6
192
56.0
224
52.8
10.6
11.0
12.0
Toysrus.com
(37)
–7.1
(18)
–5.2
1
0.2
–10.9
–4.9
0.3
Kids “R” Us
(28)
–5.4
(67)
–19.5
(25)
–5.9
–6.2
–16.1
–89.3
100.0
$343
100.0
$424
100.0
4.6
3.0
3.8
3.9
1.9
2.7
Toys “R” Us —U.S.
Segment operating earnings
$518
Corporate/other expenses
(75)
Restructuring charges Reported operating earnings
0
(63)
(4)
$443
$217
$304
(63)
(116)
ADJUSTED EBITDA BY SEGMENT Toys “R” Us —U.S. Toys “R” Us —International
0.1
MARGIN BY SEGMENT (%) $447
55.1
$264
39.3
$322
37.4
6.6
4.2
5.3
210
25.9
227
33.8
295
34.3
9.7
9.2
10.8 14.1
Babies “R” Us
197
24.3
223
33.2
262
30.5
12.4
12.8
Toysrus.com
(33)
–4.1
(16)
–2.4
1
0.1
–9.7
–4.3
0.3
Kids “R” Us Adjusted segment EBITDA
(10)
–1.2
(27)
–4.0
(20)
–2.3
–2.2
–6.5
–71.4
$811
100.0
$671
100.0
$860
100.0
7.2
5.9
7.7
Corporate/other expenses
(75)
6.9
5.7
7.0
Add-back: other D&A Consolidated adjusted EBITDA
(63)
(116)
46
40
36
$782
$648
$780
Note 1: Includes markdowns of $49 million and accelerated depreciation of $24 million in 2003 related to the closing of all stores. Note 2: Includes corporate expenses, the operating results of Toy Box, and the equity in net earnings of Toys “R”— UsJapan. Increase in amount is due to ourstrategic review expenses and Sarbanes-Oxley Section 404 compliance totaling $29 million. In addition, we incurred charges of $8 million relating to our 2004 restructuring of the Company’s corporate headquarters operations, and a $19 million increase in incentive compensation costs. $118 million net add-back in FY 2005. Source: Toys “R” Us FYE 2005 10-K Filing
17. LBO FINANCIAL MODEL
II. HEDGE FUNDS AND PRIVATE EQUITY
OPERATING EARNINGS BY SEGMENT
EXH I BI T 17.1 2 INCOME S TATE M E NT ( $ I N M I L L I O NS ) Base Case For the FYE January 31 Consolidated Net Sales Growth COGS & SG&A by Segment Margin EBITDA by Segment Margin
Consolidated EBITDA Growth Margin
Actual 2004 2005 $11,320.0 $11,100.0 0.1% -1.9%
2006 $10,875.2 -2.0%
2007 $10,456.3 -3.9%
2008 $10,405.8 -0.5%
2009 $10,741.8 3.2%
Projected 2010 2011 $11,140.9 $11,554.9 3.7% 3.7%
2012 $11,984.2 3.7%
2013 $12,429.4 3.7%
2014 $12,891.2 3.7%
2015 $13,370.2 3.7%
$10,494.0 92.8%
$10,649.0 $10,240.0 94.1% 92.3%
$9,986.4 91.8%
$9,569.5 91.5%
$9,501.9 91.3%
$9,799.4 91.2%
$10,155.5 91.2%
$10,532.8 91.2%
$10,924.1 91.2%
$11,330.0 91.2%
$11,750.9 91.2%
$12,187.5 91.2%
$811.0 7.2%
$671.0 5.9%
$860.0 7.7%
$888.7 8.2%
$886.9 8.5%
$903.9 8.7%
$942.5 8.8%
$985.5 8.8%
$1,022.1 8.8%
$1,060.1 8.8%
$1,099.4 8.8%
$1,140.3 8.8%
$1,182.7 8.8%
29.0 0.3%
23.0 0.2%
80.0 0.7%
27.9 0.3%
26.8 0.3%
26.7 0.3%
27.6 0.3%
28.6 0.3%
29.6 0.3%
30.7 0.3%
31.9 0.3%
33.1 0.3%
34.3 0.3%
$782.0
$780.0 20.4% 7.0%
$860.8 10.4% 7.9%
$860.0 -0.1% 8.2%
$877.2 2.0% 8.4%
$914.9 4.3% 8.5%
$956.9 4.6% 8.6%
$992.4 3.7% 8.6%
$1,029.3 3.7% 8.6%
$1,067.6 3.7% 8.6%
$1,107.2 3.7% 8.6%
$1,148.4 3.7% 8.6%
6.9%
$648.0 -17.1% 5.7%
D&A by Segment Margin
293.0 2.6%
328.0 2.9%
318.0 2.9%
304.4 2.8%
288.5 2.8%
284.6 2.7%
293.2 2.7%
303.8 2.7%
315.1 2.7%
326.8 2.7%
339.0 2.7%
351.5 2.7%
364.6 2.7%
Other D&A Margin
46.0 0.4%
40.0 0.4%
36.0 0.3%
35.3 0.3%
33.9 0.3%
33.7 0.3%
34.8 0.3%
36.1 0.3%
37.5 0.3%
38.9 0.3%
40.3 0.3%
41.8 0.3%
43.4 0.3%
0.0 $443.0
63.0 $217.0 -51.0% 1.9%
4.0 $422.0 94.5% 3.8%
0.0 $521.1 23.5% 4.8%
0.0 $537.6 3.2% 5.1%
0.0 $558.9 4.0% 5.4%
0.0 $586.8 5.0% 5.5%
0.0 $616.9 5.1% 5.5%
0.0 $639.9 3.7% 5.5%
0.0 $663.6 3.7% 5.5%
0.0 $688.3 3.7% 5.5%
0.0 $713.9 3.7% 5.5%
0.0 $740.4 3.7% 5.5%
$139.0 47.3 209.0 90.0 64.0 $549.2
$116.8 50.8 209.0 90.0 64.0 $530.5
$100.3 54.3 209.0 90.0 64.0 $517.5
$88.2 57.8 209.0 90.0 64.0 $509.0
$74.1 61.3 209.0 90.0 64.0 $498.3
$57.8 64.8 209.0 90.0 64.0 $485.6
$39.4 66.5 209.0 90.0 64.0 $468.9
$18.7 66.5 209.0 90.0 64.0 $448.2
$3.9 54.5 209.0 90.0 64.0 $421.4
$0.0 22.5 209.0 90.0 64.0 $385.5
Restructuring Charges Consolidated EBIT Growth Margin Interest Expense Assumed Debt Senior Secured Credit Facility Unsecured Bridge Loan Secured European Bridge Loan Mortgage Loan Agreements Total Interest Expense Interest Income on Cash Balance
3.9%
40.5
46.8
53.0
59.2
65.5
71.7
77.9
77.9
77.9
77.9
Pre-Tax Income Use of NOLs Taxes 35.0% Net Income Growth Margin
$12.4 0.0 4.3 $8.1 0.1%
$53.9 0.0 18.9 $35.0 334.2% 0.3%
$94.3 0.0 33.0 $61.3 75.1% 0.6%
$137.1 0.0 48.0 $89.1 45.3% 0.8%
$184.1 0.0 64.4 $119.6 34.3% 1.1%
$226.0 0.0 79.1 $146.9 22.8% 1.3%
$272.7 0.0 95.4 $177.3 20.7% 1.5%
$318.0 0.0 111.3 $206.7 16.6% 1.7%
$370.4 0.0 129.7 $240.8 16.5% 1.9%
$432.8 0.0 151.5 $281.3 16.8% 2.1%
Proceeds from Store Sales (After-Tax)
217.7
185.8
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0 $225.8
0.0 $220.8
0.0 $61.3
0.0 $89.1
0.0 $119.6
0.0 $146.9
0.0 $177.3
0.0 $206.7
0.0 $240.8
0.0 $281.3
Dividends Retained Earnings
Leveraged Buyout Analysis Example
II. HEDGE FUNDS AND PRIVATE EQUITY
Corporate / Other Expenses Margin
2003 $11,305.0
379
380
EX H I BI T 17.13 B ALANCE S HEET ($ I N M I L L I O NS ) Base Case For the FYE January 31
ASSETS Cash and Cash Equivalents Accounts and Other Receivables Merchandise Inventories Other Current Assets Total Current Assets
2003
Actual 2004
2005
2006
2007
2008
2009
Projected 2010
2011
2012
2013
2014
2015
$1,247.0 149.9 1,837.3 163.6 $3,397.9
$1,247.0 144.1 1,760.6 157.3 $3,309.1
$1,247.0 143.4 1,748.2 156.6 $3,295.2
$1,247.0 148.1 1,802.9 161.6 $3,359.6
$1,247.0 153.6 1,868.4 167.6 $3,436.6
$1,247.0 159.3 1,937.9 173.8 $3,518.0
$1,247.0 165.2 2,009.9 180.3 $3,602.4
$1,247.0 171.3 2,084.5 187.0 $3,689.9
$1,247.0 177.7 2,162.0 193.9 $3,780.6
$1,247.0 184.3 2,242.3 201.2 $3,874.8
Net, PP&E
4,339.0
$4,216.8
$4,103.5
$3,993.3
$3,880.0
$3,762.9
$3,641.4
$3,515.4
$3,384.8
$3,249.2
$3,108.6
Goodwill, net New Goodwill Other Assets
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
0.0 2,684.0 669.0
$11,143.0
$10,967.7
$10,765.6
$10,641.5
$10,592.7
$10,552.5
$10,512.4
$10,470.8
$10,427.6
$10,382.8
$10,336.4
Accounts Payable Accrued Expenses & Other Current Liabilities
$1,023.0 1,126.0
$997.7 1,098.1
$956.0 1,052.3
$949.3 1,044.8
$979.0 1,077.5
$1,014.6 1,116.7
$1,052.2 1,158.2
$1,091.3 1,201.2
$1,131.9 1,245.9
$1,173.9 1,292.1
$1,217.6 1,340.2
Total Current Liabilities
$2,149.0
$2,095.8
$2,008.3
$1,994.1
$2,056.5
$2,131.3
$2,210.4
$2,292.6
$2,377.7
$2,466.1
$2,557.7
Assumed Debt Senior Secured Credit Facility Unsecured Bridge Loan Secured European Bridge Loan Mortgage Loan Agreements Total Debt
$2,312.0 700.0 1,900.0 1,000.0 800.0 $6,712.0
$1,964.1 700.0 1,900.0 1,000.0 800.0 $6,364.1
$1,628.7 700.0 1,900.0 1,000.0 800.0 $6,028.7
$1,457.4 700.0 1,900.0 1,000.0 800.0 $5,857.4
$1,257.1 700.0 1,900.0 1,000.0 800.0 $5,657.1
$1,022.6 700.0 1,900.0 1,000.0 800.0 $5,422.6
$756.4 700.0 1,900.0 1,000.0 800.0 $5,156.4
$455.4 700.0 1,900.0 1,000.0 800.0 $4,855.4
$120.3 700.0 1,900.0 1,000.0 800.0 $4,520.3
$0.0 446.4 1,900.0 1,000.0 800.0 $4,146.4
$0.0 27.0 1,900.0 1,000.0 800.0 $3,727.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
485.0 497.0
Total Liabilities
$9,843.0
$9,441.9
$9,019.0
$8,833.5
$8,695.6
$8,535.8
$8,348.8
$8,129.9
$7,880.1
$7,594.5
$7,266.7
Stockholders' Equity New Preferred Stock Sponsor Equity Retained Earnings Total Stockholders' Equity
$0.0 1,300.0 0.0 $1,300.0
$0.0 1,300.0 225.8 $1,525.8
$0.0 1,300.0 446.6 $1,746.6
$0.0 1,300.0 508.0 $1,808.0
$0.0 1,300.0 597.1 $1,897.1
$0.0 1,300.0 716.7 $2,016.7
$0.0 1,300.0 863.6 $2,163.6
$0.0 1,300.0 1,040.9 $2,340.9
$0.0 1,300.0 1,247.6 $2,547.6
$0.0 1,300.0 1,488.4 $2,788.4
$0.0 1,300.0 1,769.7 $3,069.7
$11,143.0
$10,967.7
$10,765.6
$10,641.5
$10,592.7
$10,552.5
$10,512.4
$10,470.8
$10,427.6
$10,382.8
$10,336.4
$0.000
$0.000
$0.000
$0.000
$0.000
$0.000
$0.000
$0.000
$0.000
$0.000
$0.000
Total Assets LIABILITIES & STOCKHOLDERS' EQUITY
Deferred Income Taxes Other Liabilities
Total Liabilities & Stockholders' Equity Check
17. LBO FINANCIAL MODEL
$1,247.0 153.0 1,884.0 167.0 $3,451.0
EX H I BI T 17.14 INTEREST RATE AN D W O RKI NG CA P I TA L A S S UM P TI O NS ( $ I N M I LLI ONS) Base Case For the FYE January 31
Interest Rate Assumptions LIBOR
2003
Actual 2004
2007
2008
2009
Projected 2010
2011
2012
2013
2014
2015
2.75%
3.25%
3.75%
4.25%
4.75%
5.25%
5.75%
6.00%
6.00%
6.00%
6.00%
3.25%
3.75%
4.25%
4.75%
5.25%
5.75%
6.25%
6.25%
6.25%
6.25%
LIBOR Spread Fixed Rate 6.50% 3.50% 11.00% 9.00% 8.00%
6.50% 6.75% 11.00% 9.00% 8.00%
6.50% 7.25% 11.00% 9.00% 8.00%
6.50% 7.75% 11.00% 9.00% 8.00%
6.50% 8.25% 11.00% 9.00% 8.00%
6.50% 8.75% 11.00% 9.00% 8.00%
6.50% 9.25% 11.00% 9.00% 8.00%
6.50% 9.50% 11.00% 9.00% 8.00%
6.50% 9.50% 11.00% 9.00% 8.00%
6.50% 9.50% 11.00% 9.00% 8.00%
6.50% 9.50% 11.00% 9.00% 8.00%
$146.0 4.7
$153.0 5.0
$149.9 5.0
$144.1 5.0
$143.4 5.0
$148.1 5.0
$153.6 5.0
$159.3 5.0
$165.2 5.0
$171.3 5.0
$177.7 5.0
$184.3 5.0
$2,094.0 5.1
$1,884.0 5.4
$1,837.3 5.4
$1,760.6 5.4
$1,748.2 5.4
$1,802.9 5.4
$1,868.4 5.4
$1,937.9 5.4
$2,009.9 5.4
$2,084.5 5.4
$2,162.0 5.4
$2,242.3 5.4
$486.0 15.7
$167.0 5.5
$163.6 5.5
$157.3 5.5
$156.6 5.5
$161.6 5.5
$167.6 5.5
$173.8 5.5
$180.3 5.5
$187.0 5.5
$193.9 5.5
$201.2 5.5
Accounts Payable Days Outstanding
$1,022.0 35.0
$1,023.0 36.5
$997.7 36.5
$956.0 36.5
$949.3 36.5
$979.0 36.5
$1,014.6 36.5
$1,052.2 36.5
$1,091.3 36.5
$1,131.9 36.5
$1,173.9 36.5
$1,217.6 36.5
Accrued Expenses & Other
$1,185.0
$1,126.0
$1,098.1
$1,052.3
$1,044.8
$1,077.5
$1,116.7
$1,158.2
$1,201.2
$1,245.9
$1,292.1
$1,340.2
Merchandise Inventories Turns Other Current Assets Days Outstanding
Current Liabilities Days Outstanding Total Current Assets Total Current Liabilities Working Capital
40.6
40.1
40.1
40.1
40.1
40.1
40.1
40.1
40.1
40.1
40.1
40.1
$2,726.0 2,207.0 $519.0
$2,204.0 2,149.0 $55.0
$2,150.9 2,095.8 $55.1
$2,062.1 2,008.3 $53.8
$2,048.2 1,994.1 $54.1
$2,112.6 2,056.5 $56.1
$2,189.6 2,131.3 $58.4
$2,271.0 2,210.4 $60.5
$2,355.4 2,292.6 $62.8
$2,442.9 2,377.7 $65.1
$2,533.6 2,466.1 $67.5
$2,627.8 2,557.7 $70.0
($7.0)
$3.1
$5.8
$0.7
($4.6)
($5.5)
($5.7)
($5.9)
($6.1)
($6.4)
($6.6)
(Increase) / Decrease in Merchandise Inventories
210.0
46.7
76.7
12.4
(54.7)
(65.5)
(69.4)
(72.0)
(74.7)
(77.4)
(80.3)
(Increase) / Decrease in Other Current Assets Increase / (Decrease) in Accounts Payable Increase / (Decrease) in Accrued Expenses & Other Current Liabilities (Increase in) Reduction of Working Capital
319.0 1.0 (59.0)
3.4 (25.3) (27.9)
6.3 (41.7) (45.9)
0.8 (6.7) (7.4)
(5.1) 29.7 32.7
(6.0) 35.6 39.2
(6.2) 37.7 41.5
(6.5) 39.1 43.0
(6.7) 40.5 44.6
(6.9) 42.1 46.3
(7.2) 43.6 48.0
($0.1)
$1.3
($0.3)
($2.0)
($2.3)
($2.2)
($2.2)
($2.3)
($2.4)
($2.5)
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
0.0 0.0
(Increase) / Decrease in Long-Term Assets Increase / (Decrease) in Long-Term Liabilities
$464.0
381
(Increase) / Decrease in Accounts and Other Receivables
Leveraged Buyout Analysis Example
Workings Capital Assumptions Accounts and Other Receivables Days Outstanding
2006
2.75%
Interest Earned on Cash Cash Interest Rate on Debt Assumed Debt Senior Secured Credit Facility Unsecured Bridge Loan Secured European Bridge Loan Mortgage Loan Agreements
2005
382
17. LBO FINANCIAL MODEL
Calculate Acquisition Multiples On March 17, 2005, Toys announced that it had reached a definitive agreement to sell the entire company to KKR for $26.75 per share in a $7.7-billion transaction, including all transaction fees. The purchase price represented a total transaction value (enterprise value + transaction fees) that was 9.9× Toys’ FYE 2005 EBITDA and an enterprise value that was 9.4× Toys’ FYE 2005 EBITDA. The equity amount contributed by KKR was $1.3 billion (see Exhibits 17.15 and 17.16). KKR’s purchase price was a 63% premium to Toys’ share price on the day before the company announced it was exploring a sale of the global toy business. KKR may have decided to offer a high premium based on an analysis of comparable transactions that included acquisition premiums and because of Toys’ significant real estate holdings (which KKR may have felt was not fully valued by the market). Regardless, KKR would have completed financial projections that showed growth in cash flow over their investment horizon. Multiples applied against cash flow on the projected future sale date would create a final equity amount, which when compared with the initial KKR equity contribution, would result in an IRR that was acceptable to KKR.
EXH I BIT 17.1 5 TRANSACTI O N S UM M A RY ǻǞȱȱǼ
¢ȱȱȱ
ǞŘŜǯŝśȱ
ȱȱȱǻȱȱǼ ¢ȱ
ŘŘŖǯŜȱ ǞśǰşŖŖȱ
ȱȱȱǻ¡ȱǼ ȱ ȱȱȱȱ ȱ ȱ ȱȱ Ȧ
řşŚȱ ŘǰřŗŘȱ ǻŗǰŘŚŝǼ Ǟŝǰřśşȱ řŜŘȱ ǞŝǰŝŘŗȱ
ȱŘŖŖśȱ
ǞŝŞŖȱ
ȱǻ¡ȱǼȱȦȱȱŘŖŖśȱ
şǯŚ¡
ȱǻ ȱǼȱȦȱȱŘŖŖśȱ şǯş¡ DZȱȱȱȱȱȱȱȱȱȱ ¢ȱŘşǰȱŘŖŖśǯȱȱȱȱȱ
ȱ ¢ȱŘŗǰȱŘŖŖśǯ
EXH I BIT 17.1 6 SOURCES AND US E S ( $ I N M I L L I O NS ) Sources Cash on balance sheet Senior secured credit facility Unsecured bridge loan
Uses $956 700 1900
Purchase of common stock Purchase of stock options and restricted stock Settlement of equity security interests
II. HEDGE FUNDS AND PRIVATE EQUITY
$5900 227 114
Leveraged Buyout Analysis Example
383
EXH I BI T 1 7 .16 S OURCES AND US E S ( $ I N M I L L I O NS ) —co n t' d Sources
Uses
Secured European bridge loan Mortgage loan agreements Sponsor equity Total
1000 800 1300 $6656
Purchase of all warrants Transaction fees Severance and bonus payments Total
17 362 36 $6656
Summary of Fees Advisory fees and expenses Financing fees Sponsor fees Others Total
$78 135 81 68 $362
Note: Senior secured credit facility has $2.0 billion of availability. This exhibit reflects actual sources and uses for the Toys transaction that closed on July 21, 2005: the $956 million cash used is included in the model, which assumes (for simplicity) a closing on January 29, 2005 (see Exhibit 17.18). Source: Toys “R” Us, Form 10-Q, July 30, 2005.
Determine Target’s Capitalization Postacquisition Postacquisition, Toys had a capitalization of: (1) $2.3 billion of assumed existing debt plus $4.4 billion of new debt for a total of $6.7 billion in debt (see Exhibit 17.17), and (2) $1.3 billion of equity. As a result, equity represented only 16.3% of postacquisition Toys capitalization, and debt represented 83.7% of capitalization. This compares to a preacquisition equity and debt of approximately 65% and 35%, respectively. As a result, Toys’ capitalization became significantly more leveraged based on the LBO transaction (see Exhibit 17.18).
EXH I BI T 1 7 .17 LEVERAGE SUM M A RY ( $ I N M I L L I O NS ) > s Z' E>z^/^
ƵŵƵů͘DƵůƟƉůĞ
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ΨϮďŝůůŝŽŶƐĞŶŝŽƌƐĞĐƵƌĞĚĐƌĞĚŝƚĨĂĐŝůŝƚLJ hŶƐĞĐƵƌĞĚďƌŝĚŐĞůŽĂŶ
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ZĞŵĂŝŶŝŶŐĐĂƐŚĂŶĚƐŚŽƌƚͲƚĞƌŵ ŝŶǀĞƐƚŵĞŶƚƐŽŶďĂůĂŶĐĞƐŚĞĞƚ ĂƐƐƵŵĞĚďLJƚŚĞĐŽŶƐŽƌƟƵŵ
;ϭ͕ϮϰϳͿ
EĞƚůĞǀĞƌĂŐĞ
Ψϱ͕ϰϲϱ
DŽƌƚŐĂŐĞůŽĂŶĂŐƌĞĞŵĞŶƚƐ
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EŽƚĞ͗dŚĞŵŽĚĞůĂƐƐƵŵĞƐƚƌĂŶƐĂĐƟŽŶĐůŽƐĞĚŽŶ &z :ĂŶƵĂƌLJϮϵ͕ϮϬϬϱ͘ ĐƚƵĂůĚĞĂůĐůŽƐĞĚŽŶ:ƵůLJϮϭ͕ϮϬϬϱ͘
II. HEDGE FUNDS AND PRIVATE EQUITY
384
17. LBO FINANCIAL MODEL
EXH I BI T 17.1 8 CONS OLIDAT E D B A L A NCE S HE E T @ TRA N SACTION CLOS E ǻǞȱȱǼ ȱȱȱ ȱȱȱ ȱ ȱȱ ȱȱ
ȱȱȱȱȱ ŗȦřŗȦŘŖŖŚ ŗȦŘşȦŘŖŖś
ǞŘǰŖŖř ŗŚŜ ŘǰŖşŚ ŚŞŜ ǞŚǰŝŘş
ǞŘǰŘŖř ŗśř ŗǰŞŞŚ ŗŜŝ ǞŚǰŚŖŝ
ǞŚǰŚřş
ǞŚǰřřş
řŚŞ Ŗ ŝŚş
řśř Ŗ ŜŜş
ǻřśřǼ ŘǰŜŞŚ
Ŗ ŘǰŜŞŚ ŜŜş
ǞŗŖǰŘŜś
ǞşǰŝŜŞ
Ǟŗǰřŝś
ǞŗŗǰŗŚř
ȱǭȱ ȇȱ ȱ¢ ŗǰŖŘŘ ȱ¡ȱǭȱȱȱ ŗǰŗŞś ȱȱ ǞŘǰŘŖŝ
ŗǰŖŘř ŗǰŗŘŜ ǞŘǰŗŚş
ǞŖ
ŗǰŖŘř ŗǰŗŘŜ ǞŘǰŗŚş
řǰŖŖŜ Ŗ Ŗ Ŗ Ŗ řǰŖŖŜ
ŘǰřŗŘ Ŗ Ŗ Ŗ Ŗ ŘǰřŗŘ
ŝŖŖ ŗǰşŖŖ ŗǰŖŖŖ ŞŖŖ ŚǰŚŖŖ
ŘǰřŗŘ ŝŖŖ ŗǰşŖŖ ŗǰŖŖŖ ŞŖŖ ŜǰŝŗŘ
śřŞ śŚŖ
ŚŞś Śşŝ
ȱ
ǞŜǰŘşŗ
ǞśǰŚŚř
ǞŚǰŚŖŖ
ǞşǰŞŚř
ȇȱ¢ ȱȱ ȱ¢ ȱ ȱȇȱ¢
ǞŖ Ŗ řǰşŝŚ ǞřǰşŝŚ
ǞŖ Ŗ ŚǰřŘś ǞŚǰřŘś
ŗǰřŖŖ ǻŚǰřŘśǼ ǻǞřǰŖŘśǼ
ǞŖ ŗǰřŖŖ Ŗ ǞŗǰřŖŖ
ǰȱǭ ǰȱ ȱ ȱ ȱ
ȱ ȱȱȱ¢ ȱȱ ȱȱȱ ȱȱ ȱ ȱ ȱ¡ ȱ
ǻǞşśŜǼ
ȱȱȓȱ
ǻǞşśŜǼ
ǞŗǰŘŚŝ ŗśř ŗǰŞŞŚ ŗŜŝ ǞřǰŚśŗ ǞŚǰřřş
ŚŞś Śşŝ
ȱȱǭȱȇȱ¢ ǞŗŖǰŘŜś ǞşǰŝŜŞ Ǟŗǰřŝś DZȱȱȱȱȬȱǯȱȱȱȱȱȱȱ ¢ȱŘşǰȱŘŖŖśǯȱ ȱȱȱȱ ¢ȱŘŗǰȱŘŖŖśǯ DZȱȱ ȱ ¢ȱȱȱǻ ǯȱǼ ǞŜǰŜśŜ ȱȱȱ řǰşŝŘ ȱ ǞŘǰŜŞŚ DZȱȱȱȱȱȱȱȱȬȱ
II. HEDGE FUNDS AND PRIVATE EQUITY
ǞŗŗǰŗŚř
Leveraged Buyout Analysis Example
385
Determine Cash Flow Available for Debt Service KKR determined the cash flow available for debt service by subtracting CapEx from projected EBITDA and then making adjustments based on changes in working capital and other long-term assets and liabilities and payment of cash taxes. In addition, because KKR expected to receive cash from the future sale of stores, the projected after-tax proceeds of these sales increased cash. The result was a forecast of cash available for debt service through 2015 (see Exhibit 17.19). This amount was then reduced to reflect interest expense netted against interest income to create cash available for debt repayment. Normally, this cash is used to pay down debt and, in the case of Toys, the Exhibit suggests that the $2.3 billion of debt assumed on the date of acquisition is paid off first, and then the senior secured credit facility receives partial repayment. The end result of using available cash flow to retire debt is the reduction in total debt over time and improvement in debt/EBITDA ratios (see Exhibits 17.19 and 17.20). The gradual reduction in debt combined with the increase in EBITDA creates a growth in equity for a financial sponsor, enabling the sponsor to achieve its targeted IRR (see Exhibit 17.1). The Toys’ projected cash flow statement (Exhibit 17.19) shows that there should be $347.9 million in cash available during 2006 to repay a portion of the debt assumed at the time of the acquisition.2 Payment of this debt reduces total debt from $6.712 billion in 2005 to $6.364 billion in 2006 (see Exhibit 17.20). This total debt amount continues to decrease from debt repayment through 2010, when it reaches $5.423 billion (net debt of $4.176 billion). LBO models typically assume that all excess cash is used to pay down debt. This is because the financial sponsor usually thinks that this is the best use for excess cash. However, if there is a compelling investment opportunity, or if the sponsor wants the company to pay a large dividend, this cash can be diverted, unless lenders include loan covenants that prevent or minimize dividends and other large cash payments (which they usually do).
2 Sometimes,
a range of cash flows is projected since it is increasingly difficult to be precise the further out in time the projection continues. A variable cash flow projection will reveal alternative IRR outcomes and the riskiness of the debt brought onto the balance sheet.
II. HEDGE FUNDS AND PRIVATE EQUITY
386
E X HI BI T 17.19 CASH FLOW STATE M E NT ( $ I N M I L L I O NS ) ȱ ȱȱȱ ¢ȱřŗ
ŘŖŖŝ ǞŞŜŖǯŖ ŘŖşǯŗ ǞŜśŖǯş
ŘŖŖŞ ǞŞŝŝǯŘ ŘŖŞǯŗ ǞŜŜşǯŗ
ŘŖŖş ǞşŗŚǯş ŘŗŚǯŞ ǞŝŖŖǯŗ
ŘŖŗŖ ŘŖŗŗ ǞşśŜǯş ǞşşŘǯŚ ŘŘŘǯŞ Řřŗǯŗ ǞŝřŚǯŗ ǞŝŜŗǯř
ǻ ǼȱȦȱȱȱȱ ǻ ǼȱȦȱȱȱȱȱ ȱȦȱǻǼȱȱȱȱ ȱ¡ ȱȱȱȱȱ¡ȱȱȱ ȱȱȦȱǻǼȱȱ
ǻǞŖǯŗǼ ŖǯŖ ŖǯŖ ǻŚǯřǼ ŖǯŖ ǻǞŚǯŚǼ
Ǟŗǯř ŖǯŖ ŖǯŖ ǻŗŞǯşǼ ŖǯŖ ǻǞŗŝǯŜǼ
ǻǞŖǯřǼ ŖǯŖ ŖǯŖ ǻřřǯŖǼ ŖǯŖ ǻǞřřǯřǼ
ǻǞŘǯŖǼ ŖǯŖ ŖǯŖ ǻŚŞǯŖǼ ŖǯŖ ǻǞśŖǯŖǼ
ǻǞŘǯřǼ ŖǯŖ ŖǯŖ ǻŜŚǯŚǼ ŖǯŖ ǻǞŜŜǯŝǼ
ȱȱȱȱǻȬ¡Ǽ
Řŗŝǯŝ
ŗŞśǯŞ
ŖǯŖ
ŖǯŖ
ŖǯŖ
ŖǯŖ
ŖǯŖ
ŖǯŖ
ŖǯŖ
ŖǯŖ
ȱȱȱȱ
ǞŞśŜǯŜ
ǞŞŗşǯŗ
ǞŜřśǯŞ
ǞŜśŖǯŗ
ǞŜŜŝǯŚ
ǞŜŞŖǯŗ
ǞŜşŗǯş
ǞŝŖśǯř
Ǟŝŗŝǯř
ǞŝŘŝǯŖ
ȱ ȱ¡ ȱ ȱȱȱ ȱȱȱȱ£ȱȦȱ¢
ǞśŚşǯŘ ŚŖǯś ǞřŚŝǯş
ǞśřŖǯś ŚŜǯŞ ǞřřśǯŚ
Ǟśŗŝǯś śřǯŖ Ǟŗŝŗǯř
ǞśŖşǯŖ śşǯŘ ǞŘŖŖǯŚ
ǞŚşŞǯř Ŝśǯś ǞŘřŚǯś
ǞŚŞśǯŜ ŝŗǯŝ ǞŘŜŜǯŘ
ǞŚŜŞǯş ŝŝǯş ǞřŖŗǯŖ
ǞŚŚŞǯŘ ŝŝǯş Ǟřřśǯŗ
ǞŚŘŗǯŚ ŝŝǯş Ǟřŝřǯş
ǞřŞśǯś ŝŝǯş ǞŚŗşǯŚ
ȱȱ¢ ȱȱȱ¢ȱ¢
ǻǞřŚŝǯşǼ ǞŖǯŖ
ǻǞřřśǯŚǼ ǞŖǯŖ
ǻǞŗŝŗǯřǼ ǞŖǯŖ
ǻǞŘŖŖǯŚǼ ǞŖǯŖ
ǻǞŘřŚǯśǼ ǞŖǯŖ
ǻǞŘŜŜǯŘǼ ǞŖǯŖ
ǻǞřŖŗǯŖǼ ǞŖǯŖ
ǻǞřřśǯŗǼ ǞŖǯŖ
ǻǞŗŘŖǯřǼ ǻǞŘśřǯŜǼ
ǞŖǯŖ ǻǞŚŗşǯŚǼ
ȱ ȱ¡ ȱȬȱ¡
ŘŖŖŚ
ŘŖŖś
¡ȱȱȱȱȱȱ¢ȱ¢ ȱȱ ȱȱ ȱ ȱȱȦȱ ȱȱȦȱ ȱȦȱ ȱ¡ ǻ Ȭ¡ǼȱȦȱ ȱ¡ ¡ȱȱ¢ ȱ ȱȱ ȱ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ŞǯŜŗ¡ ŝǯŖŗ¡
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ǻǞŘǯŘǼ ŖǯŖ ŖǯŖ ǻŝşǯŗǼ ŖǯŖ ǻǞŞŗǯřǼ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ŘŖŗŘ ǞŗǰŖŘşǯř Řřşǯŝ ǞŝŞşǯŜ
ŘŖŗř ǞŗǰŖŜŝǯŜ ŘŚŞǯŜ ǞŞŗşǯŖ
ŘŖŗŚ ǞŗǰŗŖŝǯŘ ŘśŝǯŞ ǞŞŚşǯŚ
ŘŖŗś ǞŗǰŗŚŞǯŚ ŘŜŝǯŚ ǞŞŞŗǯŖ
ǻǞŘǯŘǼ ŖǯŖ ŖǯŖ ǻşśǯŚǼ ŖǯŖ ǻǞşŝǯŝǼ
ǻǞŘǯřǼ ŖǯŖ ŖǯŖ ǻŗŗŗǯřǼ ŖǯŖ ǻǞŗŗřǯŜǼ
ǻǞŘǯŚǼ ŖǯŖ ŖǯŖ ǻŗŘşǯŝǼ ŖǯŖ ǻǞŗřŘǯŗǼ
ǻǞŘǯśǼ ŖǯŖ ŖǯŖ ǻŗśŗǯśǼ ŖǯŖ ǻǞŗśŚǯŖǼ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ǞŖǯŖ ŗǰŘŚŝǯŖ ǞŗǰŘŚŝǯŖ
ŝǯřş¡ śǯşŚ¡ ŗǯśŝ¡ ŗǯŗŝ¡
ŝǯŖŗ¡ śǯśŜ¡ ŗǯŜŘ¡ ŗǯŘř¡
ŜǯŜŞ¡ śǯŘŜ¡ ŗǯŜş¡ ŗǯŘş¡
ŜǯŗŞ¡ ŚǯŞŘ¡ ŗǯŞŖ¡ ŗǯřŞ¡
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řǯŘś¡ ŘǯŗŜ¡ ŘǯşŞ¡ ŘǯŘş¡
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
ǞŖǯŖ ŖǯŖ ŖǯŖ ǞŖǯŖ
17. LBO FINANCIAL MODEL
ŘŖŖŜ ǞŞŜŖǯŞ Řŗŝǯś ǞŜŚřǯř
ŘŖŖř
EXH I BIT 17.2 0 RETURNS S UM M A RY ( $ I N M I L L I O NS ) ȱ ŘŖŖś ǞŝŞŖǯŖ ŘŖǯŚƖ ŝǯŖƖ
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ǞśŚşǯŘ ǞŜǰřŜŚ ŗǰŘŚŝ Ǟśǰŗŗŝ
ȱ ȱȱȱ ȱȱȱ II. HEDGE FUNDS AND PRIVATE EQUITY
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ǞŜǰŝŗŘ ŗǰŘŚŝ ǞśǰŚŜś
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ŘŖŖş ǞşŗŚǯş ŚǯřƖ ŞǯśƖ
ŘŖŗŖ ǞşśŜǯş ŚǯŜƖ ŞǯŜƖ
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ǞŜǰŖŘş ŗǰŘŚŝ ǞŚǰŝŞŘ
ǞśǰŞśŝ ŗǰŘŚŝ ǞŚǰŜŗŖ
ǞśǰŜśŝ ŗǰŘŚŝ ǞŚǰŚŗŖ
ǞśǰŚŘř ŗǰŘŚŝ ǞŚǰŗŝŜ
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ǞŗǰŗŖŖǯŚ ŗǰśřŗǯŖ ŗǰşŜŗǯŜ ŘǰřşŘǯŘ ŘǰŞŘŘǯŞ řǰŘśřǯŚ řǰŜŞŚǯŖ
Ȧ ŗŚǯśƖ ŗŞǯŚƖ ŘŗǯŞƖ ŘŚǯŞƖ ŘŝǯŜƖ řŖǯŘƖ řŘǯśƖ
ȇŖśȬȇŗŖ ŚǯŘƖ
Leveraged Buyout Analysis Example
ŘŖŖŜ ǞŞŜŖǯŞ ŗŖǯŚƖ ŝǯşƖ
ǞŗǰŗŞŗǯŚ ŗǰŜŗŘǯŖ ŘǰŖŚŘǯŜ ŘǰŚŝřǯŘ ŘǰşŖřǯŞ řǰřřŚǯŚ řǰŝŜśǯŖ
387
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17. LBO FINANCIAL MODEL
Calculate Credit Ratios Lenders in an LBO transaction take considerable risks based on their exposure to highly leveraged companies such as Toys. As a result, they require controls on the company’s total amount of debt and on the cash flow available to pay interest when due. As a condition for lending, therefore, two different kinds of credit ratios are imposed by lenders: leverage ratios and coverage ratios. Leverage ratios limit the amount of total debt and net debt that the target company is allowed to undertake relative to EBITDA. In the Toys transaction, postacquisition total debt/ EBITDA during 2005 was 8.61×. Net debt/EBITDA during 2005 was 7.01× (see Exhibit 17.20). Note that these ratios are forecast to reduce each year based on the repayment of debt until 2010, when total debt/EBITDA is 5.67× and net debt/EBITDA is 4.36×. Coverage ratios require the company to produce cash flow in excess of annual interest payments. For example, EBITDA must exceed interest payments due in any year by a certain ratio. In the Toys transaction, EBITDA/interest expense during 2006 was 1.57×. (EBITDACapEx)/interest expense was 1.17× during 2006. Through the repayment of debt, these ratios are forecast to improve each year until 2010, when EBITDA/interest expense increases to 1.92× and (EBITDA-CapEx)/interest expense increases to 1.47×.
Calculate the Equity Value, Internal Rate of Return and Multiple of Investment on Projected Exit Date To calculate equity value, IRR, and multiple of investment on the projected exit date, start with EBITDA on the projected exit date year (2010 in the Toys case—see Exhibit 17.21) and multiply that EBITDA by a range of enterprise value/EBITDA multiples that might apply as of the exit date. This creates an expected enterprise value. After the enterprise value alternatives are determined, equity value as of the exit date can be calculated by subtracting debt and adding cash. A further step sometimes involves determining the equity value of options held by nonsponsor holders (such as management) and reducing the equity value for the sponsor by this amount.
II. HEDGE FUNDS AND PRIVATE EQUITY
EXH I BI T 17.2 1 RETURNS S UMM A RY ( $ I N M I L L I O NS ) ȱ ȱ¡ȱ
ŘŖŗŖȱ ǞşśŜǯşȱ
ǞŜǰŜşŞǯřȱ ŝǰŗŝŜǯŝȱ ŝǰŜśśǯŗȱ ŞǰŗřřǯŜȱ ŞǰŜŗŘǯŖȱ şǰŖşŖǯśȱ şǰśŜŞǯşȱ
DZ ǻǞśǰŚŘŘǯŜǼ ǻǞśǰŚŘŘǯŜǼ ǻǞśǰŚŘŘǯŜǼ ǻǞśǰŚŘŘǯŜǼ ǻǞśǰŚŘŘǯŜǼ ǻǞśǰŚŘŘǯŜǼ ǻǞśǰŚŘŘǯŜǼ
DZ ǞŗǰŘŚŝǯŖȱ ǞŗǰŘŚŝǯŖȱ ǞŗǰŘŚŝǯŖȱ ǞŗǰŘŚŝǯŖȱ ǞŗǰŘŚŝǯŖȱ ǞŗǰŘŚŝǯŖȱ ǞŗǰŘŚŝǯŖȱ
ǻǞŚǰŗŝśǯŜǼ ǻǞŚǰŗŝśǯŜǼ ǻǞŚǰŗŝśǯŜǼ ǻǞŚǰŗŝśǯŜǼ ǻǞŚǰŗŝśǯŜǼ ǻǞŚǰŗŝśǯŜǼ ǻǞŚǰŗŝśǯŜǼ
¢ ǞŘǰśŘŘǯŝȱ ǞřǰŖŖŗǯŗȱ ǞřǰŚŝşǯŜȱ ǞřǰşśŞǯŖȱ ǞŚǰŚřŜǯśȱ ǞŚǰşŗŚǯşȱ ǞśǰřşřǯŚȱ
ȱ ŝǯŖŖȱ¡ȱ ŝǯśŖȱ¡ȱ ŞǯŖŖȱ¡ȱ ŞǯśŖȱ¡ȱ şǯŖŖȱ¡ȱ şǯśŖȱ¡ȱ ŗŖǯŖŖȱ¡ȱ
ŘŖŖś ǻǞŗǰřŖŖǯŖǼ ǻŗǰřŖŖǯŖǼ ǻŗǰřŖŖǯŖǼ ǻŗǰřŖŖǯŖǼ ǻŗǰřŖŖǯŖǼ ǻŗǰřŖŖǯŖǼ ǻŗǰřŖŖǯŖǼ
ŘŖŖŜ ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ȱȱ ȱ ȱ ŘŖŖś ŘŖŖŜ ŝǯŖŖȱ¡ȱ ǻǞŗǰŘŗşǯŖǼ ǞŖǯŖȱ ŝǯśŖȱ¡ȱ ǻŗǰŘŗşǯŖǼ ŖǯŖȱ ŞǯŖŖȱ¡ȱ ǻŗǰŘŗşǯŖǼ ŖǯŖȱ ŞǯśŖȱ¡ȱ ǻŗǰŘŗşǯŖǼ ŖǯŖȱ şǯŖŖȱ¡ȱ ǻŗǰŘŗşǯŖǼ ŖǯŖȱ şǯśŖȱ¡ȱ ǻŗǰŘŗşǯŖǼ ŖǯŖȱ ŗŖǯŖŖȱ¡ȱ ǻŗǰŘŗşǯŖǼ ŖǯŖȱ
ŘŖŖŝ ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ŘŖŖŞ ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ŘŖŖş ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ŘŖŗŖ ǞŘǰŚŖŖǯŚȱ ŘǰŞřŗǯŖȱ řǰŘŜŗǯŜȱ řǰŜşŘǯŘȱ ŚǰŗŘŘǯŞȱ ŚǰśśřǯŚȱ ŚǰşŞŚǯŖȱ
ŘŖŖŝ ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ŘŖŖŞ ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ŘŖŖş ǞŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ ŖǯŖȱ
ŘŖŗŖ ǞŘǰŚŖŖǯŚȱ ŘǰŞřŗǯŖȱ řǰŘŜŗǯŜȱ řǰŜşŘǯŘȱ ŚǰŗŘŘǯŞȱ ŚǰśśřǯŚȱ ŚǰşŞŚǯŖȱ
ŗřǯŖƖ ŗŜǯŞƖ ŘŖǯŘƖ ŘřǯŘƖ ŘŜǯŖƖ ŘŞǯśƖ řŖǯŞƖ
ǞŗǰŗŖŖǯŚȱ ŗǰśřŗǯŖȱ ŗǰşŜŗǯŜȱ ŘǰřşŘǯŘȱ ŘǰŞŘŘǯŞȱ řǰŘśřǯŚȱ řǰŜŞŚǯŖȱ
ȱ ȱ ŗŚǯśƖ ǞŗǰŗŞŗǯŚȱ ŗŞǯŚƖ ŗǰŜŗŘǯŖȱ ŘŗǯŞƖ ŘǰŖŚŘǯŜȱ ŘŚǯŞƖ ŘǰŚŝřǯŘȱ ŘŝǯŜƖ ŘǰşŖřǯŞȱ řŖǯŘƖ řǰřřŚǯŚȱ řŘǯśƖ řǰŝŜśǯŖȱ
ȱȱ ȱȱ ȱ ¢ȱ ǞŗŘŘǯřȱ ǞŘǰŚŖŖǯŚȱ ŗŝŖǯŗȱ ŘǰŞřŗǯŖȱ ŘŗŞǯŖȱ řǰŘŜŗǯŜȱ ŘŜśǯŞȱ řǰŜşŘǯŘȱ řŗřǯŜȱ ŚǰŗŘŘǯŞȱ ŚǰśśřǯŚȱ řŜŗǯśȱ ŚŖşǯřȱ ŚǰşŞŚǯŖȱ
Leveraged Buyout Analysis Example
II. HEDGE FUNDS AND PRIVATE EQUITY
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17. LBO FINANCIAL MODEL
The most relevant multiple to use in forecasting the exit equity value for the sponsor depends on who the expected buyer is on the exit date (IPO sale, or M&A sale to a strategic buyer or to another financial sponsor) and the multiple used to value the investment on the original acquisition date. Generally, sponsors use the same multiple for entering and exiting an investment, but this depends on the facts and circumstances of the investment. After a range of equity values is determined, the IRR of the investment can be calculated based on the number of years the investment is expected to be held and the entry and exit equity values derived from the analysis. The IRR is the discount rate which causes the present value of the future cash flow (including the equity value on the exit date) to equal the equity investment at time zero. This IRR can be calculated on most financial calculators by including the time horizon (n), which was 5 years in the Toys case, the original investment (PV), which was -$1.3 billion (without fees) for Toys and the exit equity value (FV), which, assuming a 9.0× multiple, was $4.12 billion for Toys. Assuming no interim dividend payments (PMT), solving for the IRR (i) based on the 9× multiple results in an IRR of 26%. In Exhibit 17.21, the original equity investment by KKR in Toys during 2005 was $1.3 billion. Assuming a 5-year holding period (an exit during 2010), the sponsor’s equity value at exit ranges from $2.4 billion to just under $5.0 billion, depending on the enterprise value/ EBITDA multiple used. Since the 2005 multiple (excluding fees) was 9.4×, it is reasonable to assume an exit multiple of between 9.0× and 9.5×, which suggests that the IRR for KKR in the Toys transaction may have been expected to be between 26.0% and 28.5%. Including fees, the expected return may have been 26.7%–30.2%. If an exit multiple of 9.0× had been used, the expected exit equity value would have been $4.12 billion, producing a gain of $2.82 billion (not including initial fees) since the original equity investment was $1.3 billion. As a result, the expected multiple of investment would have been $4.12 billion/$1.3 billion = 3.17 times (equity exit value/entry equity value).
LEVERAGED BUYOUT ANALYSIS POSTCREDIT CRISIS Although when KKR initiated the Toys LBO the expected IRRs may have been 26%, or higher, and expected multiple of investment at 3.17 times, or higher, there was considerable risk associated with this transaction. It is likely, therefore, that KKR completed several “stress test” scenarios that projected worsening credit, real estate, and retailing markets. Based on this risk-adjusted analysis, they may have expected lower returns. Indeed, in the postcredit crisis environment, returns for most financial sponsors were significantly diminished. This happened, in part, because creditors were unwilling to provide as much leverage in support of LBO transactions (and the cost of leverage increased). With less leverage available, financial sponsors were required to commit more up-front equity, which reduced returns. In addition, because of a massive inflow of new private equity funding that came from investors during 2006–08, there was significantly more competition for acquisition targets, which also resulted in a reduction in returns. Since 2009, many sponsors have accepted IRRs substantially below 25%, and sometimes as low as 10%–15%, while other sponsors have decided to seek returns from nontraditional sources.
II. HEDGE FUNDS AND PRIVATE EQUITY
Leveraged Buyout Analysis Postcredit Crisis
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KKR had Toys file a registration statement during 2010 in relation to a potential IPO, but the offering was delayed that year, and again in 2011 and 2012, with the registration formally withdrawn during 2013. In each year, Toys cited market conditions for not launching an offering, and so 10 years after the original purchase by KKR and its partners, there was still no exit for the investment group.
II. HEDGE FUNDS AND PRIVATE EQUITY