Transcript Metrics and Multiples - Villanova University

Leverage Buyouts
Arzac, Chapter 13
How To Go Private
• four commonly used techniques for
going private transactions
• shell corporation that combines with firm
via merger
• asset sales
• tender offer
• reverse stock split
“Going Private”
• leverage transaction of public firm into
privately held company
• LBO
• MBO
• often associated with improvement in
performance
LBOs
• peak from 1986 to 1989
• largest was RJR Nabisco in 1988 with price
of $24.6b and then Beatrice in 1985 at
$5.4b (Mergerstat)
• buying group generally includes current
mgt
• expectation at some point that reverse
transaction will occur
Why Pay Premiums?
• premiums paid for firms in LBOs average
40% of market price 1-2 months prior to
announcement of buyout
• gains do occur and are achieved through stock
price performance
• sources of gains:
•
•
•
•
•
taxes
management incentives
wealth transfer effects
asymmetric information and underpricing
efficiency considerations
Strip Financing
• LBOs sometimes structured to use strip
financing
• nonequity financing like senior debt,
subordinated debt, convertible debt, and
preferred stock often used
• others below senior and above common are
mezzanine level
• strip says buyer who purchases X% of any
mezzanine level security must purchase X% of all
mezzanine level securities and some equity too
Pro Forma Cash Flows for Leverage Buyout
EBIT
Interest
EBT
Taxes @ 40%
Net Income
Depreciation
Cash Flow
Amortization of loans
Cash Flow Cushion
Year 0
150.0
Year 1
165.0
88.5
76.5
30.6
45.9
30.0
75.9
60.9
15.0
Year 2
181.5
76.5
105.0
42.0
63.0
30.0
93.0
72.9
20.1
Year 3
199.7
62.2
137.5
55.0
82.5
30.0
112.5
87.2
25.3
Year 4
219.6
45.0
174.6
69.8
104.8
30.0
134.8
104.4
30.4
Year 5
241.6
24.5
217.1
86.8
130.3
30.0
160.3
129.9
35.4
Changing Debt Ratio in an LBO
Equity
Debt
Total Assets
Percent Debt
Year 0
50.0
450.0
500.0
90%
Year 1
95.9
389.1
485.0
80%
Year 2
158.9
316.2
475.1
67%
Year 3
241.4
229.0
469.7
49%
Year 4
346.2
124.6
470.1
26%
Year 5
476.5
0.0
476.5
0%
Ownership Structure Changes
• most complete form of ownership change
when take a public firm private through an
LBO
• purchase control using a high debt
component with mgt often part of equity base
• fundamental operating changes generally
made in attempt to increase profitability and
firm value
Financing
• firms with valuations less than about $400 will not generally
have access to public high yield market to raise funds for LBO
•
used secured debt from bank – private placement of subordinated
debt and equity participation
• typical financial structure for smaller firms prior to 1980s
•
•
debt – about 5X EBITDA
equity – about 1-1.5X EBITDA
•
•
•
•
secured financing – about 3X EBITDA
high-yield financing – about 2.5-3X EBITDA
equity – about 1.5X EBITDA
sales about 7-8X EBITDA
•
mezzanine financing fills in gap
• everything changed in 1980s for larger firms because of highyield debt market
• problem when high-yield debt market is not as active
Example 1
• Let the LBO purchase price be $210 million, of which
$60 million is secured debt. $100 million is
subordinated debt with a below-market coupon
interest of 6% plus 27% of the equity, and $50
million is invested by the sponsor for 73% of the
equity. Assume the FCFs generated during the first 5
years go to pay interest and amortize the secured
debt in its entirety and that cash balances are
negligible. Furthermore, let expected year-5 EBITDA
equal $49.5 million and assume that the company is
expected to be sold for 8 times EBITDA or $396
million net of fees and expenses. Then, the cash
flows and the return to subordinated holders are as
follows:
Year
Bond price
Coupon
Principal
Equity Kicker
Total CF
IRR
RETURN TO SPONSOR:
Year
Initial Investment
Exit Proceeds
Return Multiple (216/50)
IRR
0
1
2
3
4
5
6
6
6
6
6
6
6
6
6
100
80
186
-100
-100
17.30%
0
1
2
3
4
5
-50
216
4.3X
34.00%
LBO Financing
1)
2)
3)
4)
5)
determine debt capacity
determine equity needed from sponsor
find total financing amount
find purchase price in terms of EBITDA
determine if lender’s equity requirement
satisfies return required by sponsor
Debt Capacity
• need to find in order to determine
affordable price for LBO
• example 3 (Arzac) – Consider a target with 1st-year pro-forma
EBITDA of $150m, growth rate of sales and EBITDA of 7%,
initial cash balance of $1.9m, and senior secured debt making
up 73% of total borrowing to be amortized in 7 years. (Firm has
debt capacity of about 4.74x EBITDA or 4.74*150m = $710.8m,
amortize $322.8m of it, and be left with the $388m of
subordinated debt at the end of year 5 and a cash balance of
$2.6m. See Exhibit 7.5.) Assume that the LBO sponsor expects
to exit the investment in 5 years at 7x forward EBITDA. What is
residual equity at the end of the 5th year? If the sponsor
requires 30% return, what is the max equity that can be used
and an affordable purchase multiple? Fees and expenses are
.15x EBITDA.
Peregrine Coatings
•
Peregrine Coatings was a small specialty chemical company engaged in
the manufacturing and distribution of coatings, paints, and related
products primarily in the United States. In the spring of 2005, its
owner, a diversified chemical company decided to sell Peregrine
Coatings. As is customary in this type of transaction, Peregrine was to
be sold with no cash and no outstanding debt. Assume that lenders are
willing to lend on a secured basis up to 60% of total debt and required
25% of the purchase price to be equity. They would be charged 6.7%
cash interest and require the term loan to be paid down with all
available pre-loan amortization cash flow over 7 years. Subordinated
lenders would provide 40% of the total debt at 8% cash interest with
principal due in 7 years. Both loans would be callable after 12/31/2010
without penalty. The sponsor needed to supply the remaining 25% of
the capital and required a 25% IRR. Fees and expenses associated
with the transaction would be about 2% of the purchase price.
Exhibit 13.2. Peregrine Coatings. Seven-Year Projections
($ millions)
Actual
2006
2007
2008
2009
2010
2011
2012
2013
Sales
EBITDA
Depreciation
Deferred taxes
Capital expenditures
Increase in net working capital including cash
578.0
93.1
16.0
11.6
34.0
7.1
630.0
107.1
18.9
12.6
29.3
4.1
683.6
119.6
20.5
13.7
31.2
3.8
741.7
133.5
22.3
14.8
33.9
7.6
801.0
144.2
24.0
16.0
35.9
7.7
861.1
155.0
25.8
17.2
37.8
7.8
921.4
161.2
27.6
18.4
39.7
7.8
985.9
172.5
29.6
19.7
42.5
8.4
Projection assumptions:
Net sales growth
EBITDA margin
Net fixed assets/sales
Net working capital less cash/sales
Cash and marketable securities/sales
Depreciation/sales
Deferred taxes/sales
9.0%
16.1%
20.0%
12.0%
2.0%
2.8%
2.0%
9.0%
17.0%
20.0%
11.5%
2.0%
3.0%
2.0%
8.5%
17.5%
20.0%
11.0%
2.0%
3.0%
2.0%
8.5%
18.0%
20.0%
11.0%
2.0%
3.0%
2.0%
8.0%
18.0%
20.0%
11.0%
2.0%
3.0%
2.0%
7.5%
18.0%
20.0%
11.0%
2.0%
3.0%
2.0%
7.0%
17.5%
20.0%
11.0%
2.0%
3.0%
2.0%
7.0%
17.5%
20.0%
11.0%
2.0%
3.0%
2.0%
5.31%
5.12%
5.59%
5.44%
5.30%
5.16%
5.16%
Exhibit 13.3. Peregrine Coatings. Debt Capacity of Leveraged Buyout as of 12/31/2006
($ millions)
Year-end
Net Sales
EBITDA
Depreciation
EBIT
Interest income @
Senior debt interest @
Subordinated debt interest expense @
Income before taxes
Provision for tax
40%
Net income
Deferred taxes
Depreciation
Capex and incr in net work. capital. incl. cash
Available for debt retirement
Debt amortization
Senior debt
Subordinated debt
Debt balance
Cash balance
Debt/2006 EBITDA
EBITDA net interest coverage
2006
2007
2008
2009
2010
2011
2012
2013
578.0
93.1
16.0
77.1
5.00%
6.70%
8.00%
630.0
107.1
18.9
88.2
0.6
22.9
18.2
47.7
19.1
28.6
12.6
18.9
33.4
26.7
683.6
119.6
20.5
99.1
0.7
21.1
18.2
60.4
24.2
36.3
13.7
20.5
35.0
35.4
741.7
133.5
22.3
111.3
0.7
18.7
18.2
75.0
30.0
45.0
14.8
22.3
41.4
40.7
801.0
144.2
24.0
120.2
0.8
16.0
18.2
86.7
34.7
52.0
16.0
24.0
43.6
48.5
861.1
155.0
25.8
129.2
0.9
12.8
18.2
99.0
39.6
59.4
17.2
25.8
45.7
56.8
921.4
161.2
27.6
133.6
0.9
9.0
18.2
107.3
42.9
64.4
18.4
27.6
47.5
62.9
985.9
172.5
29.6
142.9
1.0
4.8
18.2
120.9
48.4
72.6
19.7
29.6
50.9
71.0
341.9
228.0
569.9
12.6
5.32
315.3
228.0
543.2
13.7
279.8
228.0
507.8
14.8
239.2
228.0
467.1
16.0
190.7
228.0
418.7
17.2
133.9
228.0
361.9
18.4
71.0
228.0
299.0
19.7
0.0
228.0
228.0
21.1
2.6
3.1
3.7
4.3
5.1
6.1
7.8
Lender requirement: 25% of purchase price, hence
Debt capacity
Equity
Total
Fees and expenses
Less cash
Offer price
2006 EBITDA
EBITDAx
2012 EBITDA
Enterprise Value at entry multiple of
Minus fees & expenses
Minus net debt at end of 2010
Sponsor's IRR with exit in 2010
Percent EBITDAx
of capital
75%
5.3
25%
1.8
100%
7.1
2%
($000)
569.9
190.0
759.8
15.2
744.7
12.6
732.1
107.1
6.835
6.84
2%
161.24
1,102.1
22.0
343.4
736.6
31.1%
Exhibit 13.4. Peregrine Coatings
LBO Return on Equity and Affordable Bid
($ millions)
2012 EBITDA
EBITDAx
Enterprise Value before+C113 fees & expenses
Minus fees & expenses
Minus net debt at the end of 2011
Exit equity
Present value of equity at
Return multiple
Net debt
Equity
Affordable bid for enterprise
EBITDAx
2%
25%
161.2
6.84
1,102.1
22.0
343.4
736.6
241.4
3.1x
554.7
241.4
$796.1
7.43x
Exhibit 13.5. Peregrine Coatings LBO
Valuation of Unit of Note and Equity Kicker
($ millions)
2006
Year-end
Junior subordinated note principal
Coupon payments @
Principal repayment
Note cash flow
Equity kicker to yield
Expected cash flow on unit
Present value of unit @
2007
2008
2009
2010
5.55
5.55
5.55
5.55
5.55
5.55
5.55
5.55
5.55
5.55
5.55
5.55
2011
110.95
5.0%
12.0%
12.0%
110.95
5.55
110.95
116.50
49.34
165.83
Equity Kicker
($ millions)
2011 EBITDA
EBITDAx
Enterprise Value minus fees & expenses
Minus net debt at the end of 2010
Senior debt
Subordinated note
Junior subordinated note
Minus cash balance
Exit equity
Required equity kicker
Equity kicker as percent of equity
2%
146.0
228.0
110.9
18.4
161.2
6.84
1,102.1
466.5
635.6
49.3
7.76%
Exhibit 13.6. Peregrine Coatings LBO
Valuation of Junior Subordinated Note and Original Issue Discount Amortization
($ millions)
2006
Year-end
Junior subordinated note principal
Coupon payments @
Principal repayment
Note cash flow
Present value of note @
Original issue discount (OID)
OID amortization
$
$
2008
2009
2010
2011
2012
2013
5.5
5.5
5.5
5.5
5.5
5.5
5.5
92.1
18.8
2.3
5.5
94.7
16.3
2.5
5.5
97.4
13.6
2.7
5.5
100.4
10.6
3.0
5.5
103.6
7.3
3.2
5.5
107.1
3.8
3.5
5.5
110.9
116.5
110.9
3.8
110.9
5.0%
8.75%
2007
89.8
21.1
Exhibit 13.7. Peregrine Coatings
Cash Flow and Debt Balance with Junior Subordinated Financing
($ millions)
Year-end
Net Sales
EBITDA
Depreciation
EBIT
Interest income @
Senior debt interest @
Sub. debt interest @
Jr sub note interest @
Original issue discount amortization
Income before taxes
Provision for tax
Net income
Deferred taxes
Depreciation and oth non-cash items
OID amortization
Capex and incr in net work. Capital
Available for debt retirement
Debt amortization
Senior debt
Subordinated debt
Junior subordinated debt
Debt balance
Cash balance
EBITDA net interest coverage
2006
2007
2008
2009
2010
2011
2012
2013
578.0
93.1
16.0
77.1
5.00%
6.70%
8.00%
5.00%
630.0
107.1
18.9
88.2
0.6
22.9
18.2
5.5
2.3
39.8
15.9
23.9
12.6
18.9
2.3
33.4
24.3
683.6
119.6
20.5
99.1
0.7
21.3
18.2
5.5
2.5
52.2
20.9
31.3
13.7
20.5
2.5
35.0
33.0
741.7
133.5
22.3
111.3
0.7
19.1
18.2
5.5
2.7
66.4
26.6
39.8
14.8
22.3
2.7
41.4
38.2
801.0
144.2
24.0
120.2
0.8
16.5
18.2
5.5
3.0
77.7
31.1
46.6
16.0
24.0
3.0
43.6
46.0
861.1
155.0
25.8
129.2
0.9
13.4
18.2
5.5
3.2
89.6
35.8
53.7
17.2
25.8
3.2
45.7
54.4
921.4
161.2
27.6
133.6
0.9
9.8
18.2
5.5
3.5
97.4
39.0
58.5
18.4
27.6
3.5
47.5
60.5
985.9
172.5
29.6
142.9
1.0
5.7
18.2
5.5
3.8
110.6
44.2
66.4
19.7
29.6
3.8
50.9
68.6
341.9
228.0
110.9
680.8
12.6
317.7
228.0
110.9
656.6
13.7
2.3
284.7
228.0
110.9
623.6
14.8
2.7
246.4
228.0
110.9
585.3
16.0
3.2
200.4
228.0
110.9
539.3
17.2
3.7
146.0
228.0
110.9
484.9
18.4
4.3
85.5
228.0
110.9
424.4
19.7
4.9
16.9
228.0
110.9
355.8
21.1
6.0
40%
Exhibit 13.8. Peregrine Coatings
Ownership with Management Stock Options
($ millions, except share value and exercise price)
2011 Enterprise value minus fees & expenses
Minus fees and expenses
Net debt
2011 Equity value
Options
Exercise price
Exercise proceeds
Diluted shares
Value per share
Management ownership
Mezzanine ownership
Sponsor ownership
Total
Initial ownership:
Mezzanine investors
Sponsor
2%
1,102.1
22.0
466.5
613.5
500,000
20.60
10.3
623.8
10,500,000
59.41
4.76%
7.91%
87.33%
100.00%
29.7
49.3
544.8
623.8
8.30%
91.70%
100.00%
830,453
9,169,547
10,000,000
Exhibit 13.9. Peregrine Coatings. Adjusted Present Value as of 12/31/2006
($000)
2006
Year-end
Net Sales
EBITDA
Depreciation
EBIT
Taxes
Unlevered net income
Defered taxes
NOPAT
Depreciation
CAPEX & increase in net WC.
Unlevered free cash flow
Net interest expense
Tax shield
Unlevered cost of equity
PV FCF 2007-2011 @
Continuation value @ EBITDAx
PV 2011 continuation value @
PV Tax shield @
Enterprise value (EV)
Private equity discount on EV
EV after private equity discount
40%
13.58%
13.58%
7.8x
13.58%
8.75%
20%
578.0
93.1
16.0
77.1
30.8
46.3
2007
630.0
107.1
18.9
88.2
35.3
52.9
12.6
65.5
18.9
33.4
51.0
48.4
19.4
2008
683.6
119.6
20.5
99.1
39.6
59.5
13.7
73.1
20.5
35.0
58.6
46.9
18.8
2009
741.7
133.5
22.3
111.3
44.5
66.8
14.8
81.6
22.3
41.4
62.4
44.8
17.9
2010
801.0
144.2
24.0
120.2
48.1
72.1
16.0
88.1
24.0
43.6
68.5
42.5
17.0
2011
861.1
155.0
25.8
129.2
51.7
77.5
17.2
94.7
25.8
45.7
74.9
39.6
15.8
213.7
1,257.7
665.4
70.2
949.2
189.8
759.4
Peregrine Coatings
Cost of Capital Calculation
Long-term government bond yield
Market equity premium
Beta coefficient
Cost of equity before small cap premium
Small capitalization premium
Peregrine Coatings cost of equity
Unlevered k
4.60%
4.35%
1.17
9.68%
3.90%
13.58%