Investment Banking, valuation and M&A
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LBO Analysis
205
from PP&E). As discussed in Chapter 3, in the event that capex projections are not
provided/available, the banker typically projects capex as a fixed percentage of sales
at historical levels with appropriate adjustments for cyclical or non-recurring items.
The sum of the annual cash flows provided by operating activities and investing
activities provides annual cash flow available for debt repayment, which is commonly
referred to as free cash flow (see Exhibit 5.25).
EXHIBIT 5.8
Investing Activities
($ in millions, fiscal year ending December 31)
Projection Period
Year 10Year 9Year 8Year 7Year 6Year 5Year 4Year 3Year 2Year 1
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Investing Activities
Capital Expenditures (21.6) (22.9) (23.8) (24.5) (25.3) (26.0) (26.8) (27.6) (28.4) (29.3)
Other Investing Activities
- - - - - -
- - --
Cash Flow from Investing Activities ($21.6) ($22.9) ($23.8) ($24.5) ($25.3) ($26.8)($26.0) ($27.6) ($28.4) ($29.3)
Cash Flow Statement Assumptions
Capital Expenditures (% of sales)
2.0%2.0%2.0%2.0%2.0%2.0%2.0%2.0%2.0% 2.0%
Cash Flow Statement
As shown in Exhibit 5.8, we do not make any assumptions for ValueCo’s other
investing activities line item. Therefore, ValueCo’s cash flow from investing activities
amount is equal to capex in each year of the projection period.
Financing Activities The financing activities section of the cash flow statement
is constructed to include line items for the (repayment)/drawdown of each debt
instrument in the LBO financing structure. It also includes line items for dividends
and equity issuance/(stock repurchase). These line items are initially left blank until
the LBO financing structure is entered into the model (see Step III) and a detailed
debt schedule is built (see Step IV(a)).
EXHIBIT 5.9
Financing Activities
($ in millions, fiscal year ending December 31)
Projection Period
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
2009
2010 2011 2012 2013 2014 2015 2016 2017 2018
Financing Activities
Revolving Credit Facility
Term Loan A
Term Loan B
Term Loan C
Existing Term Loan
2nd Lien
Senior Notes
Senior Subordinated Notes
Other Debt -------- --
Dividends -------- --
Equity Issuance / (Repurchase)
- - - - - - - - --
Cash Flow from Financing Activities -
-
-- -
-
- - --
$79.0Excess Cash for the Period $85.8 $91.4 $95.3 $98.1 $101.1 $104.1 $107.2 $113.8$110.4
Beginning Cash Balance
25.0
104.0
189.8 281.2 376.5 474.6 575.7 679.8 897.5787.0
Ending Cash Balance
$104.0
$189.8 $376.5$281.2
$474.6
$575.7 $679.8 $787.0 $897.5 $1,011.2
Cash Flow Statement
TO BE LINKED FROM DEBT SCHEDULE
Excess Cash for the Period accrues to the Ending Cash
Balance until the LBO financing structure is entered into
the model and the debt schedule is built.
As shown in Exhibit 5.9, prior to giving effect to the LBO transaction, ValueCo’s
projected excess cash for the period accrues to the ending cash balance in each year
of the projection period.
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206 LEVERAGED BUYOUTS
Cash Flow Statement Links to Balance Sheet Once the cash flow statement is built,
the ending cash balance for each year in the projection period is linked to the cash
and cash equivalents line item in the balance sheet, thereby fully linking the financial
statements of the pre-LBO model.
EXHIBIT 5.10
Cash Flow Statement Links to Balance Sheet
($ in millions, fiscal year ending December 31)
Projection Period
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
2009
2010 2011
2012
2013 2014 2015
2016
2017 2018
Excess Cash for the Period $79.0 $85.8 $91.4 $95.3 $98.1 $101.1 $104.1 $107.2 $110.4 $113.8
Beginning Cash Balance 25.0
104.0 189.8 281.2 376.5 474.6 575.7 679.8 787.0 897.5
$281.2 $376.5 $474.6 $575.7 $679.8 $787.0 $897.5 $1,011.2
Projection Period
Pro Forma Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
2008
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Cash and Cash Equivalents $25.0 $104.0 $189.8 $281.2 $376.5 $474.6 $575.7 $679.8 $787.0 $897.5 $1,011.2
Cash Flow Statement
Balance Sheet
= Ending Cash Balance
2009
(from Cash Flow Statement)
Ending Cash Balance $104.0 $189.8
As shown in Exhibit 5.10, in 2009E, ValueCo generates excess cash for the
period of $79 million, which is added to the beginning cash balance of $25 million
to produce an ending cash balance of $104 million. This amount is linked to the
2009E cash and cash equivalents line item on the balance sheet.
At this point in the construction of the LBO model, the balance sheet should bal-
ance (i.e., total assets are equal to the sum of total liabilities and shareholders’ equity)
for each year in the projection period. If this is the case, then the model is functioning
properly and the transaction structure can be entered into the sources and uses.
If the balance sheet does not balance, then the banker must revisit the steps
performed up to this point and correct any input, linking, or calculation errors
that are preventing the model from functioning properly. Common missteps include
depreciation or capex not being properly linked to PP&E or changes in balance sheet
accounts not being properly reflected in the cash flow statement.
STEP III. INPUT TRANSACTION STRUCTURE
EXHIBIT 5.11 Steps to Input the Transaction Structure
Step III(a): Enter Purchase Price Assumptions
Step III(b): Enter Financing Structure into Sources and Uses
Step III(c): Link Sources and Uses to Balance Sheet Adjustments Columns
Step III(a): Enter Purchase Price Assumptions
A purchase price must be assumed for a given target in order to determine the
supporting financing structure (debt and equity).
For the illustrative LBO of ValueCo (a private company), we assumed that a
sponsor is basing its purchase price and financing structure on ValueCo’s LTM
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9/30/08 EBITDA of $146.7 million and a year-end transaction close.
6
We also as-
sumed a purchase multiple of 7.5x LTM EBITDA, which is consistent with the
multiples paid for similar LBO targets (per the illustrative precedent transactions
analysis performed in Chapter 2, see Exhibit 2.33). This results in an enterprise
value of $1,100 million and an implied equity purchase price of $825 million after
subtracting ValueCo’s net debt of $275 million.
EXHIBIT 5.12
Purchase Price Input Section of Assumptions Page 3 (see Exhibit 5.54) –
Multiple of EBITDA
($ in millions)
Public / Private Target 2
7.5xEntry EBITDA Multiple
146.7LTM 9/30/2008 EBITDA
$1,100.0Enterprise Value
Less: Total Debt (300.0)
Less: Preferred Securities -
Less: Noncontrolling Interest -
25.0Plus: Cash and Cash Equivalents
$825.0Equity Purchase Price
Purchase Price
Enter "1" for a public target
Enter "2" for a private target
*
Our LBO model template automatically updates the labels
and calculations for each selection (see Exhibit 5.13)
For a public company, the equity purchase price is calculated by multiplying the
offer price per share by the target’s fully diluted shares outstanding.
7
Net debt is
then added to the equity purchase price to arrive at an implied enterprise value (see
Exhibit 5.13).
EXHIBIT 5.13
Purchase Price Assumptions – Offer Price per Share
($ in millions, except per share data)
Public / Private Target 1
$16.50Offer Price per Share
50.0Fully Diluted Shares Outstanding
$825.0Equity Purchase Price
300.0Plus: Total Debt
Plus: Preferred Securities -
-Plus: Noncontrolling Interest
Less: Cash and Cash Equivalents (25.0)
$1,100.0Enterprise Value
Purchase Price
6
As ValueCo is private, we entered a “2” in the toggle cell for public/private target (see
Exhibit 5.12).
7
In this case, a “1” would be entered in the toggle cell for public/private target (see
Exhibit 5.13).
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208 LEVERAGED BUYOUTS
Step III(b): Enter Financing Structure into Sources and Uses
A sources and uses table is used to summarize the flow of funds required to consum-
mate a transaction. The sources of funds refer to the total capital used to finance an
acquisition. The uses of funds refer to those items funded by the capital sources—in
this case, the purchase of ValueCo’s equity, the repayment of existing debt, and the
payment of transaction fees and expenses. Regardless of the number and type of
components comprising the sources and uses of funds, the sum of the sources of
funds must equal the sum of the uses of funds.
We entered the sources and uses of funds for the multiple financing structures
analyzed for the ValueCo LBO into an assumptions page (see Exhibits 5.14 and
5.54).
EXHIBIT 5.14
Financing Structures Input Section of Assumptions Page 3 (see Exhibit 5.54)
($ in millions)
Structure
54321
Structure 1 Structure 2 Structure 3 Structure 4 Status Quo
Revolving Credit Facility Size $100.0 $100.0 $100.0 - $100.0
Revolving Credit Facility Draw - - 25.0 - -
Term Loan A - 125.0 - - -
Term Loan B 450.0 350.0 350.0 - 425.0
Term Loan C - - - - -
2nd Lien - - - - -
Senior Notes - - 150.0 - -
Senior Subordinated Notes 300.0 300.0 250.0 - 325.0
Equity Contribution 385.0 360.0 385.0 - 410.0
Rollover Equity - - - - -
Cash on Hand 25.0 25.0 - - -
- --- -
Total Sources of Funds $1,160.0 $1,160.0 $1,160.0 - $1,160.0
Equity Purchase Price $825.0 $825.0 $825.0 - $825.0
Repay Existing Bank Debt 300.0 300.0 300.0 - 300.0
Tender / Call Premiums - - - - -
Financing Fees 20.0 20.0 20.0 - 20.0
Other Fees and Expenses 15.0 15.0 15.0 - 15.0
- - - - - -
- - - - - -
- - - - - -
- - - - - -
Total Uses of Funds $1,160.0 $1,160.0 $1,160.0 - $1,160.0
Financing Structures
Sources of Funds
Uses of Funds
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Sources of Funds Structure 1 served as our preliminary proposed financing struc-
ture for the ValueCo LBO. As shown in Exhibit 5.14, it consists of:
$450 million term loan B (“TLB”)
$300 million senior subordinated notes (“notes”)
$385 million equity contribution
$25 million of cash on hand
This preliminary financing structure is comprised of senior secured leverage of
3.1x LTM EBITDA, total leverage of 5.1x, and an equity contribution percentage of
approximately 33% (see Exhibit 5.2).
We also contemplated a $100 million undrawn revolving credit facility (“re-
volver”) as part of the financing. While not an actual source of funding for the
ValueCo LBO, the revolver provides liquidity to fund anticipated seasonal working
capital needs, issuance of letters of credit, and other cash uses at, or post, closing.
Uses of Funds The uses of funds include:
the purchase of ValueCo’s equity for $825 million
the repayment of ValueCo’s existing $300 million term loan
8
the payment of total transaction fees and expenses of $35 million (consisting of
financing fees of $20 million and other fees and expenses of $15 million)
The total sources and uses of funds are $1,160 million, which is $60 million
higher than the implied enterprise value calculated in Exhibit 5.12. This is due to the
payment of $35 million of total fees and expenses and the use of $25 million of cash
on hand as a funding source.
Step III(c): Link Sources and Uses to Balance Sheet Adjustments Columns
Once the sources and uses of funds are entered into the model, each amount is
linked to the appropriate cell in the adjustments columns adjacent to the opening
balance sheet (see Exhibit 5.15). Any goodwill that is created, however, needs to be
calculated on the basis of equity purchase price and existing book value of equity
(see Exhibit 5.20). The equity contribution must also be adjusted to account for any
transaction-related fees and expenses (other than financing fees) that are expensed
upfront.
9
These adjustments serve to bridge the opening balance sheet to the pro
forma closing balance sheet, which forms the basis for projecting the target’s balance
sheet throughout the projection period.
8
In the event the target has debt being refinanced with associated breakage costs (e.g., call or
tender premiums), those expenses are included in the uses of funds.
9
In accordance with FAS 141(R), M&A transaction costs are expensed as incurred. Debt
financing fees, however, continue to be treated as deferred costs and amortized over the life
of the associated debt instruments.
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210 LEVERAGED BUYOUTS
EXHIBIT 5.15 Sources and Uses Links to Balance Sheet
Sources of Funds
Uses of Funds
Revolving Credit Facility - 0.528$ytiuqE oCeulaV esahcruP
Term Loan B 450.0 Repay Existing Debt 300.0
Senior Subordinated Notes 300.0 Financing Fees 20.0
Equity Contribution 385.0 Other Fees and Expenses 15.0
0.52dnaH no hsaC
Total Sources $1,160.0 0.061,1$sesU latoT
Opening Adjustments Pro Forma
2008
+ - 2008
Cash and Cash Equivalents $25.0 (25.0) -
Accounts Receivable 165.0 165.0
Inventories 125.0 125.0
Prepaids and Other Current Assets 10.0
10.0
0.523$stessA tnerruC latoT 0.003$
Property, Plant and Equipment, net 650.0 650.0
Other Assets 75.0 75.0
Deferred Financing Fees - 20.0 20.0
Goodwill and Intangible Assets 175.0
125.0 300.0
0.522,1$stessA latoT 0.543,1$
Accounts Payable 75.0 75.0
Accrued Liabilities 100.0 100.0
Other Current Liabilities 25.0
25.0
0.002$seitilibaiL tnerruC latoT 0.002$
Revolving Credit Facility - -
Term Loan A - -
Term Loan B - 450.0 450.0
Term Loan C - -
Existing Term Loan 300.0 (300.0) -
2nd Lien - -
Senior Notes - -
Senior Subordinated Notes - 300.0 300.0
Other Debt - -
Other Long-Term Liabilities 25.0
25.0
0.525$seitilibaiL latoT 0.579$
Noncontrolling Interest - -
Shareholders' Equity 700.0
370.0 (700.0) 370.0
0.007$ytiuqE 'sredloherahS latoT 0.073$
Total Liabilities and Equity $1,225.0
0.543,1$
000.0000.0kcehC ecnalaB
= $825.0 million - $700.0 million
= Equity Purchase Price
Less: Existing Book Value of Equity
ValueCo's existing equity of $700.0 million
is eliminated through the transaction and
replaced with the sponsor's equity
contribution.
= $385.0 million - $15.0 million
= Equity Contribution - Other Fees and Expenses
($ in millions)
Exhibit 5.16 provides a summary of the transaction adjustments to the opening
balance sheet.
Sources of Funds Links The balance sheet links from the sources of funds to
the adjustments columns are fairly straightforward. Each debt capital source corre-
sponds to a like-named line item on the balance sheet and is linked as an addition
in the appropriate adjustment column. For the equity contribution, however, the
transaction-related fees and expenses must be deducted in the appropriate cell dur-
ing linkage.
Term Loan B, Senior Subordinated Notes, and Equity Contribution As shown in
Exhibit 5.17, in the ValueCo LBO, the new $450 million TLB, $300 million notes,
and $385 million equity contribution ($370 million after deducting $15 million
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EXHIBIT 5.16 Balance Sheet Adjustments
($ in millions)
+ $125 million of Goodwill
–
$25 million of Cash on Hand
+ $20 million of Financing Fees
+ $450 million of Term Loan B
–
$300 million of Existing Term Loan
+ $300 million of Senior Subordinated Notes
+ $385 million Sponsor Equity Contribution
–
$700 million of Existing Shareholders' Equity
–
$15 million of Other Fees and Expenses
Additions
Adjustments
Eliminations
Assets
Liabilities
Shareholders’ Equity
Assets
Liabilities
Shareholders’ Equity
of other fees and expenses) were linked from the sources of funds to their corre-
sponding line items on the balance sheet as an addition under the “+” adjustment
column.
EXHIBIT 5.17
Term Loan B, Senior Subordinated Notes, and Equity Contribution
($ in millions)
Opening Adjustments Pro Forma
2008
+
- 2008
Revolving Credit Facility - -
Term Loan B - 0.0540.054
Existing Term Loan 300.0 300.0
Senior Subordinated Notes - 0.0030.003
Other Long-Term Liabilities 25.0
25.0
0.525$ seitilibaiL latoT 0.572,1$
Noncontrolling Interest - -
Shareholders' Equity 700.0
370.0 1,070.0
Total Shareholders' Equity $700.0 0.070,1$
Total Liabilities and Equity $1,225.0
0.543,2$
Balance Sheet
= $385.0 million - $15.0 million
= Equity Contribution - Other Fees and Expenses
Cash on Hand As shown in Exhibit 5.18, the $25 million use of cash on hand
was linked from the sources of funds as a negative adjustment to the opening cash
balance as it is used as a source of funding.
EXHIBIT 5.18
Cash on Hand
($ in millions)
AdjustmentsOpening Pro Forma
2008
+
-
2008
Cash and Cash Equivalents $25.0 (25.0) -
Balance Sheet
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212 LEVERAGED BUYOUTS
Uses of Funds Links
Purchase ValueCo Equity As shown in Exhibit 5.19, ValueCo’s existing share-
holders’ equity of $700 million, which is included in the $825 million purchase
price, was eliminated as a negative adjustment and replaced by the sponsor’s equity
contribution (less other fees and expenses).
EXHIBIT 5.19
Purchase ValueCo Equity
($ in millions)
AdjustmentsOpening Pro Forma
2008
+ - 2008
Noncontrolling Interest - -
Shareholders' Equity 700.0
370.0 (700.0) 370.0
$700.0 Total Shareholders' Equity
$370.0
Balance Sheet
Goodwill Created Goodwill is created from the excess amount paid for a target
over its existing book value. For the ValueCo LBO, it is calculated as the equity
purchase price of $825 million less book value of $700 million. As shown in Exhibit
5.20, the net value of $125 million is added to the existing goodwill of $175 mil-
lion, summing to total pro forma goodwill of $300 million.
10
The goodwill created
remains on the balance sheet (unamortized) over the life of the investment, but is
tested annually for impairment.
EXHIBIT 5.20
Goodwill Created
($ in millions)
Opening Adjustments Pro Forma
2008
+ -
2008
Property, Plant and Equipment, net 650.0
Equity Purchase Price
650.0
$825.0
Goodwill and Intangible Assets 175.0 125.0
Less: Existing Book Value of Equity
300.0
(700.0)
$125.0 Goodwill Created
175.0Plus: Existing Goodwill
$300.0 Total Goodwill
Balance Sheet
Calculation of Goodwill
10
The allocation of the entire purchase price premium to goodwill is a simplifying assumption
for the purposes of this analysis. In an actual transaction, the excess purchase price over the
existing book value of equity is allocated to assets, such as PP&E and intangibles, as well as
other balance sheet items, to reflect their fair market value at the time of the acquisition. The
remaining excess purchase price is then allocated to goodwill. From a cash flow perspective,
in a stock sale (see Exhibit 6.10), there is no difference between allocating the entire purchase
premium to goodwill as opposed to writing up other assets to fair market value. In an asset sale
(see Exhibit 6.10), however, there are differences in cash flows depending on the allocation of
goodwill to tangible and intangible assets as the write-up is tax deductible.
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Repay Existing Debt ValueCo’s existing $300 million term loan is assumed to be
refinanced as part of the new LBO financing structure, which includes $750 million
of total funded debt. As shown in Exhibit 5.21, this is performed in the model by
linking the repayment of the existing $300 million term loan directly from the uses
of funds as a negative adjustment.
EXHIBIT 5.21
Repay Existing Debt
($ in millions)
Opening Adjustments Pro Forma
2008
+
- 2008
Revolving Credit Facility - -
Term Loan B - 450.0 450.0
Existing Term Loan 300.0 (300.0) -
Balance Sheet
Financing Fees As opposed to M&A transaction-related fees and expenses, financ-
ing fees are a deferred expense and, as such, are not expensed immediately. Therefore,
deferred financing fees are capitalized as an asset on the balance sheet, which means
they are linked from the uses of funds as an addition to the corresponding line item
(see Exhibit 5.22). The financing fees associated with each debt instrument are amor-
tized on a straight line basis over the life of the obligation.
11
As previously discussed,
amortization is a non-cash expense and, therefore, must be added back to net income
in the operating activities section of the model’s cash flow statement in each year of
the projection period.
For the ValueCo LBO, we calculated the financing fees associated with the
contemplated financing structure to be $20 million. Our illustrative calculation is
based on fees of 1.75% for arranging the senior secured credit facilities (the revolver
and TLB), 2.25% for underwriting the notes, 1.00% for committing to a bridge loan
for the notes, and $0.6 million for other financing fees and expenses.
12
The left-lead arranger of a revolving credit facility typically serves as the “Admin-
istrative Agent”
13
and receives an annual administrative agent fee (e.g., $150,000),
which is included in interest expense on the income statement.
14
Other Fees and Expenses Other fees and expenses typically include payments
for services such as M&A advisory (and potentially a sponsor deal fee), legal,
11
Although financing fees are paid in full to the underwriters at transaction close, they are
amortized in accordance with the tenor of the security for accounting purposes. Deferred
financing fees from prior financing transactions are typically expensed when the accompanying
debt is retired and show up as a one-time charge to the target’s net income, thereby reducing
retained earnings and shareholders’ equity.
12
Fees are dependent on the debt instrument, market conditions, and specific situation. The fees
depicted are for illustrative purposes only and indicative of those used during the mid-2000s.
13
The bank that monitors the credit facilities including the tracking of lenders, handling of
interest and principal payments, and associated back-office administrative functions.
14
The fee for the first year of the facility is generally paid to the lead arranger at the close of
the financing.
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214 LEVERAGED BUYOUTS
accounting, and consulting, as well as other miscellaneous deal-related costs. For
the ValueCo LBO, we estimated this amount to be $15 million. Within the con-
text of the LBO sources and uses, this amount is netted upfront against the equity
contribution.
EXHIBIT 5.22
Financing Fees
($ in millions)
Opening Adjustments Pro Forma
2008
+ -
2008
Property, Plant and Equipment, net 650.0 650.0
Goodwill and Intangible Assets 175.0 125.0 300.0
Other Assets 75.0 75.0
Deferred Financing Fees -
20.0
20.0
Total Assets
$1,345.0
$1,225.0
Balance Sheet
Size (%) ($)
Revolving Credit Facility Size $100.0 1.75% $1.8
Term Loan B 450.0 1.75% 7.9
Senior Subordinated Notes 300.0 2.25% 6.8
Senior Subordinated Bridge Facility 300.0 1.00% 3.0
Other Financing Fees & Expenses - - 0.6
Total Financing Fees $20.0
Fees
Calculation of Financing Fees