Think Value

The evaluation of a Leveraged Buyout (LBO) transaction is a rather complex process.

Such transactions involve several key aspects:

• The transaction is typically funded largely through debt.
• Management’s stake increases significantly.
• Focus shifts towards profitability.
• Directorial oversight diminishes notably.

The stages of the evaluation methodology in practice are as follows:

1. Setting the initial purchase price for the LBO – determining how much the acquisition will cost and the associated options (options sometimes close and sometimes not. If closed, it requires additional shares to be added, and their cost must also be determined).
2. Defining the capital structure Post-LBO (see attached photo). This should detail where financing will come from, what types of financing, and under what conditions.
3. Establishing a financial model – Post-LBO operations should be forecasted until the Exit period (several years). This model should include the planned financial structure. Operational parameters for forecasting should be defined, and a balance of future earnings, profit margins, and cash flows should be projected.
4. Scheduling debt repayment – an assessment should be made of how much an organization can afford to borrow based on executed allowances.
5. Evaluation of loan ratings and comparison of capital costs – initially with actual obligations. For example, if it is expected that an unsecured loan will be 12%, how this figure correlates with ratings/risk, reflecting our issued obligations, should be determined.
6. Analysis of obtained results to reconcile forecasts with expected operations and loans. Predicted future cash flows should align with actual ones.
7. Determination of requested IRR by Equity Sponsors and comparison with modeled IRRs. Adjustment of capital structure or acquisition price to match modeled projected figures.
8. Verification of Exit period – at this stage, analysis is conducted to determine when the organization should exit, as different IRRs will apply at different stages.

Additionally, for more accurate analysis after the completion of these stages, two more stages are necessary:

9. Evaluation using the WACC method to verify Exit Multiplier, IRR, and EXIT period. The essence here is that, practically, using the eighth step, the forecasted value of the future, based on fixed multipliers, is obtained. For example, EV/EBITDA. But in reality, such a valuation does not reflect reality, and it is better for an organization to determine its value using a more qualified method.
10. Additional evaluation using the APV method; this method provides interesting information about how the capital’s value and Equity Beta were determined before actual loans from issued obligations.

*Corporate Valuation Theory, Evidence and Practice
Mark E. Zmijewski; Robert W. Holthausen
Second Edition