lbo overview
TRANSCRIPT
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The Art of the LBO
November 2004
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Agenda
I. An Overview of Leveraged Buyouts
II. The Building Blocks
III. Putting It All Together
IV. How It Happens in Reality
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I. An Overview of LeveragedBuyoutsWhat Are LBOs?
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What Is an LBO?
A Leveraged BuyOut is the acquisition of an entire Company ordivision
n Buyer (the Sponsor) raises debt and equity to acquire Target
Borrows majority of purchase price
Contributes proportionately small equity investment
n
Buyer grows Company, improves performance Relies on Companys free cash flow and asset sales to
repay debt
Potentially makes add-on acquisitions
Later sells or IPOs all or a portion of the Company to exitinvestment
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What Is An LBO?Typical Leveraged Buyout Structure
EquityInvestment
PurchasePrice
BanksBondholdersBank
Loan
High Yield
Bonds
NewCo(Merged Into
Target)
Target
Acquiror
(LBO Firm)
Current
Owners
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More Common Than You Think
Silver Lake $2.0bn
TPG, Bain & GS $1.6bn
Madison Dearborn Partners $1.5bn
KKR $1.5bn
THLee $1.1bn
Bain $1.0bn
Blackstone $700mm
Some prominent LBOs:
Company Sponsor Size
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Value of LBO Activity: 1997-2003
$39$43
$81$86
$60
$85 $86
0
20
40
60
80
100
1997 1998 1999 2000 2001 2002 2003
Glo
balAnnounced
Volume
($Billions)
Source: GS F&P, Securities Data Co., Buyouts, Thompson Financial Securities Data
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LBO Analysis An Important Banker Tool
n M&A valuation
Complements other valuation techniques
n Acquisition financing
LBO
Corporate acquisition
Staple-on financing
n Dividend recapitalization
n Straight debt financings
n Complex merger plan analysis
Cash flow impact vs. EPS
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II. The Building BlocksHow Are LBOs Financed?
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The Building BlocksTypes of Acquisition Financing
Bank Debt
(Senior)
High Yield Debt(Subordinated)
Private
Equity
~ 45%
~ 25%
~ 30%
100%
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How Are LBOs Financed?Hypothetical Example
Revolving Credit Facility - 6 Years $ 0.0
Tranche A Senior Term Loan - 6 Years 150.0
Tranche B Senior Term Loan - 8 Years 200.0
Total Senior Secured Debt 350.0 43.8% 2.9x
Senior Subordinated Notes due 2014 200.0
Total Debt 550.0 68.8% 4.6x
Management Rollover Equity 50.0
Sponsor Cash Equity 200.0
Total Equity 250.0 31.3%
Total Capitalization $800.0 100.0% 6.7x
LTM EBITDA = $120.0 million.
Cum. Multiple% of of LTM
($ in mil l ions) 12/31/2003 Capitalization EBITDA
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Ranking in Capital Structure
Cost
Maturity and Amortization
Structure of Coupon or Dividend
Callability and Prepayment
Fees to Underwriters
Ratings
Covenants and Legal Restrictions
Marketing and the Capital-Raising Process
Comparing the Building BlocksHow the Pieces Differ
Investor Base
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Private EquityTerminology
n Most junior money in the capital structure
n Typically no dividends
n Voting control at all times
n Co-investing with other sponsors
n Raised in the alternative investment market
Portion from Sponsor put your money where yourmouth is
Pension funds, endowments, investment portfolios,investment banks, commercial banks, fund of funds
Represents 5% to 10% of investors portfolios
n Net IRRs to LPs are generally 15-25%
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Size of the Private Equity MarketUS Fund Raising Activity
$11.6
$18.4
$23.2
$34.5
$55.4
$34.6
$63.3
$36.9
$17.0
$24.0
$9.9
0
20
40
60
80
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
YTD
($
Billions
)
Source: Buyouts Magazine
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Average LBO Equity Contribution
40.6%40.0%39.4%
7.0%
9.7%
13.4%
20.7%
22.0%25.2%26.2%
23.7%22.9%
30.0%
31.6%
35.7%
37.8%
0
5
10
15
20
25
30
35
40
45%
1987 1988 1989 19901991(a)1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
AverageEquityContribution
toLBOs(%)
0
2
4
6
8
10
12
14
16%
HistoricalSingle
BDefaultRates(%)
(a) No data for 1991Source: Portfolio Management Data and Standard & Poors
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...But Equity Alone Is Not EnoughUsing Leverage to Turbo-Charge Returns
8.8x
7.2x6.7x
5.3x5.0x
5.2x 5.3x 5.2x
5.8x 5.7x5.3x
4.5x4.0x
3.7x 3.8x 4.0x
4.5x
0
1
2
3
4
5
6
7
8
9
10
1987 1988 1989 1990 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
YTD
Average
De
btMu
ltip
leso
fHighlyLeverage
dLoans
(a)
1987
Secon
dQuarter
2004
Total Debt/EBITDA
(a) Criteria: Pre-1996: L+250 and higher; 1996 to date: L+225 and higher; Media and Telecom loans excluded; therewere too few details in 1991 to form a meaningful sample.
Source: Portfolio Management Data.
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How Are LBOs Financed?Hypothetical Example
Revolving Credit Facility - 6 Years $ 0.0
Tranche A Senior Term Loan - 6 Years 150.0
Tranche B Senior Term Loan - 8 Years 200.0
Total Senior Secured Debt 350.0 43.8% 2.9x
Senior Subordinated Notes due 2014 200.0
Total Debt 550.0 68.8% 4.6x
Management Rollover Equity 50.0
Sponsor Cash Equity 200.0
Total Equity 250.0 31.3%
Total Capitalization $800.0 100.0% 6.7x
LTM EBITDA = $120.0 million.
Cum. Multiple% of of LTM
($ in mil l ions) 12/31/2003 Capitalization EBITDA
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Ranking
Interest Rate
Callability
Maturity
Fees to
Underwriters
Ratings
Covenants
Marketing
Process
Leveraged Bank DebtTerminology
Senior secured, most senior debt in the capital structure
Floating, typically LIBOR + 250 bps and higher, quarterly payments
Varies with credit profile, typically 5-8 years, but before more junior debt
Typically prepayable at par
1.75% to 2.25%
Usually BB+ to B+ (rating agencies now rate bank loans)
Maintenance covenants, set out in Credit Agreement
Sold via syndication process and confidential offering memorandum(bank book)
Diligence, commitment, launch, syndicate, fund
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Leveraged Bank DebtTerminology
n Revolving Credit Facilities vs. Term Loans
Revolvers allow multiple drawings (like a credit card)
Term Loans are funded at closing
n Pro Rata Facilities
Consist of Revolvers and A Term Loans (Term Loan A)
Sold to traditional commercial banks
Same LIBOR spread, 5-6 year maturities, even amortization
n Institutional Tranches
Consist of B, C or D Term Loans
Sold to over 100 institutions and funds
Progressively higher spreads, 6-8 year maturities, minimalfront-end amortization
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Leveraged Bank DebtOnly a Subset of the Broader Loan Market
$930 BTotal Loan Market
$329 BLeveraged Loan
Market
$73 BSponsored
Loan
Source: Loan Pricing Gold Sheets, Buyouts Magazine, Standard & Poors - 2003
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Leveraged Bank DebtHistorical Growth in the Market
$329
$265
$216
$185
$243$256
$220
$50
$16
$49
$71
0
50
100
150
200
250
$300
350
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
$billions
Source: Portfolio Management Data 1993-2000; Loan Pricing Corporation 2001-2003
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How Are LBOs Financed?Hypothetical Example
Revolving Credit Facility - 6 Years $ 0.0
Tranche A Senior Term Loan - 6 Years 150.0
Tranche B Senior Term Loan - 8 Years 200.0
Total Senior Secured Debt 350.0 43.8% 2.9x
Senior Subordinated Notes due 2014 200.0
Total Debt 550.0 68.8% 4.6x
Management Rollover Equity 50.0
Sponsor Cash Equity 200.0
Total Equity 250.0 31.3%
Total Capitalization $800.0 100.0% 6.7x
LTM EBITDA = $120.0 million.
Cum. Multiple% of of LTM
($ in mil l ions) 12/31/2003 Capitalization EBITDA
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Ranking
Interest Rate
Callability
Maturity
Fees to
Underwriters
Ratings
Covenants
Marketing
Process
Usually subordinated and/or unsecured
Fixed, expressed as a coupon, varies with credit quality, semiannualpayments
Bullet maturity in 10 years
10NC5 and 35% Equity Clawback now standard
2.5% to 3.0%
Usually B+ to CCC+
Incurrence covenants, governed by the Indenture
Sold via SEC Prospectus / 144A Offering Circular
Diligence, documentation, roadshow, price, fund
High Yield DebtTerminology
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Mezzanine FinancingTerminology
n Structure
Rank / Return / Equity / All-In
n Investors
Mezz buyers in the market
Banks / Other financial institutions
n Issuers Perspective
Leverage equity more; push risk / return profile
Fill hole in cap structure
Disclosure / Size
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LBO Market Activity
n LBO activity continues to be very strong
n Extremely receptive financing markets
Large amount of bank loan refinancings and new CLOs
Substantial cash positions of high yield mutual funds
n Large corporations divesting assets to reduce debt
n Return of the jumbo LBO
n Financial sponsors creating consortiums to cover large equityinvestments and diversify risk
n Although the LBO market is back, sponsors remain disciplined
$7.05 B $4.75 B $4.3 B
III. Putting It All TogetherThe Analysis
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The Five Simple Steps of LBO Analysis
n Step #1: Evaluate the Story
Is this a good debt story?
What are the risks?
What is the real EBITDA?
n Step #2: Construct Sources & Uses
n Step #3: Run the IRRs
n Step #4: Does the LBO work?
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Step #1 Understand the StoryDig a Little Deeper
n Is this a good debt story?
Stability of revenues: Cyclicality? Contracts?Customers? Organic growth?
Margins: Commodity risk? Supplier reliance? Pricing?
Capex: Maintenance vs. discretionary?
Working capital: Seasonality? Overall management?
Management team: Track record? Acquisitions?
n What are potential risks and mitigants?
n Projections
Are they realistic?
How do they compare to historical?
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Step #1 Understand the StoryEBITDA Revisited
n What is the right time period to use?
n Dont take EBITDA at face value look for adjustments
n Common add-backs
Restructuring charges
Non-cash compensation
Asset impairments
Sponsor fees
Money-losing businesses
n Are adjustments really non-recurring?
Look at historical financials
Use common sense
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Step #2 Construct Sources and Uses
Revolving Credit Facility $ 0.0 Purchase Target Equity $ 250.0
Term Loan A 150.0 Refinance Existing Debt 525.0
Term Loan B 200.0 Transaction Costs 25.0
Total Senior Debt 350.0
Senior Subordinated Notes 200.0
Total Debt 550.0
Management Rollover Equity 50.0
Sponsor Cash Equity 200.0
Total Sources $800.0 Total Uses $800.0
Sources Uses
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Step #2 Construct Sources and UsesThe Typical Sources of Funds
n Bank debt (Senior debt)
Start with 2.5x senior leverage
Price term loan @ LIBOR + 3.00%
Use 100% excess cash flow sweep
n Total debt
Start with 4.5x total leverage
Difference between total and bank is high yield debt
Minimum high yield size of $150mm
Price high yield @ 10.00%
n Equity contribution
Minimum 30% contribution
New sponsor cash equity vs. management rollover
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Step #2 Construct Sources and UsesThe Typical Uses of Funds
n Retire existing debt
Existing covenants will typically prohibit post-LBO debtlevels
Dont forget tender/call premiums
n Pay transaction fees & expenses
Bank debt fees: 1.75% to 2.25%
High yield fees: 2.50% to 3.00%
Dont forget legal expenses
n Purchase target equity
Make this the plug to balance Sources & Uses for now
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Step #3 Run the IRRs
n Calculate returns depending on future exit strategy in Years35
n Typical exit analysis contemplates outright sale of company
Make base case exit EBITDA multiple = entry multiple
n Deduct net debt in exit year to compute future equity value
n Allocate equity to owners based on ownership
Financial sponsor vs. management
Exercise of warrants if appropriate
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Step #4 Does the LBO Work?Ask yourself the following questions:
n Do the senior and total debt multiples make sense in thecontext of the overall purchase price multiple?
n Are the coverage ratios adequate?
EBITDA / Interest Expense > 2.00x
(EBITDA - Capex) / Interest Expense > 1.50x
n How is the bank debt amortizing?
Is the bank debt completely repaid by year 7?
n What are the results after running more realistic anddownside cases?
n What are the expected credit ratings?
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Step #4 Does the LBO Work?Iterate Until The LBO Works For All Constituencies
Debt Holders:Feasibility
Equity Holders:Attractiveness
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Step #4 Does the LBO Work?How Does the Implied Valuation Compare?
n Triangulate with Other Enterprise Valuation Techniques
Deal Comps
Common Stock Comps
Other Recent LBOs
n Can a financial sponsor beat a strategic?
Synergy opportunities
Merger plan analysis
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IV. How It Happens In RealityThe Tension between Buyer andSeller
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The Scenario
n An attractive business is up for auction
n Your client is a large private equity player
n Tomorrow is the final bid deadline
n You believe your client is competing vs. a large corporationand other financial sponsors
n The corporate can pay tomorrow in cash
n The seller wants to know youre good for the moneyn Your client wants guidance from you on:
Maximum leverage
Certainty of funds
Financing conditions
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What Does the Seller Want?
n Seller generally wants to maximize selling price
n But not all bids are created equal seller also wantscertainty
How long between signing and closing?
Sponsor generally needs to raise the debt in this period
Compare with corporate buyer with available stock/cash
n Mere promise by buyer to raise the debt is insufficient
n
Seller wants legal commitment
n Although Sponsor has committed financing, the letterstypically have outs that weaken the commitment
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What Can the Buyer Do?
n Buyer must make seller comfortable that the financing risk isminimal by providing committed financing
n Committed financing is usually comprised of a bankcommitment and a bridge commitment
The bank commitment typically represents the senior
secured portion of the capital structure (i.e., Bank Debt)
The bridge commitment typically represents thesubordinated portion of the capital structure (i.e., HighYield)
n Sponsor typically has access from its own funds but checkabsolute dollar size of equity needed
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The Commitment Letters
n The bank and bridge commitments are comprised of fourletters
Commitment letter that covers both facilities
Fee letter for the bank facility
Separate fee letter for the bridge facility
Engagement letter for the take-out of the bridge facility